Defined benefit schemes

The Group operates a number of defined benefit schemes. For the UK defined benefit schemes, the assets are held in separate trustee administered funds and employees are entitled to retirement benefits based on their final salaries and length of service.

Overseas defined benefit schemes are a mixture of funded and unfunded plans. Additionally in the US, and to a lesser extent in some other countries, the Group's employment practices include the provision of healthcare and life insurance benefits for retired employees. These schemes are unfunded.

The valuations of the schemes are based on the most recent funding valuations, updated by the scheme actuaries to December 31, 2006. The most recent funding valuations of the main UK schemes were:

• Rolls-Royce Pension Fund – March 31, 2003
• Rolls-Royce Group Pension Scheme – April 5, 2004
• Vickers Group Pension Scheme – March 31, 2004

The principal actuarial assumptions used at the balance sheet date were as follows:

	2006			2005
	UK schemes %	Overseas schemes %		UK schemes %	Overseas schemes %
1 Benefits accruing after April 5, 2005 are assumed to increase in payment at a rate of 2.3 per cent.
Rate of increase in salaries	4.4	3.6		4.4	3.4
Rate of increase of pensions in payment	2.91	0.2		2.6	0.2
Discount rate	5.1	5.6		4.7	5.3
Expected rate of return on scheme assets	6.6	7.0		6.2	7.0
Inflation assumption	2.9	2.4		2.9	2.6

The mortality assumptions adopted for the UK pension schemes are derived from the PA92 actuarial tables published by the Institute of Actuaries, projected forward and, where appropriate, adjusted to take account of the relevant scheme's actual experience. The resulting range of life expectancies in the principal UK schemes are as follows:

Life expectancy from age 65

Current pensioner	17.5 years to 22.0 years
Future pensioner	19.5 years to 23.9 years

Other demographic assumptions have been set on advice from the relevant actuary, having regard to the latest trends in scheme experience and other relevant data. The assumptions are reviewed and updated as necessary as part of the periodic actuarial valuation of the schemes.

Assumptions in respect of overseas schemes are also set in accordance with advice from local actuaries.

The future costs of healthcare benefits are based on an assumed healthcare costs trend rate of nine per cent grading down to five per cent over seven years.

Amounts recognised in the income statement

	2006				2005
	UK schemes £m	Overseas schemes £m	Total £m		UK schemes £m	Overseas schemes £m	Total £m
Operating cost:
Current service cost	102	28	130		79	22	101
Past service cost	—	2	2		—	8	8
	102	30	132		79	30	109
Financing (income)/costs:
Expected return on assets	(328)	(15)	(343)		(298)	(14)	(312)
Interest on liabilities	310	30	340		295	26	321
	(18)	15	(3)		(3)	12	9
Total income statement charge	84	45	129		76	42	118

The operating cost is charged as follows:

	2006 £m	2005 £m
Cost of sales	93	77
Commercial and administrative costs	30	25
Research and development	9	7

Actuarial gains of £602m (2005 £282m losses) have been reported in the statement of recognised income and expense. Cumulative actuarial gains from January 1, 2004 reported in the statement of recognised income and expense are £313m (2005 £289m losses).

Amounts recognised in the balance sheet

	2006				2005
	UK schemes £m	Overseas schemes £m	Total £m		UK schemes £m	Overseas schemes £m	Total £m
Present value of funded obligations	(6,338)	(271)	(6,609)		(6,661)	(296)	(6,957)
Fair value of scheme assets	5,673	233	5,906		5,343	220	5,563
	(665)	(38)	(703)		(1,318)	(76)	(1,394)
Present value of unfunded obligations	—	(290)	(290)		—	(263)	(263)
Irrecoverable surplus	—	(2)	(2)		—	(2)	(2)
Net liability recognised in the balance sheet	(665)	(330)	(995)		(1,318)	(341)	(1,659)

Changes in present value of defined benefit obligations

	2006				2005
	UK schemes £m	Overseas schemes £m	Total £m		UK schemes £m	Overseas schemes £m	Total £m
At January 1	(6,661)	(559)	(7,220)		(5,688)	(419)	(6,107)
Exchange adjustments	—	65	65		—	(49)	(49)
Current service cost	(102)	(28)	(130)		(79)	(22)	(101)
Past service cost	—	(2)	(2)		—	(8)	(8)
Finance cost	(310)	(30)	(340)		(295)	(26)	(321)
Contributions by employees	(39)	(2)	(41)		(35)	(1)	(36)
Net benefits paid out	279	18	297		253	13	266
Actuarial gains/(losses)	495	(25)	470		(817)	(53)	(870)
Settlements/curtailment	—	2	2		—	6	6
At December 31	(6,338)	(561)	(6,899)		(6,661)	(559)	(7,220)

The defined benefit obligation relating to post-retirement medical benefits would increase by £35m if the healthcare trend rate increases by one per cent, and reduce by £28m if it decreases by one per cent. The pension expense relating to post-retirement medical benefits, comprising service cost and interest cost, would increase by £4m if the healthcare trend increases by one per cent, and reduce by £3m, if it decreases by one per cent.

Changes in fair value of scheme assets

	2006				2005
	UK schemes £m	Overseas schemes £m	Total £m		UK schemes £m	Overseas schemes £m	Total £m
At January 1	5,343	218	5,561		4,527	171	4,698
Exchange adjustments	—	(27)	(27)		—	22	22
Expected return on assets	328	15	343		298	14	312
Contributions by employer	122	31	153		146	31	177
Contributions by employees	39	2	41		35	1	36
Benefits paid out	(279)	(18)	(297)		(253)	(13)	(266)
Actuarial gains/(losses)	120	12	132		590	(2)	588
Settlements/curtailment	—	(2)	(2)		—	(6)	(6)
At December 31	5,673	231	5,904		5,343	218	5,561
Actual return on scheme assets			475				900

The fair value of the scheme assets in the principal schemes and the expected rates of return at December 31 were as follows:

	2006			2005
UK schemes	Expected rate of return %	Market value £m		Expected rate of return %	Market value £m
Equities	7.5	3,876		7.1	3,654
Sovereign debt	4.5	629		4.1	565
Corporate bonds	4.9	1,164		4.5	978
Other	5.0	4		4.3	146
	6.6	5,673		6.2	5,343

	2006			2005
Overseas schemes	Expected rate of return %	Market value £m		Expected rate of return %	Market value £m
Equities	8.3	146		8.6	131
Corporate bonds	4.9	71		4.5	72
Other	5.1	16		4.6	17
	7.0	233		7.0	220

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

The expected rate of return on individual categories of scheme assets are determined by reference to gilt yields. The expectation is that the return from equities and corporate bonds will exceed the return from gilts by three per cent per annum and 0.45 per cent per annum respectively. The overall expected rate of return is calculated by weighting the individual returns expected from each asset class in accordance with the actual asset balance in the schemes' investment portfolios.

History of plans

The history of the plans for the current and prior years is as follows:

Balance sheet

	2006 £m	2005 £m	2004 £m
Present value of defined benefit obligations	(6,899)	(7,220)	(6,107)
Fair value of scheme assets	5,904	5,561	4,698
Deficit	(995)	(1,659)	(1,409)

Experience gains/losses

	2006 £m	2005 £m	2004 £m
Actuarial gains on scheme assets	132	588	126
Experience gains/(losses) on scheme liabilities	470	(870)	(133)
Total amount recognised in the statement of recognised income and expense	602	(282)	(7)

In accordance with the transitional provision amendments to IAS 19 Employee Benefits in December 2004, the disclosures above are determined prospectively from 2004.

The Group expects to contribute approximately £185m to its defined benefit schemes in 2007, excluding any additional amounts contributed to address the deficit as discussed in the Chief Executive's review section.

Defined contribution schemes

The Group operates a number of defined contribution schemes.

The total expense recognised in the income statement was £16m (2005 £14m).