National Grid UK Pension Scheme Defined Benefit Section

pensions update oct 2006 in this issue 2

Chairman’s Report

4

Membership Details

5

Financial Report

6

Funds and Investments

9

News and General Information

13 The Pensions Act 2004 14 Trustees and Pensions Representatives 16 Further Information

chairman’s report

In this update we focus not only on the Scheme’s Annual Report and Financial Statements as we do around this time every year, but also update you with the results of the 2006 Actuarial Valuation by way of an additional update. Once again it has been a busy year for the Scheme, the Trustees and their advisers and 2006/07 promises to be the same. The sale of four of the Gas Distribution Networks was completed on 1 June 2005. As a result of the sales approximately 3,600 members left the Scheme and transferred their benefits to new arrangements. The assets and liabilities in respect of these members were transferred in December 2005. There have been a number of changes to the Trustees on the Trustee Board both during and after the Scheme year end due to a combination of the sale of the Gas Distribution networks and individuals leaving employment. We welcome the new Trustees and extend our thanks to the Trustees who have stepped down from their roles for their hard work and commitment and send them our best wishes for the future. Whilst the Fund slightly underperformed the benchmark investment return set by the Trustees over the last scheme year it is pleasing to report that the Fund has exceeded the benchmark over the previous three and five year periods. The Scheme’s investment strategy has been the subject of ongoing review, further details about the investment policy can be found on page 7 and in the Valuation Update. There have been a number of changes to pensions legislation that have occurred recently most notably the Pensions Act 2004 and the Finance Act 2004. Some Pensions Act 2004 legislation came into effect on 6 April 2005. This included the establishment of a new Pensions Regulator and the Pension Protection Fund, both of which are intended to improve protection for pension scheme members.

2

The Trustees have been reviewing their procedures against the Pensions Regulator’s Codes of Practice as they have been issued and consider that they are currently well-placed in relation to the new legislation. The Pension Protection Fund is funded by a levy on all defined benefit pension schemes. The Company has increased the expenses it pays to the Scheme to cover the estimated cost of the levy. Many of the provisions of the Finance Act 2004 took effect from 6 April 2006, often referred to as ‘A-Day’, and aimed to simplify the taxation of pensions. The main change introduced by the new pension tax rules was the replacement of the old limits with a Lifetime Allowance, which is the maximum tax efficient amount of benefits that any individual can receive from all UK tax favourable pension arrangements, and an Annual Allowance, a tax efficient limit on the value of pension benefits an individual can earn each year. The Trustees’ and company’s approach was to honour existing promises; and to take advantage of the flexibility offered to members under the new rules where this could be provided at a reasonable cost. A number of changes to the scheme rules were made following A-Day. Details of these changes were set out in the April 2006 Pensions Update. Finally thanks are due to the staff at Eastlands who administer the Scheme benefits and to Aerion Fund Management Ltd and also the UK Pensions Department for their hard work and support particularly in the preparation for A-Day.

David R Rees Chairman

3

membership details

31 March 2006

31 March 2005

6,501

11,133

In receipt of pension: Retired Members

55,268

56,062

Dependants

16,701

16,850

433

464

Total

72,402

73,376

Deferred Pensioners

29,376

29,434

108,279

113,943

33,153

34,927

141,432

148,870

Contributing Members

Children

Total Membership Equivalent Pension Benefit* Total Membership

The main change in membership during the year was a decrease in the number of contributing members as a result of approximately 3,600 contributing members leaving service on being transferred as the result of the sale by National Grid Gas of four of its Gas Distribution networks.

*These members received a refund of their contributions on leaving the Scheme, but they are entitled to Equivalent Pension Benefit from the Scheme at State Pension Age,

60,000

because they have been contracted out of

55,000

the State Graduated Scheme.

50,000 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0

4

6,501

11,133

Contributing Members 2006

55,268

56,062

Retired Members 2005

16,701

16,850

Dependants

433

464

Children

29,376

29,434

Deferred Pensioners

financial report

At 31 March 2006 the Fund was

Annualised Returns to 31 March 2006

valued at £12,752.2 million compared to the value as at 31 March 2005, of

% 18

£11,873.2 million, an increase that was

15

primarily the result of a rise in the value of the Scheme’s investments. The Scheme’s performance compared to its benchmark is set out in the adjacent graph.

12 9 6 3 0

1 year Scheme

3 years

5 years

Benchmark

5

funds and investments

Movements in assets for the year ended 31 March 2006 £ million Value of fund at 31 March 2005

11,873.2

Contributions:

126.0

Investment Income:

413.8

Change in the Market Value of Investments: Benefits Paid:

1,556.5 (1,205.2)*

Administrative/Investment Management Expenses: Value of fund at 31 March 2006

(12.1) 12,752.2

*This figure includes an amount of £624.2million in respect of bulk transfers out of the Scheme to other pension arrangements, primarily in connection with the sale of four of the Gas Distribution Networks.

A copy of the Annual Report & Financial Statements is available from Eastlands at the address shown on page 15. Independent Auditors' statement to the Trustees of the National Grid UK Pension Scheme We have examined the summary financial information set out above which is the responsibility of the Trustees. We have agreed to report to you our opinion on its consistency with the full financial statements. In our opinion the summary financial information is consistent with the full financial statements of the National Grid UK Pension Scheme for the year ended 31 March 2006. Our audit opinion on the full financial statements and our statement about contributions were dated 21 September 2006. PricewaterhouseCoopers LLP London 28 September 2006 Chartered Accountants and Registered Auditors

6

funds and investments

Investment Strategy As reported in the November 2005 Pensions Update the Trustees made a

Strategic asset allocation as at 31 March 2006 2.4%

number of changes to their investment strategy including the asset allocation benchmark for property, cash and private equity. Also, during 2005 the Trustees

14.0%

considered the effect that the transfer of contributing members and assets as a result of the sale of four Gas Distribution Networks would have on their

21.8% 7.5%

investment strategy. Having sought advice the Trustees decided to reduce

1.0%

their allocation to equities to 37% (including Private Equity) and proportionately 20.6%

increase their allocation to Bonds. The graph to the right sets out the Trustees’ current strategic asset allocation.

32.7%

As part of the 2006 valuation process the Trustees have agreed a revised investment strategy with the company and this is explained in more detail in the Valuation Update issued with this Pensions Update.

Distribution of investments as at 31 March 2006 2.0%

Distribution of Investments The Fund Managers have made some tactical asset allocation decisions which

13.8%

have resulted in minor changes to the way in which the Scheme’s assets are actually invested. The changes are in keeping with the parameters set out by

19.3% 8.6%

the Trustees in the Statement of Investment Principles.

1.6%

The adjacent chart shows the actual distribution of Investments, as at 31 March 2006.

32.1%

22.6%

Overseas Equities Property Cash UK Equities Fixed Interest Bonds Index Linked Gilts Private Equity

7

funds and investments

The top 5 holdings in each of the fund’s main asset classes as at 31 March 2006 are as follows: Property Investments

Equity Investments Ranking in 2005

£m

£m BP

227.1

(1)

Alvis Retail Park, Coventry

71.3

Royal Dutch

150.1

(-)

Two Rivers Limited Partnership

65.7

GlaxoSmithKline

148.6

(4)

White City Industrial Estate, London

56.2

HSBC

132.8

(3)

65 Curzon Street, London

46.9

Vodafone

123.5

(2)

Henderson UK Retail Warehouse Fund

37.3

Fixed Interest Bonds

Index Linked Bonds

£m Treasury 7.5% 2006

210.8

UK Treasury 2.5% 2016

460.5

Treasury 5% 2025

191.2

UK Treasury 2.5% 2013

411.1

Treasury 8.0% 2021

167.4

UK Treasury 2.5% 2020

404.0

Treasury 4.25% 2032

164.0

UK Treasury 2.5% 2011

297. 4

Treasury 4.25% 2036

160.4

UK Treasury 2.5% 2024

246.3

Further information about the Scheme’s investments is contained in the Statement of Investment Principles which can be obtained from Eastlands.

8

£m

news and general information

Pension Increases The Trust Deed and Rules of the Scheme provide for reviews of pensions in payment and in deferment to take account of movements in the Retail Prices Index (RPI). The Trustees have adopted the Statutory Pensions Increases (Review) Orders and an increase of 2.7% was applied from April 2006. The next review date will be in April 2007 and will be based on the movements in the RPI over the year to September 2006. Please see the notes on pensions increases on the back page of this Update for more information.

Reminders Moving House? It is important to ensure that Eastlands is kept informed about any changes to your address so that you can be contacted about your pension benefits. If you are a contributing member, then Eastlands will be informed about address changes by your payroll department. Letter of Intent: Lump Sum If you are a contributing member, a deferred member or if you retired in the last five years, a lump sum may be payable on your death, at the discretion of the Trustees. To assist the Trustees in exercising their discretion, it is important to complete a Letter of Intent, and to keep it up to date if your circumstances change. Letter of Intent: Dependant’s Pension Similarly, unless you left service or retired before 1 October 1987, you may nominate a Dependant by using a Nomination of Dependant form. If you are married or are in a Civil Partnership, your spouse or Civil Partner will automatically be treated as your Dependant, and you do not need to complete this form. Please contact Eastlands if you would like to update your Letter of Intent. Alternatively, contributing members can print Letters of Intent and Nomination of Dependant’s forms from the Infonet. National Fraud Initiative The Trustees have a duty to protect the Fund. To this end, from time-to-time they may share the information held by the Scheme with other bodies (for example those administering public funds) solely for the prevention and detection of fraud. The Trustees are currently participating (as they have done in the past) in an anti-fraud initiative organised under the Audit Commission Act 1998. Under this initiative details of pensioners and deferred pensioners are provided to the commission so that they can compare the Scheme’s information with that provided by (mainly) public bodies. This helps the Trustees to ensure that pensions are not being paid to persons who are deceased.

9

news and general information

Rule Changes A Deed of Variation was executed on 6 April 2006 introducing a number of changes in the Scheme’s rules, mainly reflecting changes arising out of the Finance Act 2004. Details of these changes were set out in pages 6-10 of the April 2006 Pensions Update. If you would like a further copy of this Update please contact Eastlands. A copy of the Trust Deed and Rules is available from Eastlands on request. Risk Management The Trustees have overall responsibility for risk management. They are committed to identifying, evaluating and managing risk and to implementing and maintaining control procedures to reduce significant risks to an acceptable level. In order to meet this responsibility the Trustees have adopted a risk policy. The objective of this policy is to limit the exposure of the Scheme to business, financial, operational, compliance and other risks where possible. The Trustees of the Scheme have established a Risk Management Committee for this purpose and a Risk Register has also been created. The purpose of the Risk Register is: ■ to highlight the scope of risk to which the Scheme is exposed from the Trustees’ perspective; ■ to rank those risks in terms of likelihood and impact; and ■ to identify management actions that are either currently being taken, or that are believed should be taken, in order to mitigate the identified risks.

10

news and general information

Myners Review In 2001, a Government sponsored review of Institutional Investment, by Paul Myners, set out 10 principles for best practice for UK Pension Fund investment aimed to enhance Trustee decision making. The Government had indicated that although these guidelines are voluntary, they expected trustees to engage with the principles and to disclose their compliance with them. The Trustees remain fully compliant with the Myners Principles other than in the following areas: Payment of Trustees: The Trustees do not consider it is appropriate for Trustees, who are employed by a participating employer, to be paid in addition to their remuneration as employees. Their view is that the participating employers provide sufficient support in terms of time off and training. The Scheme also has a Trustee elected from retired members; this Trustee is not currently paid, but is fully reimbursed for expenses incurred in connection with the Trusteeship and provided with support for training and development. The Trustees will continue to keep this approach under review. Investment Manager mandate not to be terminated for under-performance alone The Trustees consider that the spirit behind the requirement is that trustees should not be short-termist in assessing an investment manager. They fully support this approach and evaluate their investment managers over appropriate timescales. Clear timescales exist for measurement and evaluation. The Trustees do not, however, consider it appropriate to include in the written mandate that it will not be terminated for under-performance alone. This would restrict the options available to the Trustees and they believe that this would not be in the best interest of the beneficiaries.

11

news and general information

Investment Manager mandate and trust deed to incorporate the principle of the US Department of Labor Interpretative bulletin on activism The Trustees have in place a detailed corporate governance and voting policy which is reviewed from time to time to take into account changes in best practice. They do not consider it appropriate to amend Scheme documentation. Statement of Investment Principles The Trustees have in place a comprehensive Statement of Investment Principles (SIP) but do not consider it appropriate to include projections of investment returns within the SIP. The Trustees do not automatically send a copy of the SIP to all members, however the SIP is available on request from the Scheme Secretary. More information regarding compliance with individual Myners principles is available on request from the Scheme Secretary.

12

the pensions act 2004

The Pensions Act 2004 As reported in previous Pension Updates the detail of the Act is contained in a series of regulations and Codes of Practice. The Pensions Regulator is responsible for issuing the Codes of Practice and has stated that they are: ‘... not statements of law and there is no penalty for failing to comply with them. Nevertheless, Codes have legal effect; they must be taken into account by the regulator, a court or tribunal, if they are relevant to what is being decided". The current position in respect of the Codes of Practice (CoP) is: ■ Notifiable Events – In force ■ Reporting Breaches of Legislation – In force ■ Funding Defined Benefits – In force ■ Member Nominated Trustees (MNTs) – In force ■ Trustee’s Knowledge and Understanding (TKU) – In force ■ Internal Disputes Resolution (IDR) – Withdrawn ■ Early Leavers – In force ■ Modification of Subsisting Rights – In force ■ Internal Controls, Drafted – In force ■ Reasonable Periods for the purposes of the Occupational Pension Schemes OPS (Disclosure of Information) Regulations 2006 – Drafted, Consultation closed The Trustees and Scheme Secretariat are working together to implement any changes to policies and procedures where necessary as a result of the new legislation.

13

trustees and pensions representatives

Scheme Representation

UK Pensions Department

Employers’ Trustees:

The UK Pensions Department is based

The current Employers’ Trustees are:

in Warwick at the address shown below. This address should be used

David R Rees (Chairman)

for any correspondence with the

Maggie Hurt

Scheme Secretary. Queries regarding

Andrew Kluth

scheme benefits should continue to

Jonathan Munsey

be addressed to Eastlands in

Mike Calviou

Basingstoke.

Colin Shoesmith The Members’ Trustees are: Terry Merrin

Constituency 1 (Scotland and the North)

Phil Byrne

Constituency 2 (Wales and parts of the West)

Darren Hudson

Constituency 3 (The Midlands)

Dennis Duffy

Constituency 4 (London and part of the East)

Goldie Murray

Constituency 5 (The South and Overseas)

Stanley Edwards

Pensioner Trustee

Since the April 2006 Pensions Update, elections have been held for a Pensions Representative in Constituency 3 and 4. The elections resulted in John Smith replacing John Atkins in Constituency 3 and Joy Pearce replacing Amanda Higgens in Constituency 4. All Trustees, whether appointed by the company or elected by members or pensioners, represent the interests of all classes of beneficiary.

14

The full address is: UK Pensions Department National Grid House Warwick Technology Park Gallows Hill Warwick CV34 6DA

further information

If you have any questions about any of the information contained in this Update, please contact Eastlands on one of the numbers below: Current Employees: 7805 8996 (internal) 01256 308996 (external) Pensioners and Deferred Pensioners: 0345 585 247 (calls charged at local rate)

Alternatively you can write to the following address: Eastlands (Benefits Administration) Ltd PO Box 6666 Basingstoke RG24 4DB Email: [email protected]

15

Notes a Every effort has been made to ensure the accuracy of this publication, however it cannot override any requirements of the Scheme’s Trust Deed and Rules or any legislative requirements. b The Company that sponsors the Scheme is able to withdraw from its commitment to fund increases on pensions by notifying the Trustees of its intentions. Should the Company take such an action, increases on pensions already in payment when it gave notice would be safeguarded. These pensions would continue to be increased to the extent that the funds allowed, in line with the movements in the RPI. Future benefits for employee members, relating to service after notice was given, would also be increased in line with the RPI if the actuary advised that there was sufficient money in the fund to pay for this level of increase. If there was insufficient money in the fund, however, a minimum increase would be paid of RPI subject to a maximum of 5% per annum. At present, pensions are funded on the assumption that they will increase in line with the movements in the RPI.

Issued on behalf of UK Pensions Department Warwick October 2006 Produced by The Clockwork Marketing Company Limited Reigate