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Financial position and financial management

Retirement arrangements

We operate two principal occupational pension schemes in the UK, the National Grid UK Pension Scheme and the National Grid Electricity Group of the Electricity Supply Pension Scheme (National Grid Electricity Supply Pension Scheme).

With the exception of the National Grid UK Pension Scheme, which also has a defined contribution section, the above schemes are defined benefit pension schemes, which are closed to new entrants. Membership of the defined contribution section of the National Grid UK Pension Scheme is offered to all new employees in the UK.

We also operate defined benefit pension plans for our US employees. Post-retirement healthcare and life insurance benefits are also provided to qualifying retirees.

Net pension and other post-retirement obligations

Net pension obligations at 31 March 2007 included in the balance sheet were £659 million compared with £1,275 million at 31 March 2006. This comprised the present value of fund obligations of £16,044 million and unfunded obligations of £83 million, less plan assets at fair value of £15,468 million (2006: £16,520 million and £96 million, less £15,341 million respectively).

Net other post-retirement obligations at 31 March 2007 included in the balance sheet were £586 million compared with £640 million at 31 March 2006. This comprised the present value of fund obligations of £1,126 million and other post-employment liabilities of £33 million, less plan assets at fair value of £531 million and unvested benefits of £42 million (2006: £1,223 million and £34 million, less £568 million and £49 million respectively).

The total net pension and other post-retirement obligations of £1,245 million at 31 March 2007 (2006: £1,915 million) is calculated in accordance with IFRS. Net of deferred tax, these obligations amounted to £778 million (2006: £1,518 million).

The decrease of £670 million in the total net pension and other post-retirement obligations during 2006/07 arose from exchange movements of £115 million, actuarial gains of £365 million, expected returns on plan assets less interest on obligations of £57 million and employer contributions of £304 million, offset by a £130 million increase in obligations from service costs and £41 million of other movements.

The above amounts differ from the actuarial valuations used to calculate the amounts we need to pay into pension and other post-retirement pension schemes, details of which are described below.

National Grid UK Pension Scheme

The last completed full actuarial valuation of the National Grid UK Pension Scheme was as at 31 March 2006. This concluded that the pre-tax funding deficit was £371 million (£260 million net of tax) in the defined benefit section on the basis of the funding assumptions adopted by the actuary.

It has been agreed that no funding of the deficit identified in the 2006 actuarial valuation will need to be provided to the scheme until the outcome of an interim actuarial valuation at 31 March 2007 is known, following which we will pay the gross amount of any deficit up to a maximum amount of £520 million (£364 million net of tax) into the scheme. Until the 31 March 2007 actuarial valuation has been completed, we have arranged for banks to provide the trustees of the National Grid UK Pension Scheme with letters of credit. The main conditions under which these letters of credit could be drawn relate to events which would imperil the interests of the scheme, such as National Grid Gas plc, a subsidiary undertaking, becoming insolvent or a failure to make agreed payments into the fund. Employer cash contributions for the ongoing cost of the National Grid UK Pension Scheme are currently being made at a rate of 32.7% of pensionable payroll.

National Grid Electricity Supply Pension Scheme

The actuarial valuation of the National Grid Electricity Supply Pension Scheme at 31 March 2004 was completed during the year ended 31 March 2005 and revealed a pre-tax deficit of £272 million (£190 million net of tax) on the basis of the funding assumptions adopted by the actuary.

It has been agreed that no funding of the deficit identified in the 2004 actuarial valuation will need to be provided to the scheme until the outcome of the actuarial valuation at 31 March 2007 is known. At this point, we will pay the gross amount of any deficit up to a maximum amount of £68 million (£48 million net of tax) into the scheme. Until the 31 March 2007 actuarial valuation has been completed, we have arranged for banks to provide the trustees of the National Grid Electricity Supply Pension Scheme with letters of credit. The main conditions under which these letters of credit could be drawn relate to events which would imperil the interests of the scheme, such as National Grid Electricity Transmission plc, a subsidiary undertaking, becoming insolvent or the failure to make agreed payments into the fund. Employer cash contributions for the ongoing cost of the National Grid Electricity Supply Pension Scheme are currently being made at a rate of 13.1% of pensionable payroll.

National Grid US pension and post-retirement plans

The National Grid USA companies have non-contributory defined benefit pension plans covering substantially all employees. All employees, except union-represented employees hired on or after 15 July 2002 participate in a cash balance pension plan design. Under that design, pay-based credits are applied based on service time, and interest credits are applied based on an average annual 30 year Treasury bond yield. Non-union employees hired by our New England business prior to 15 July 2002 and New England business union employees generally participate in the historic final average pay pension plan designs that have been in effect for several decades. In addition, a large number of employees hired by our New York state business prior to July 1998 are cash balance design participants who receive a larger benefit if so yielded under pre-cash balance conversion final average pay formula provisions. Employees hired by our New York business following the August 1998 cash balance design conversion participate under cash balance design provisions only.

Supplemental non-qualified, non-contributory executive retirement programmes provide additional defined pension benefits for certain executives.

We also provide post-retirement benefits other than pensions. Benefits include health care and life insurance coverage to eligible retired employees. Eligibility is based on certain age and length of service requirements and in some cases retirees must contribute to the cost of their coverage.

In New England, our funding policy is to contribute to the Plans each year the amount required to reach 100% of the Funding Target, under the Pension Protection Act of 2006, by the end of the year 2009. In New York, the funding policy is determined by our settlement agreements with the New York Public Service Commission and the amounts recovered in rates, subject to the minimum contribution required by federal law and a maximum equal to the maximum tax-deductible amount.

We manage our benefit plan investments to minimise the longterm cost of operating the plans, with a reasonable level of risk. Risk tolerance is reviewed based on the results of a periodic asset/liability study. This study includes an analysis of plan liabilities and funded status and results in the determination of the allocation of assets across equity and fixed income. Equity investments are broadly diversified across US and non-US equities, as well as across growth, value, and small and large capitalisation equity. Likewise, the fixed income portfolio is broadly diversified across the various fixed income market segments. For the other post-retirement benefits, since the earnings on a portion of the assets are taxable, those investments are managed to maximise after tax returns consistent with the broad asset class parameters established by the asset allocations. Investment risk and return is reviewed by the investment committee on a quarterly basis.