GROUP PENSION SCHEME ANNUAL REPORT AND FINANCIAL STATEMENTS V:\HGPS\HGPS RA2004.doc

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1 GROUP PENSION SCHEME ANNUAL REPORT AND FINANCIAL STATEMENTS 2004 V:\HGPS\HGPS RA2004.doc

2 ANNUAL REPORT AND FINANCIAL STATEMENTS 2004 TRUSTEES C R Green (Chairman) C C Hartridge- Price A J Martin J F Searing G M Slough C Woodley SECRETARY C J Symonds SPONSORING EMPLOYERS Hermes Pensions Management Limited and BT Pension Scheme Trustees ACTUARY Mrs J Dingle Watson Wyatt LLP INDEPENDENT AUDITORS Deloitte & Touche LLP LEGAL ADVISERS Sacker & Partners LLP BANKERS The Royal Bank of Scotland plc PENSIONS ADMINISTRATORS SBJ Benefit Consultants ACCOUNTANTS AND INVESTMENT ADMINISTRATORS Hermes Administration Services Limited INVESTMENT MANAGER Hermes Investment Management Limited CUSTODIAN JPMorgan Chase Bank The particulars on this page are as at 31 December Carol Woodley was appointed as a Trustee on 21 December Sacker & Partners LLP replaced Sacker & Partners as legal advisers on 31 December Pension Scheme Registry Number: V:\HGPS\HGPS RA2004.doc

3 CONTENTS TRUSTEES MISSION STATEMENT 1 CHAIRMAN S STATEMENT 2 TRUSTEES REPORT 3 ACTUARIAL STATEMENTS AND CERTIFICATE 18 SCHEDULE OF CONTRIBUTIONS 22 FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER STATEMENT OF TRUSTEES RESPONSIBILITIES 24 INDEPENDENT AUDITORS REPORT 25 INDEPENDENT AUDITORS STATEMENT ABOUT CONTRIBUTIONS 27 FUND ACCOUNT 29 NET ASSETS STATEMENT 30 STATEMENT OF CHANGE IN MARKET VALUE OF ASSETS 31 NOTES TO THE ACCOUNTS 32 APPENDIX 1 TRUSTEE ARRANGEMENTS 38 V:\HGPS\HGPS RA2004.doc

4 TRUSTEES MISSION STATEMENT The Trustees mission is to manage the Scheme efficiently in the interests of the members, to provide the expected benefits, and to ensure that an excellent quality of service is given to those members. V:\HGPS\HGPS RA2004.doc 1

5 CHAIRMAN S STATEMENT 2004 was both a busy year for the Trustees and one which produced excellent returns and a good investment performance for our Members. Taking account of new contributions and an increase in market values, the Scheme s assets increased in value by 20% and were at the year end valued at million. We outperformed both our benchmark and our peer group in Over the 5 year period to 2004 the Scheme s return exceeded the benchmark and equalled its peer group. We should pay tribute to the Advisers and Managers in Hermes who have enabled us to achieve this creditable performance. We were delighted to welcome as an additional Independent Trustee, Carol Woodley. She brings a wealth of actuarial experience, (something the Trustees had identified as an area we would benefit from having among the Trustee body), as well as pensions expertise. The Actuarial Valuation as at 31 December 2003 was completed during the year. It revealed a reduced funding deficit from the previous actuarial valuation, and the employers have been able to reduce both the ongoing contribution rate and the additional contributions required to clear the deficit. This was largely due to the employers change of policy on Pensionable Salary increases from 1 April We have made some significant adjustments to our investment strategy as outlined in the Trustees Report. In aggregate we believe they will reduce slightly the volatility of the investment returns while, we hope, continuing to produce good positive returns in the long term. We introduced an Audit Committee to increase the oversight of the financial aspects of the Scheme. We also launched a website on the Hermes intranet for our members to have access to a wealth of information about their pension scheme. We hope this year to find a means to make this accessible to Members who are no longer Hermes employees Looking forward, we can expect to spend considerable time getting to grips with the new pensions legislation introduced last year, which is being implemented over the next year or so. I would like to thank my fellow Trustees who have put in a tremendous amount of time and effort to making this such a successful year. COLIN GREEN V:\HGPS\HGPS RA2004.doc 2

6 TRUSTEES REPORT The Trustees are pleased to present the report of the Hermes Group Pension Scheme (HGPS) for the year ended 31 December The Scheme was set up by the Principal Employers, Hermes Pensions Management Limited (Hermes) and the Trustees of the BT Pension Scheme, by a Deed made on 16 September Members of the Scheme are contracted out of the State Second Pension (S2P). The Scheme is treated as an exempt approved scheme by Inland Revenue for taxation purposes. The Scheme is a defined benefit pension scheme. THE TRUST DEED The Trust Deed of the Scheme was executed on 16 September On 21 December 2004, the Trustees and Principal Employers executed a Deed of Amendment to amend the Trust Deed. The main amendment was to allow the appointment, from time to time, of a sixth Trustee. The additional Trustee will be independent, in that they will not be a member of HGPS or an employee or exemployee of any employer participating in the Scheme. An additional Trustee, Mrs Carol Woodley, has now been appointed (see page 4). The opportunity was also taken to make two minor clarificatory changes to the Rules in the Trust Deed regarding Inland Revenue limits on pension benefits. The changes made explicit some overriding Inland Revenue requirements that were previously implicit and have not affected any member s benefits. OVERVIEW OF THE YEAR 2.7 million of net new money was added to the Scheme in The value of investments increased by 4.1 million taking the value of the Scheme at the end of 2004 to 40.2 million. The scheme earned a return of 12.6 % overall in the year ended 31 December million Total Assets at Market Value V:\HGPS\HGPS RA2004.doc 3

7 TRUSTEES A list of the current Trustees is shown at the beginning of the report. The Chairman is Colin Green. Two of the Trustees, John Searing and Andrew Martin, are member-nominated trustees. Two of the Trustees, Colin Hartridge-Price and Graham Slough are nominated by the employers. Carol Woodley was appointed as an additional independent Trustee on 21 December When HGPS was established, the arrangements for appointing Trustees were approved by the membership. In October 2004 a letter was sent to all the members explaining a proposal to introduce some flexibility to the arrangements. In particular, it was felt that it would be helpful if an additional independent Trustee could be appointed from time to time, so that there would be six Trustees. HGPS Trustees normally serve a maximum of two terms of office, but a Trustee may now serve a third term if the Principal Employers and the other Trustees agree. A membernominated Trustee would also have to seek re-election by the active members. It is not intended that all the Trustees serve three terms of office. Instead, reappointments will be dealt with on a case-by-case basis. If 10% or more of members had objected to the proposals, either a ballot would have been held requiring a simple majority, or the arrangements would have been reviewed. In fact, only two members objected to the proposals, and so they have been implemented. The Trust Deed was amended accordingly (see page 3) and Carol Woodley was appointed as an additional Trustee. The Trustee arrangements are set out in more detail in Appendix 1. The Trustees normally meet quarterly but sometimes have additional meetings. In 2004 they had eight meetings. The Trustees have a calendar of business which enables them to determine investment policy and monitor the performance of all aspects of the Scheme. APPOINTMENT OF ADVISERS The Trustees have appointed the persons or organisations shown at the beginning of the report to act on behalf of the Scheme. On 31 December 2004 the Trustees legal advisers, Sacker & Partners, became a Limited Liability Partnership and the Trustees have signed a new appointment letter with them. This has limited the liability of the firm and its staff to HGPS. Hermes Investment Management Limited, which is a wholly owned subsidiary of Hermes Pensions Management Limited, is the Scheme s Investment Adviser and Manager. The Trustees have set objectives and constraints for the Investment Manager, who has full discretion to act within these policies. At 31 December 2004 a significant part of the Scheme s assets was invested in a long-term unitised insurance policy with Hermes Assured Limited (see Note 6 to the Accounts), a subsidiary of Hermes Pensions Management Limited. The Scheme pays some fees in respect of the insurance policy and also incurs charges in respect of the Hermes UK Focus Fund, but otherwise the Hermes Group does not receive fees for managing the Scheme s investments. The auditors, Deloitte & Touche LLP, do not provide any non-audit work for the Scheme. However, they do undertake substantial audit and non-audit work for the Principal Employers, Hermes Pensions Management Limited and the Trustees of the BT Pension Scheme. V:\HGPS\HGPS RA2004.doc 4

8 SCHEME ADMINISTRATION SBJ Benefit Consultants Limited maintains the membership records of the Scheme, calculates benefits, and deals with other administrative matters. The payment of pensions is still dealt with by the Hermes HR Department. The administrator's full address is: SBJ Benefit Consultants Ltd Manor House 1 The Crescent Leatherhead Surrey KT22 8DH Telephone number: Fax number: The Trustees review all service providers on a regular basis. Early in 2005, the Trustees commenced a review of the pensions administrators. Members will be advised if there is any change to the present arrangements. MEMBERS AND BENEFICIARIES Hermes employees have the option of joining the Scheme, or making their own pension arrangements. Hermes policy is to require employees to positively opt out of membership of the Scheme and this appears to be effective in reducing the number of non-joiners. PENSIONERS Number of pensioners at 1 January Deferred pensions brought in to payment 2 Retirements during year 5 Death in retirement (1) Spouse s/dependant s pensions brought in to payment 1 Number of pensioners at 31 December DEFERRED PENSIONERS Number of deferred pensioners at 1 January Deferred pensions brought in to payment (2) Transfer to other schemes - Refund of contributions (4) New deferred pensions during year 21 Number of deferred pensioners at 31 December ACTIVE MEMBERS Number of active members at 1 January New members during year 50 Members leaving service during year (36) Number of active members at 31 December V:\HGPS\HGPS RA2004.doc 5

9 ACTUARIAL VALUATION Members pay a contribution to the Scheme of 5% of their basic annual pensionable salary. The employers pay the balance of the costs of the Scheme. After the Scheme Actuary carried out a full valuation of the Scheme as at 31 December 2003 she issued a report to the Trustees on 2 July 2004, and a 10 year schedule of contributions was agreed by the Trustees and employers on 5 July The outcome of the valuation was that on an ongoing basis there was a deficit of assets, compared with the amount needed to cover the cost of the benefits earned up to 31 December 2003, of 1.27 million. The funding level was 96% using the Actuary s assumptions compared to 93% at the previous valuation as at 31 December On the Minimum Funding Requirement (MFR) valuation basis the funding level was 99% at the end of The Actuary reported that the long-term rate of employers contributions required to cover the accrual of future service (including an allowance for administrative expenses) is 12.7% of current members Contributory Pay. In order to remove the deficit over the future working life of the current active members (15 years) the employers need to pay additional contributions of 0.8% of Contributory Pay. The employers also agreed to pay further contributions of 0.3% of Contributory Pay in respect of a redundancy case after the valuation date. This contribution is sufficient to meet the additional liability arising from the redundancy over a period of ten years. Therefore the total required employers contribution rate is 13.8% of Contributory Pay. The Actuary s statements on the funding position are on pages This would have enabled the employers contributions to reduce from a rate of 18.5% to 13.8% of Contributory Pay from 1 July In fact, the employers continued to pay at a rate of 18.5% of Contributory Pay until 31 December 2004 and the extra contributions are shown as special contributions in Note 2 to the accounts (page 33). The principal reason for the reduction in the employers contribution rate was the employers new pensionable salary policy (see below). Previously, the Actuary assumed that pensionable salaries would rise each year at a rate higher than the inflation rate. However, at the 2003 valuation she assumed that pensionable salaries would rise in line with inflation, although she also assumed there will still be additional increases for promotions and anomalies. A copy of the schedule of contributions is on page 22 and the Actuary s latest certificate confirming its adequacy for MFR purposes is on page 21. EMPLOYERS NEW PENSIONABLE SALARY POLICY As noted in the Trustees Report last year, towards the end of 2003 Hermes advised the Trustees that it intended to introduce a change to its salary policy for employees. The change was that increases to individuals pensionable salaries, on which members benefits and contributions are based, would be capped at the rate of inflation. Some people would receive non-pensionable salary supplements. However, promotion increases, including anomalies, would still be included in pensionable salaries. The change was implemented on 1 April 2004 and employees were advised accordingly. V:\HGPS\HGPS RA2004.doc 6

10 As this was effectively a change to the way Hermes pays salaries it did not have to seek the Trustees agreement and the change was introduced without any amendment to the HGPS Trust Deed being necessary. The employers said they hope that if the Scheme s funding situation improves they could go back to ensuring that all salary increases of whatever nature could be fully pensionable. The Trustees asked the employers to consider making a firmer commitment as to what would happen to the non-pensionable supplement if the Scheme moves into surplus, but no firmer commitment has been forthcoming. It should be emphasised that this change does not affect the benefits of any member who was in receipt of a pension or became entitled to a deferred pension before 1 April BENEFITS, PENSION INCREASES AND TRANSFERS All benefits are funded. Pensions and deferred pensions for those members of the Scheme who had previously been members of the Hermes Pension Scheme are increased in April each year in line with the rise in the Retail Price Index. The increase for 2004 was 2.8%, based on the increase in the Retail Price Index from September 2002 to September The increase for 2005 is 3.1% based on the increase in the Retail Price Index from September 2003 to September Pensions and deferred pensions for those members of the Scheme who had not previously been members of the Hermes Pension Scheme are increased in line with the rise in the Retail Price Index, up to a maximum of 5% per annum. The increase for these members was also 2.8% for 2004 and 3.1% for Transfers into and out of the Scheme are made on terms determined by the Actuary under the Rules of the Scheme. Transfer values represent fair value in relation to the alternative benefits payable. No allowance is made for any discretionary increases to pensions. Lump sum death benefits for active members of the Scheme are insured under a Group Policy with Legal & General Assurance Society Ltd. BENEFIT STATEMENTS Pensioners and deferred pensioners are advised annually of the increase to their benefits. A benefit statement showing benefits as at 1 April 2004 was sent to each active member in July AUDIT COMMITTEE To improve the Trustees oversight of financial controls, at the end of 2003 the Trustees agreed to establish an Audit Committee consisting of three Trustees, Mr Green, Mr Hartridge-Price and Mr Searing. Mrs Woodley has also joined the Committee following her appointment as a Trustee on 21 December V:\HGPS\HGPS RA2004.doc 7

11 The Committee will generally meet twice each year. The Committee has had meetings in May 2004 and January The Committee considers the Annual Report and Financial Statements before it is finally approved by the Trustees, and meets with the external auditors and Hermes management. The Committee will regularly consider a number of areas of the Scheme s operations including financial control and the effectiveness of the audit process, and make recommendations to the full Trustee board where necessary. At the January 2005 meeting, the Committee discussed with the external auditors, Deloitte & Touche LLP, their engagement letter, their independence, audit fees and the annual audit plan. STATEMENT OF INVESTMENT PRINCIPLES In compliance with the Pensions Act 1995, the Trustees maintain a Statement of Investment Principles (SIP), which sets out their policy for investing the assets of the Scheme. In 2004 and early 2005 the Trustees and Employers discussed some changes, in particular following the review of the strategic asset mix (see page 9). As a result a revised SIP was signed in May 2005, but the Trustees were already following its provisions during Any member of the Scheme who would like a copy of the SIP should contact Mr C J Symonds, the Scheme Secretary, at the address on page 17. A copy is also available on the HGPS intranet site. For a number of years the Trustees have maintained detailed objectives and constraints for investing the Scheme s assets, and these are additional to the SIP. The objectives and constraints are reviewed and amended from time to time. The Trustees have not made any investments which are not consistent with the SIP, nor have they made any employer-related investments or loans. INVESTMENT MECHANISM Most of the Scheme's equity assets are held in pooled unitised index-tracking funds. With the exception of the Emerging Markets fund (which is operated by State Street), these funds have been operated by Hermes Assured Limited. Exposure to the Hermes Assured index-tracking funds is obtained via a unitised insurance policy whose value is determined by the performance of the underlying funds. The Scheme has continued to invest in the following Hermes Assured Funds: UK Index Tracker European (ex-uk) Index Tracker US Index Tracker Japanese Index Tracker Pacific (ex-japan) Index Tracker. In 2004 the Trustees also made a new investment of some 960,000 in the Hermes Assured UK Corporate Bonds Fund. The value of the unitised insurance policy at 31 December 2004 was 30.6 million. While it is correct for accounting purposes to treat the unitised insurance policy in the accounts as the Scheme's asset, the Trustees nevertheless consider that for asset- V:\HGPS\HGPS RA2004.doc 8

12 mix purposes the values of the underlying funds should be used to determine sector exposure and the tables and charts which follow have been drawn up on that basis. On 1 July 2004 the Trustees made an investment of 500,000 in the Hermes UK Focus Fund, which is a pooled investment vehicle. It invests in a small number of UK companies that have consistently underperformed their peers as a result of structural or strategic governance weaknesses that could be remedied by active shareholder involvement. The fund has a good record of outperforming the FTSE All-Share Index, even after deducting costs, and the Trustees believed that this relatively small amount of active equities investment would be beneficial for investment returns (see the Asset Mix section below). Hermes Investment Management Limited is the investment manager for the Hermes Assured index-tracking funds. Hermes Focus Asset Management Limited manages the Hermes UK Focus Fund. Exposure to fixed interest and index-linked gilts is by direct investment. Exposure to property is via the Hermes Property Unit Trust (HPUT). HPUT is managed by Hermes Property Asset Management Limited. It is a balanced fund providing exposure to all sectors of the commercial property market. This is an efficient means of investing indirectly in property for small pension schemes. ASSET MIX The Trustees set targets for the Scheme s long term strategic asset mix. The strategic asset mix as at 31 December 2004 is shown on page 11. The Trustees reviewed the strategic asset mix with their advisers during 2003 and It included an allocation of 85.5% to equities in the UK and overseas. This had been the case for some years. In the long term equities are expected to produce better returns than other major asset classes, although returns from equities are volatile from year to year. To date the Trustees and employers have been comfortable with the volatility in the investment returns as the Scheme is fairly immature i.e. there are relatively few pensioners compared to the active members who are not yet entitled to their benefits. This means that the Scheme s income far exceeds outgoings at present. However, as noted in the Trustees Report last year, after the review the Trustees decided to effect a small reduction in the exposure to equities and they agreed to reduce it from a total of 85.5% to 80%. It was also agreed that the allocation to equities should be changed to a 50/50 split between the UK and overseas. The Trustees also considered the full range of asset classes available to pension schemes, including alternative asset classes such as private equity and hedge funds. They have considered the views of the consultants, Watson Wyatt LLP, the employers, Hermes Investment Management Limited (the investment manager) and an external investment company. The conclusion was that the reduction in the equities allocation (5.5%) should be switched to fixed interest bonds (2.75% in gilts and 2.75% in corporate bonds) to reduce overall risk, since bonds are expected to produce less volatile returns than equities. No investments in alternative asset classes were made, but this will be reviewed from time to time. V:\HGPS\HGPS RA2004.doc 9

13 The Trustees also agreed to introduce a small element of active management to the UK equities assets and this was achieved when the investment was made in the Hermes UK Focus Fund on 1 July Returns from this Fund are expected to be better than index returns, but also more volatile. The switch between UK and overseas equities was implemented on a gradual basis from January to December The switch from equities to fixed interest bonds was implemented in the second half of the year. Despite the introduction of some active UK equities management, during 2004 the Scheme s overall risk reduced slightly and so total returns are expected to be a little less volatile. V:\HGPS\HGPS RA2004.doc 10

14 The strategic asset mix as at 31 December 2004 was as follows. Strategic Asset Mix % UK equities Overseas Equities Property Unit Trusts Index Linked Fixed Interest The Trustees have authorised the Investment Manager to make short term tactical shifts in asset allocation within defined ranges around the strategic asset mix. The Scheme s actual asset mixes at 1 January 2004 and 31 December 2004 are shown below: 1 January 2004 % UK equities Overseas Equities Property Unit Trusts Index Linked Cash and AVC Funds 31 December 2004 % UK equities Overseas Equities Property Unit Trusts Index Linked Cash and AVC Funds Fixed Interest V:\HGPS\HGPS RA2004.doc 11

15 INVESTMENT DURING THE YEAR The net investment during the year was as follows: million UK Equities (7.0) Overseas Equities 7.2 UK Property Unit Trusts 0.5 UK Index Linked Investments 0.3 UK Fixed Interest 1.8 Deposits and AVCs (0.3) 2.6 INVESTMENT PORTFOLIO AT 31 DECEMBER 2004 The breakdown of the investment portfolio at 31 December 2004 is shown in the following table. UK Equities million million Hermes Assured Unitised Insurance Policy 15.4 Hermes UK Focus Fund Overseas Equities Hermes Assured Unitised Insurance Policy 14.2 State Street Emerging Markets Fund UK Property Unit Trusts 3.9 Index Linked UK Government Securities 2.0 Fixed Interest UK Government Securities 0.9 Hermes Assured UK Corporate Bond Fund 1.0 Deposits, Bank Balances and AVC Funds V:\HGPS\HGPS RA2004.doc 12

16 The amount invested in overseas equities at 31 December 2004 was as follows: million % of total investments North America Europe Japan Pacific Basin (ex Japan) Emerging Markets The Scheme does not hold any employer-related investments. INVESTMENT MANAGER S REPORT FOR THE YEAR 2004 was a good year for the Scheme, with all asset classes producing returns well in excess of inflation. Property was the best performer, followed by equities, particularly in the UK. Net investment during the year was driven by the successive changes to the longterm strategic asset mix. Over the year there was a phased switch from UK equities into overseas equities, such that the scheme s equity exposure is now equally split between the UK and overseas markets. In addition to reducing the scheme s dependence on the UK market, this move also reduces its exposure to any one stock. During the second half equity exposure overall was reduced and bond weightings increased by 5.5%, diversifying the strategic mix by incorporating firstly Corporate bonds and then Conventional bonds for the first time. In July the scheme reintroduced an element of active management into its essentially passive equity strategy by investing 500,000 into the Hermes UK Focus Fund, an activist fund which aims to beat the market by engaging with the management of the companies in which it invests in order to improve their performance. INVESTMENT PERFORMANCE The Scheme s performance is measured by the WM Company, which also provides information comparing the Scheme s performance with that of a benchmark and other pension schemes. V:\HGPS\HGPS RA2004.doc 13

17 The benchmark return is obtained by combining the strategic asset allocation of the Scheme with the asset class returns of the WM universe of pension funds with assets of 10 million- 50 million. The following table shows the Scheme s rate of return for the year ended 31 December 2004, and also the market returns for the major classes of asset in which the Scheme was invested: The Scheme 12.6 Market Indices UK Equities (FTSE Actuaries All Share Index) 12.8 Overseas Equities (FT/S&P Actuaries World ex UK) 7.8 Rate of Return % Index Linked (FTSE Actuaries Index Linked over 5 years) 9.0 Property (IPD Universe Benchmark) 18.0 During the year, the Retail Price Index increased by 3.5%. The Scheme s performance in the last five years is shown in the following table: COMPARISON WITH BENCHMARK AND WM AVERAGE (FUNDS MILLION) Annual Rate of Return (%) to 2004 HGPS Benchmark WM Average, funds with assets of 10 to 50 million For the second year in succession the Scheme had a positive return (12.6%) on its assets in 2004, after the three earlier years of negative returns. It outperformed the benchmark and its peer group in Over the five year period from 2000 to 2004, the Scheme's return of -0.8% per annum was also ahead of the benchmark (-1.2%) and equal with its peer group (-0.8%). V:\HGPS\HGPS RA2004.doc 14

18 MYNERS REPORT In 2001 a review of institutional investment in the UK by Paul Myners concluded with a set of ten Principles, which were revised by the Government, that trustees of final salary schemes (such as HGPS) could use on a voluntary basis when looking at their investment policy. The HGPS Trustees were already virtually fully compliant, and applying the new Principles has not required many changes to existing procedures. HGPS does not have a permanent investment sub-committee as there is a small body of Trustees, many of whom have investment experience. The Trustees meet at least quarterly and believe that strategic (as opposed to day to day) decisions should be fully considered by the full Trustee body. All the HGPS Trustees receive training appropriate to their needs, and they will continue to assess whether they have the right set of skills both individually and collectively. This includes an annual review. The Trustees have agreed a three year business plan, which includes rolling reviews of the investment manager, all advisers and all other aspects of the Scheme s operations. The plan is updated annually. The Trustees have agreed a corporate governance policy. The Trustees have also documented their response to the Myners Principles. Copies of both documents are available from the Scheme Secretary, at the address on page 17. CUSTODY OF THE SCHEME S ASSETS The Trustees consider that it is important to keep the investment management of its assets separate from their custody, to minimise the risk of the assets being misused. The custodians will deliver assets only on receipt of a properly executed instruction from the investment manager. The Trustees are responsible for appointing and replacing the custodians who have custody of the Scheme s assets, and this is done by written agreement. Before a custodian is appointed, a thorough due diligence exercise is carried out by Hermes Administration Services Limited on behalf of the Trustees. The Trustees custodian was JPMorgan Chase Bank throughout The Trustees have maintained bank accounts in their name to make and receive payments for the Scheme. PENSIONS ACT 2004 AND FINANCE ACT 2004 The Pensions Act 2004 gave effect to a Pension Protection Fund (PPF) that, from 6 April 2005, will start to provide some compensation to members of defined benefit pension schemes whose employers collapse leaving the scheme with insufficient money to meet the benefits members were expecting. All company defined benefit pension schemes (such as HGPS) will be required to pay an annual levy to the PPF. This levy will not be passed on to HGPS members. Also coming into effect from 6 April 2005 under the Pensions Act 2004 is a more powerful Pensions Regulator that replaces the Occupational Pensions Regulatory Authority, and will endeavour to minimise the risk of work-based pension schemes making a claim on the PPF. A major part of the role of the new Pensions Regulator will be to issue Codes of Practice setting out expected standards of conduct and practice in many areas of pension scheme administration and trusteeship. The V:\HGPS\HGPS RA2004.doc 15

19 HGPS Trustees will obviously be paying close attention to these Codes of Practice, when published, as they aim to operate at the forefront of good practice. In 2004 the Finance Act contained major reforms to simplify the tax treatment of registered pension schemes. The new regulations will come into effect from April 2006 and their implementation will require a considerable amount of work by pension scheme administrators. ADDED YEARS AND ADDITIONAL VOLUNTARY CONTRIBUTIONS A member of the Scheme is able to provide increased benefits in two ways: i) by buying added years of pensionable service in the Scheme by paying an additional percentage of salary during their active membership; and ii) by making additional voluntary contributions (AVCs) to a with-profits fund managed by Prudential Assurance Company Limited. A member can pay into both the added years and AVC arrangements provided that Inland Revenue limits on contributions are not exceeded. Until December 2004 members could also choose to pay AVCs to a deposit account with Abbey National Plc. However, the Trustees were concerned about the future of this account following the takeover of Abbey National by Banco Santander Central Hispano, Spain s largest bank, in November This option is no longer available to new contributors. A new provider will be sought if any member wishes to invest AVCs in a cash fund. The Trustees have reviewed the two external AVC providers in 2004 and agreed that their performance has been satisfactory, although the Abbey National option has now been withdrawn, as stated above. Towards the end of 2004 members were invited to say if they would be interested in having any additional options. No suggestions were forthcoming. Most members prefer to buy added years. INTERNAL DISPUTE RESOLUTION PROCEDURE The Trustees have found that virtually any query or request for information about the Scheme is capable of being answered satisfactorily by the Hermes HR Department. Nevertheless, as a result of the Pensions Act 1995, the Trustees have put in place a procedure to resolve disputes, which gives a member the means of having a grievance considered at the highest level. The dispute resolution procedure is in two stages. At stage 1, the dispute/complaint is considered by the Secretary to the Trustees. A member not satisfied with his decision can ask at stage 2 for the matter to be reconsidered by the Trustees. No formal complaints were received in A member of the Scheme who has a query or complaint which is likely to prove difficult to resolve is given a copy of the dispute resolution procedure. A copy of the procedure can be obtained from Hermes HR Department or the Secretary to the Scheme at the address on the following page. V:\HGPS\HGPS RA2004.doc 16

20 THE REPORT AND FINANCIAL STATEMENTS The Trustees believe that this report contains all the information which is required to be disclosed to members under current legislation. The financial statements have been prepared and audited in accordance with the regulations made under sections 41(1) and (6) of the Pensions Act A summary of the report and accounts is being sent to all active members, pensioners and deferred pensioners. Copies of the full report and accounts are being made available via the HGPS intranet site to active members of the Scheme, who may also obtain a hard copy on request. A hard copy of the full report and accounts is available to pensioners and deferred pensioners on request. Members who have a general query about the report or their benefit entitlements in Hermes Group Pension Scheme, should contact either Sheena Gibson, Associate Director HR, or Chris Symonds, Scheme Secretary, Hermes Pensions Management Limited, Lloyds Chambers, 1 Portsoken Street, London E1 8HZ, telephone no Further information on HGPS is available to employees on the HGPS section of Hermes intranet. COLIN R GREEN Chairman V:\HGPS\HGPS RA2004.doc 17

21 ACTUARIAL STATEMENT Actuarial Statement made for the purposes of Regulation 30 of The Occupational Pension Scheme (Minimum Funding Requirement and Actuarial Valuations) Regulations 1996 Name of scheme: Hermes Group Pension Scheme Effective date of valuation: 31 December Security of prospective rights In my opinion, the resources of the Scheme are likely in the normal course of events to meet in full the liabilities of the Scheme as they fall due. In giving this opinion, I have assumed that the following amounts will be paid to the Scheme: By members: 5% of Contributory Pay By employers: 18.5% of Contributory Pay until June 2004; 13.8% of Contributory Pay from July 2004; subject to review at the next actuarial valuation. 2. Summary of methods and assumptions used For the purposes of Section 1 I have assumed that the Scheme will continue. In the normal course of events active members will continue to accrue benefits under the Scheme and their benefits will be based on their actual Pensionable Service at cessation of active membership and Pensionable Salary at that time. The liabilities referred to relate to the benefits which are expected to become payable under the normal operation of the Scheme. They take account of future benefit accruals and include appropriate allowance for future earnings increases. I have adopted the Projected Unit funding method, and valued assets at their stated market value. V:\HGPS\HGPS RA2004.doc 18

22 Main financial assumptions % per annum Price inflation 2.75 Return on existing assets 6.96 Return on future investments 6.96 General pay inflation* 2.75 Pension increases in deferment 2.75 Pension increases in payment 2.75 * Plus a promotional scale Further details of the methods and assumptions used are set out in my actuarial valuation addressed to the Trustees dated 2 July Judith Dingle Fellow of the Institute of Actuaries Partner, Watson Wyatt LLP 21 Tothill Street Westminster London SW1H 9LL 2 July 2004 V:\HGPS\HGPS RA2004.doc 19

23 Minimum Funding Requirement Failure Report Name of scheme Hermes Group Pension Scheme Effective date of valuation 31 December 2003 As required under Regulation 21 Failure reports of the Occupational Pension Schemes (Minimum Funding Requirements and Actuarial Valuations) Regulations 1996 (SI 1996/1536). The valuation of the Scheme as at 31 December 2001 disclosed an MFR funding level (i.e. value of assets divided by value of liabilities, as calculated using the method and assumptions defined for MFR purposes) of 102%. Following this, contributions by the Company were set so that the MFR funding level was expected to be at least 100% by the end of the period covered by the contribution schedule. By the date of the next valuation, 31 December 2003, the funding level had reduced to 99%. The principal reason for the failure to meet the MFR on 31 December 2003 was that the actual investment returns achieved on the Scheme s assets were below those expected by the assumptions underlying the MFR test. More details of the valuation of the Scheme as at 31 December 2003 and of the change in the financial position since 31 December 2001 are included in the report on the actuarial valuation as at 31 December Judith Dingle Fellow of the Institute of Actuaries Partner, Watson Wyatt LLP 21 Tothill Street Westminster London SW1H 9LL 2 July 2004 V:\HGPS\HGPS RA2004.doc 20

24 Actuarial certificate given for the purposes of section 58 of the Pensions Act 1995 (Certificate of Schedule of Contributions) Name of scheme Hermes Group Pension Scheme Adequacy of rates of contributions 1. I hereby certify that, in my opinion, the rates of the contributions payable in accordance with the schedule of contributions dated 5 July 2004 are adequate for the purpose of securing that by the end of the period it covers the scheme will meet the minimum funding requirement imposed by section 56(1) of the Pensions Act In forming this opinion I have complied with the requirements imposed by sections 56(3) and 58 of the Pensions Act 1995, the Occupational Pension Schemes (Minimum Funding Requirement and Actuarial Valuations) Regulations 1996 and the mandatory guidelines on minimum funding requirement (GN27), prepared and published by the Institute of Actuaries and the Faculty of Actuaries, and have made the assumptions prescribed by them. Judith Dingle Fellow of the Institute of Actuaries Partner Watson Wyatt LLP 21 Tothill Street Westminster London SW1H 9LL 8 July 2004 Note: The certification of the adequacy of rates of contributions for the purpose of securing the meeting of the minimum funding requirement is not a certification of their adequacy for the purpose of securing the scheme's liabilities by the purchase of annuities, if the scheme were wound up. V:\HGPS\HGPS RA2004.doc 21

25 Schedule of contributions for the purposes of Section 58 of the Pensions Act 1995 Hermes Group Pension Scheme The table below sets out rates of contribution payable by or on behalf of active members of Hermes Group Pension Scheme (the Scheme) and by or on behalf of employer in relation to the Scheme for the ten years from the date of certification by the Actuary. 1. Rates of contribution: Member rate: Employer rate: 5% of Contributory Pay 13.8% of Contributory Pay An allowance for scheme expenses and the cost of the life insurance premium is included in the rate of contribution set out above. Additional contributions may be payable by the Employer, on the advice of the Scheme Actuary, to cover any enhancement in benefits or to cover the cost of any Scheme benefits which are not included in the normal funding rate (e.g. redundancy benefits). 2. Due dates of payment: Member contributions, including AVCs Employer contributions: due on, or before, the 19 of each month after that in which contributions are deducted from earnings due on, or before, the 19 of each month after that in which contributions are deducted from earnings. Signed by: C J Symonds On behalf of the Trustees of the Hermes Group Pension Scheme Date: 5 July 2004 Signed by: A Watson On behalf of the Trustees of the BT Pension Scheme Date: 5 July 2004 Signed by: A Watson On behalf of Hermes Pensions Management Limited Date: 5 July 2004 Valuation date: 31 December 2003 Date of signing valuation report: 2 July 2004 Date of certifying schedule of contributions 8 July 2004 V:\HGPS\HGPS RA2004.doc 22

26 GROUP PENSION SCHEME FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2004 V:\HGPS\HGPS RA2004.doc 23

27 STATEMENT OF TRUSTEES' RESPONSIBILITIES The following statement is made with a view to distinguishing for Scheme members and beneficiaries the respective responsibilities of the Trustees and of the Independent Auditors in relation to the financial statements. It should be read in conjunction with the Independent Auditors' Report on pages 25 and 26. The financial statements are the responsibility of the Trustees and are required to comply with applicable United Kingdom law and accounting standards. Pension scheme regulations require the Trustees to make available to Scheme members, beneficiaries and certain other parties audited financial statements for each Scheme year which: show a true and fair view of the financial transactions of the Scheme during the Scheme year and of the amount and disposition at the end of that year of the assets and liabilities, other than liabilities to pay pensions and benefits after the end of the Scheme year; and contain the information specified in the schedule to The Occupational Pension Schemes (Requirement to obtain Audited Accounts and a Statement from the Auditor) Regulations 1996, including a statement whether the financial statements have been prepared in accordance with the Statement of Recommended Practice Financial Reports of Pension Schemes (revised November 2002). The Trustees have supervised the preparation of the financial statements and have agreed suitable accounting policies, to be applied consistently, making any judgements or estimates on a prudent and reasonable basis. The Trustees are responsible under pensions legislation for ensuring that there is prepared, maintained and from time to time revised a schedule of contributions showing the rates of contribution (other than voluntary contributions) payable towards the Scheme by or on behalf of the employer and the active members of the Scheme and the dates on or before which such contributions are to be paid. The Trustees are also responsible under pensions legislation for keeping records in respect of contributions received in respect of any active member of the Scheme and for procuring that contributions are made to the Scheme in accordance with the schedule of contributions. Under Trust Law the Trustees have general responsibility for the system of internal control, for ensuring that adequate accounting records are kept and for taking such steps as are reasonably open to them to safeguard the assets of the Scheme and to prevent and detect fraud and other irregularities. V:\HGPS\HGPS RA2004.doc 24

28 REPORT OF THE INDEPENDENT AUDITORS TO THE TRUSTEES OF THE HERMES GROUP PENSION SCHEME We have audited the financial statements of the Hermes Group Pension Scheme for the year ended 31 December 2004 which comprise the fund account, net assets statement, change in market value of net assets and the related notes 1 to 14. These financial statements have been prepared on the basis of the accounting policies set out therein. This report is made solely to the trustees, as a body, in accordance with regulation 3 of the Occupational Pension Schemes (Requirement to obtain Audited Accounts and a Statement from the Auditor) Regulations 1996 made under the Pensions Act Our audit work has been undertaken so that we might state to the trustees those matters we are required to state to them in an auditors report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the trustees as a body for our audit work, for this report, or for the opinion we have formed. Respective responsibilities of trustees and auditors As described in the statement of trustees responsibilities, the Scheme s trustees are responsible for obtaining audited financial statements which comply with applicable United Kingdom law and accounting standards and for making available certain other information about the Scheme in the form of an annual report. Our responsibility is to audit the financial statements in accordance with United Kingdom legal and regulatory requirements and auditing standards. We report to you our opinion as to whether the financial statements show a true and fair view and contain the information specified in the Schedule to the Occupational Pension Schemes (Requirement to obtain Audited Accounts and a Statement from the Auditor) Regulations 1996 made under the Pensions Act We report to you if we have not received all the information and explanations that we require for our audit. We read the other information contained in the annual report for the above year as described in the contents section and consider whether it is consistent with the audited financial statements. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the financial statements. Basis of audit opinion We conducted our audit in accordance with United Kingdom auditing standards issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements. It also includes an assessment of the significant estimates and judgements made by or on behalf of the trustees in the preparation of the financial statements, and of whether the accounting policies are appropriate to the Scheme s circumstances, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or other irregularity or error. In V:\HGPS\HGPS RA2004.doc 25

29 forming our opinion we also evaluated the overall adequacy of the presentation of the information in the financial statements. Opinion In our opinion the financial statements show a true and fair view of the financial transactions of the Scheme during the Scheme year ended 31 December 2004, and of the amount and disposition at that date of the assets and liabilities, other than liabilities to pay pensions and benefits after the end of the Scheme year, and contain the information specified in the Schedule to the Occupational Pension Schemes (Requirement to obtain Audited Accounts and a Statement from the Auditor) Regulations 1996 made under the Pensions Act Deloitte & Touche LLP Chartered Accountants and Registered Auditors London Date: V:\HGPS\HGPS RA2004.doc 26

30 INDEPENDENT AUDITORS STATEMENT ABOUT CONTRIBUTIONS, UNDER REGULATION 4 OF THE OCCUPATIONAL PENSIONS SCHEMES (REQUIREMENT TO OBTAIN AUDITED ACCOUNTS AND A STATEMENT FROM THE AUDITOR) REGULATIONS 1996, TO THE TRUSTEES OF THE HERMES GROUP PENSION SCHEME We have examined the summary of contributions to the Hermes Group Pension Scheme for the Scheme year ended 31 December 2004 contained in Note 2 to the Accounts. This statement is made solely to the trustees, as a body, in accordance with regulation 4 of the Occupational Pension Schemes (Requirement to obtain Audited Accounts and a Statement from the Auditor) Regulations 1996 made under the Pensions Act Our work has been undertaken so that we might state to the trustees those matters we are required to state to them in an auditors statement about contributions and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the trustees as a body for our work, for this statement, or for the opinion we have formed. Respective responsibilities of trustees and auditors As described in the statement of trustees responsibilities, the Scheme s trustees are responsible for ensuring that there is prepared, maintained and from time to time revised a schedule of contributions which sets out the rates and due dates of certain contributions payable towards the Scheme by or on behalf of the employer and the active members of the Scheme. The trustees have a general responsibility for procuring that contributions are made to the Scheme in accordance with the schedule of contributions. It is our responsibility to provide a statement about contributions paid under the schedule of contributions and to report our opinion to you. We read the other information contained in the annual report for the above year as described in the contents section and consider whether it is consistent with the audited summary of contributions. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the summary of contributions. Basis of statement about contributions We planned and performed our work so as to provide the information and explanations which we considered necessary in order to give reasonable assurance that contributions reported in the summary of contributions have been paid in accordance with the schedule of contributions. For this purpose the work that we carried out included examination, on a test basis, of evidence relevant to the amounts of contributions paid to the Scheme and the timing of those payments under the schedule of contributions. Our statement about contributions is required to refer to those breaches of the schedule of contributions which come to our attention in the course of our work. V:\HGPS\HGPS RA2004.doc 27