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24 Employee benefits

Retirement benefit obligations

The Group operates a number of retirement benefit plans throughout the world, the principal ones being in the UK and US. The major schemes are self-administered with the schemes' assets being held independently of the Group. Retirement benefit costs are assessed in accordance with the advice of independent qualified actuaries. The UK Group scheme is a hybrid scheme with both defined benefit and defined contribution sections but, predominantly, consisting of defined benefit liabilities. There are a number of defined contribution schemes, principally overseas.

The most recent actuarial valuation of the UK Group scheme was completed on 1 January 2004.

The principal assumptions used for the UK Group scheme are shown below. Weighted average assumptions have been shown for the other schemes.

Principal assumptions used for the UK Group scheme

%	2005 UK Group scheme	2005 Other schemes	2004 UK Group scheme	2004 Other schemes	2003 UK Group scheme	2003 Other schemes
Inflation	2.80	2.95	2.80	2.98	2.75	2.98
Expected rate of increase in salaries	4.50	4.43	4.80	4.44	4.75	4.45
Expected rate of increase for pensions in payment and deferred pensions	2.50 to 4.00	-	2.80 to 4.00	-	2.75 to 4.00	-
Rate used to discount scheme liabilities	4.85	5.54	5.40	5.84	5.50	6.11
Expected return on assets	6.40	7.31	6.60	7.23	6.81	7.75

The amounts recognised in the income statement are as follows:

All figures in £ millions	UK Group scheme	Defined benefit other	Sub total	Defined contribution	2005 Total
Current service cost	(25)	(2)	(27)	(35)	(62)
Past service cost	-	-	-	-	-
Curtailments	-	2	2	-	2
Total operating charge	(25)	-	(25)	(35)	(60)
Expected return on plan assets	75	6	81	-	81
Interest on pension scheme liabilities	(79)	(6)	(85)	-	(85)
Net finance charge	(4)	-	(4)	-	(4)
Net income statement charge	(29)	-	(29)	(35)	(64)
Actual return on plan assets	214	7	221	-	221
All figures in £ millions	UK Group scheme	Defined benefit other	Sub total	Defined contribution	2004 Total
Current service cost	(22)	(2)	(24)	(32)	(56)
Past service cost	-	-	-	-	-
Total operating charge	(22)	(2)	(24)	(32)	(56)
Expected return on plan assets	71	6	77	-	77
Interest on pension scheme liabilities	(72)	(6)	(78)	-	(78)
Net finance charge	(1)	-	(1)	-	(1)
Net income statement charge	(23)	(2)	(25)	(32)	(57)
Actual return on plan assets	135	9	144	-	144
All figures in £ millions	UK Group scheme	Defined benefit other	Sub total	Defined contribution	2003 Total
Current service cost	(21)	(2)	(23)	(28)	(51)
Past service cost	-	-	-	-	-
Total operating charge	(21)	(2)	(23)	(28)	(51)
Expected return on plan assets	65	4	69	-	69
Interest on pension scheme liabilities	(67)	(7)	(74)	-	(74)
Net finance charge	(2)	(3)	(5)	-	(5)
Net income statement charge	(23)	(5)	(28)	(28)	(56)
Actual return on plan assets	145	12	157	-	157

The total operating charge is included in administrative and other expenses.

The amounts recognised in the balance sheet are as follows:

The following amounts have been recognised in the statement of recognised income and expense:

All figures in £ millions	2005	2004	2003
Amounts recognised for defined benefit schemes	21	(60)	(25)
Amounts recognised on post-retirement medical benefit schemes	5	(1)	(3)
Total recognised in year	26	(61)	(28)
Cumulative amounts recognised	(63)	(89)	(28)

The fair value of plan assets comprises the following:

%	2005 UK Group scheme	2005 Other funded plans	2005 Total	2004 UK Group scheme	2004 Other funded plans	2004 Total	2003 UK Group scheme	2003 Other funded plans	2003 Total
Equities	47.4	4.3	51.7	49.7	4.2	53.9	50.5	4.2	54.7
Bonds	24.7	2.0	26.7	21.5	2.1	23.6	22.5	2.1	24.6
Properties	8.9	-	8.9	8.9	-	8.9	9.2	-	9.2
Other	11.7	1.0	12.7	13.5	0.1	13.6	11.4	0.1	11.5

The plan assets do not include any of the Group's own financial instruments, nor any property occupied by the Group.

Changes in the values of plan assets and liabilities are as follows:

All figures in £ millions	2005 UK Group scheme	2005 Other	2005 Total	2004 UK Group scheme	2004 Other	2004 Total	2003 UK Group scheme	2003 Other	2003 Total
Fair value of assets
Opening fair value of plan assets	1,198	82	1,280	1,089	75	1,164	974	57	1,031
Exchange differences	-	9	9	-	(5)	(5)	-	(5)	(5)
Expected return on plan assets	75	6	81	71	6	77	65	4	69
Actuarial gains and losses	139	1	140	64	3	67	80	8	88
Contributions by employer	35	10	45	30	9	39	24	9	33
Contributions by employee	6	-	6	6	-	6	6	-	6
Benefits paid	(63)	(6)	(69)	(62)	(6)	(68)	(60)	(6)	(66)
Acquisition through business combination	-	8	8	-	-	-	-	8	8
Closing fair value of plan assets	1,390	110	1,500	1,198	82	1,280	1,089	75	1,164
Present value of defined benefit obligation
Opening defined benefit obligation	(1,502)	(113)	(1,615)	(1,340)	(114)	(1,454)	(1,207)	(96)	(1,303)
Exchange differences	-	(12)	(12)	-	6	6	-	9	9
Current service cost	(25)	(2)	(27)	(22)	(2)	(24)	(21)	(2)	(23)
Curtailment	-	2	2	-	-	-	-	-	-
Interest cost	(79)	(6)	(85)	(72)	(6)	(78)	(67)	(7)	(74)
Contributions by employee	(6)	-	(6)	(6)	-	(6)	(6)	-	(6)
Acquisition through business combination	-	(10)	(10)	-	-	-	-	(10)	(10)
Benefits paid	63	6	69	62	6	68	60	6	66
Actuarial gains and losses	(112)	(7)	(119)	(124)	(3)	(127)	(99)	(14)	(113)
Closing defined benefit obligation	(1,661)	(142)	(1,803)	(1,502)	(113)	(1,615)	(1,340)	(114)	(1,454)

The history of the defined benefit plans is as follows:

All figures in £ millions	2005	2004	2003
Present value of defined benefit obligation	(1,803)	(1,615)	(1,454)
Fair value of plan assets	1,500	1,280	1,164
Net pension liability	(303)	(335)	(290)
Experience adjustments on plan liabilities	(119)	(127)	(113)
Experience adjustments on plan assets	140	67	88

The expected rates of return on categories of plan assets are determined by reference to relevant indices. The overall expected rate of return is calculated by weighting the individual rates in accordance with the anticipated balance in the plan's investment portfolio.

The Group expects to contribute approximately £41m to its defined benefit plans in 2006.

Other post-retirement obligations

The Group operates a number of post-retirement medical benefit schemes, principally in the USA. These plans are unfunded. The method of accounting and the frequency of valuations are similar to those used for defined benefit pension schemes.

The principal assumptions used are shown below:

%	2005	2004	2003
Inflation	3.0	3.0	3.0
Initial rate of increase in healthcare rates	10.0	12.0	12.0
Ultimate rate of increase in healthcare rates	5.0	5.0	5.0
Rate used to discount scheme liabilities	5.6	6.1	6.1

The amounts recognised in the income statement are as follows:

All figures in £ millions	2005	2004	2003
Current service cost	(1)	(1)	(1)
Interest cost	(3)	(4)	(4)
Net income statement charge	(4)	(5)	(5)
The current service cost has been included in administrative and other expenses.
All figures in £ millions	2005	2004	2003
Opening obligation	(58)	(61)	(63)
Exchange differences	(7)	6	6
Current service cost	(1)	(1)	(1)
Interest cost	(3)	(4)	(4)
Benefits paid	4	3	4
Actuarial gains and losses	5	(1)	(3)
Closing obligation	(60)	(58)	(61)

The effect of a one percentage point increase (and decrease) in the assumed medical cost trend rates is as follows:

All figures in £ millions	2005 1% increase	2005 1% decrease	2004 1% increase	2004 1% decrease	2003 1% increase	2003 1% decrease
Effect on:
Aggregate of service cost and interest cost	0.2	(0.2)	0.2	(0.2)	0.3	(0.3)
Defined benefit obligation	4.7	4.1	4.1	(3.7)	4.8	(4.2)

Share-based compensation

The Group recognised the following charges in the income statement in respect of its share-based payment plans:

All figures in £ millions	2005	2004	2003
Pearson plans	13	15	20
IDC plans	10	10	9
Total share-based payment costs	23	25	29

The Group operates the following equity-settled employee option and performance plans:

Profit Sharing Plan - The Group operates a profit sharing plan for all employees, the payment of which is at the discretion of the Pearson board and may be made in cash or Pearson shares.

Save for Shares Plans - Since 1994 the Group has operated a Save-As-You-Earn plan for UK employees. In 1998, the Group introduced a Worldwide Save for Shares Plan. Under these plans, employees can save a portion of their monthly salary over periods of three, five or seven years. At the end of this period, the employee has the option to purchase ordinary shares with the accumulated funds at a purchase price equal to 80% of the market price prevailing at the time of the commencement of the employee's participation in the plan. Options that are not exercised within six months of the third, fifth or seventh anniversary after grant lapse unconditionally.

Employee Stock Purchase Plan - In 2000, the Group established an Employee Stock Purchase Plan which allows all employees in the United States to save a portion of their monthly salary over six month periods. At the end of the period the employee has the option to purchase ADRs with their accumulated funds at a purchase price equal to 85% of the lower of the market price prevailing at the beginning or end of the period.

Executive Share Option Plan - Under this plan, options were granted to senior management at an exercise price equal to the market price of the shares on the date of grant. Options granted prior to 1996 are not subject to performance conditions. The exercise of options granted since 1996 is subject to growth in the Group's adjusted earnings per share over a three year period prior to exercise. Options become exercisable on the third anniversary of the date of grant and lapse if they remain unexercised at the tenth. No new awards will be made under this plan.

Reward Plan - Awards of premium priced options were made under this plan in 1999 and 2000 with an exercise price above the market value of the shares at the grant date. The exercise of options is subject to Pearson's share price remaining above certain thresholds for specified periods of time and to growth in the Group's adjusted earnings per share over the three year period prior to exercise. Options became exercisable on the third anniversary of the date of grant and lapse if they remain unexercised at the tenth. No new awards will be made under this plan.

Special Share Option Plan - In 2000, the Group made a special one-off award of share options with an exercise price equal to the market price of the shares on the grant date. They vested in tranches of 50% on the first anniversary of the date of grant and 25% on the second and third anniversaries of the grant date. Options lapse if they remain unexercised at the tenth anniversary of the grant date. No new awards will be made under this plan.

Long-Term Incentive Plan - This plan was introduced in 2001 and consists of two parts: share options and/or restricted shares.

Options were granted under this plan in 2001 based on a pre-grant earnings per share growth test and are not subject to further performance conditions on exercise. The options became exercisable in tranches and lapse if they remain unexercised at the tenth anniversary of the date of grant.

The vesting of restricted shares is normally dependent upon the satisfaction of corporate performance targets over a three year period. These targets may be based on market and/or non-market performance criteria. Restricted shares granted in 2001 vested based on Pearson's three-year cumulative free cash flow per share performance. Awards made in December 2002 and September 2003 vest in tranches. One sixth of the award vests after three years with no performance conditions. The vesting of the balance depends on Pearson's share price performance over the seven year period following the grants. Restricted shares awarded in December 2004 and September 2005 vest dependent on the following market and non-market performance criteria: relative shareholder return, return on invested capital and a combination of earnings per share and sales growth. The award is split equally across all three measures.

Annual Bonus Share Matching Plan - This plan permits executive directors and senior executives around the Group to invest up to 50% of any after tax annual bonus in Pearson shares. If these shares are held and the Group meets an earnings per share growth target, the Company will match them on a gross basis of up to one share for every one held after three years and another one for two originally held after five years.

The number and weighted average exercise prices of share options granted under the Group's schemes are as follows:

	2005 Number of share options 000s	2005 Weighted average exercise price £	2004 Number of share options 000s	2004 Weighted average exercise price £	2003 Number of share options 000s	2003 Weighted average exercise price £
Outstanding at beginning of year	26,179	5.93	32,284	6.93	35,608	8.84
Granted during the year	606	5.06	886	4.56	2,309	5.16
Exercised during the year	(324)	6.78	(254)	10.10	(89)	10.60
Forfeited during the year	(4,352)	10.42	(6,301)	7.49	(5,053)	16.25
Expired during the year	(432)	-	(436)	-	(491)	-
Outstanding at end of year	21,677	5.05	26,179	5.93	32,284	6.93
Options exercisable at the end of year	7,634	7.80	9,071	9.23	9,882	9.44

Options were exercised regularly throughout the year. The weighted average share price during the year was £6.52 (2004: £6.25; 2003: £5.72). Early exercises are treated as an acceleration of vesting and the remaining charge is recognised at the date of exercise.

The options outstanding at the end of the year have weighted average remaining contractual lives and exercise prices as follows:

Range of exercise prices £	2005 Number of share options 000s	2005 Weighted average contractual life Years	2004 Number of share options 000s	2004 Weighted average contractual life Years	2003 Number of share options 000s	2003 Weighted average contractual life Years
0 - 5	2,773	2.08	3,251	2.97	2,740	3.66
5 - 10	5,555	4.48	6,538	5.44	7,797	6.02
10 - 15	8,237	4.63	9,604	5.57	11,758	6.63
15 - 20	1,168	3.80	1,469	4.81	2,210	5.78
20 - 25	930	3.80	1,346	4.92	2,210	6.02
>25	3,014	4.22	3,971	4.65	5,569	5.79
Total	21,677	4.13	26,179	5.00	32,284	5.99

In 2005, 2004 and 2003 options were granted under the Worldwide Save for Shares Plan. The weighted average estimated fair value for the options granted was calculated using a Black-Scholes option pricing model.

The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows:

	2005 Weighted average	2004 Weighted average	2003 Weighted average
Fair value	£2.34	£2.70	£1.82
Weighted average share price	£6.54	£6.58	£5.15
Weighted average exercise price	£5.08	£4.96	£4.25
Expected volatility	33.69%	41.95%	48.74%
Expected life	3.6 years	3.8 years	4.0 years
Risk free rate	4.48%	4.77%	3.84%
Expected dividend yield	2.40%	2.72%	4.55%
Forfeiture rate	20.0%	21.1%	18.7%

The expected volatility is based on the historic volatility of the Company's share price over the previous 3 - 7 years depending on the vesting term of the options.

During the year the following shares were granted under restricted share arrangements:

	2005 Number of shares 000s	2005 Weighted average fair value £	2004 Number of shares 000s	2004 Weighted average fair value £	2003 Number of shares 000s	2003 Weighted average fair value £
Annual Bonus Share Matching Plan	71	5.57	53	5.42	108	4.36
Long-term Incentive Plan	3,987	5.05	2,413	4.54	1,711	5.21

The fair value of shares awarded under the Annual Bonus Share Matching Plan was determined using a Black-Scholes model. Shares awarded under the Long-Term Incentive Plan were also valued using a Black-Scholes model provided the shares vest unconditionally. The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows:

The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows:

	2005 Weighted average	2004 Weighted average
Fair value	£6.19	£4.54
Weighted average share price	£6.69	£6.13
Weighted average exercise price	-	-
Expected volatility	32.79%	38.39%
Expected life	3.3 years	3.0 years
Risk free rate	4.19%	4.59%
Expected dividend yield	2.35%	4.00%
Forfeiture rate	9.9%	4.5%

In 2003, no restricted shares granted were valued using a Black-Scholes model. The fair value of restricted shares that vest conditionally upon the fulfilment of a market condition were valued by an independent actuary using a Monte Carlo model. Shares with a non-market vesting condition were fair valued based on the share price at the date of grant taking into account any future dividend payments. The performance conditions were considered by adjusting the number of shares expected to vest based on the most likely outcome of the relevant performance criteria.

Subsidiary share option plans

IDC, a 61% subsidiary of the Group, operates the following share-based payment plans:

2001 Employee Stock Purchase Plan In 2001, IDC adopted the 2001 Employee Stock Purchase Plan for all eligible employees worldwide. The 2001 Employee Stock Purchase Plan allows employees to purchase stock at a discounted price at specific times.

2000 Long-Term Incentive Plan Under this plan, the Compensation Committee of the Board of Directors can grant share-based awards representing up to 20% of the total number of shares of common stock outstanding at the date of grant. The plan provides for the discretionary issuance of share-base awards to directors, officers and employees of IDC, as well as persons who provide consulting or other services to IDC. The exercise price for all options granted to date has been equal to the market price of the underlying shares at the date of grant. Options expire ten years from the date of grant and generally vest over a three to four year period without any performance criteria attached.

In addition, grants of restricted stock can be made to certain executives and members of the Board of Directors of IDC. The awarded shares are available for distribution, at no cost, at the end of a three-year vesting period. No performance criteria are attached to shares granted under this plan.

The number and weighted average exercise prices of share options granted under the 2000 Long-Term Incentive Plan is as follows:

The options outstanding at the end of the year have a weighted average remaining contractual life and exercise price as follows:

Range of exercise prices £	2005 Number of share options 000s	2005 Weighted average contractual life Years	2004 Number of share options 000s	2004 Weighted average contractual life Years	2003 Number of share options 000s	2003 Weighted average contractual life Years
0 - 4.4	33	4.2	64	4.3	143	6.1
4.4 - 7.5	206	3.6	287	4.5	499	5.0
7.5 - 12	2,685	5.3	3,398	6.3	4,117	7.3
12 - 20	5,243	7.4	6,083	8.4	4,599	8.8
> 20	1,901	9.5	-	-	-	-
	10,068	5.4	9,832	7.5	9,358	7.9

During the year IDC granted the following shares under restricted share arrangements:

Shares awarded under the 2000 Long-Term Incentive Plan were valued based on the share price prevailing at the date of grant. The fair value of the options granted under the Long-Term Incentive Plan and of the shares awarded under the 2001 Employee Stock Purchase Plan was estimated using a Black-Scholes model. The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows:

The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows:

	Long-Term Incentive Plan			Employee Stock Purchase Plan
	2005 Weighted average	2004 Weighted average	2003 Weighted average	2005 Weighted average	2004 Weighted average	2003 Weighted average
Fair value	$5.56	$7.50	$8.09	$3.68	$3.24	$2.64
Weighted average share price	$21.38	$17.48	$16.40	$15.46	$14.48	$11.24
Weighted average exercise price	$21.38	$17.48	$16.40	$15.46	$14.48	$11.24
Expected volatility	24.50%	32.20%	61.10%	20.00%	20.00%	25.00%
Expected life	4.0 years	4.0 years	4.0 years	0.5 years	0.5 years	0.5 years
Risk free rate	3.86%	3.45%	2.00%	2.33%	1.03%	1.20%
Expected dividend yield	0.0%	0.0%	0.0%	0.0%	0.0%	0.0%
Forfeiture rate	0.0%	0.0%	0.0%	0.0%	0.0%	0.0%

The expected volatility is based on the historic volatility of IDC's share price over the vesting term of the options.

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