Pirelli

23. Employee benefit obligations

Employee benefit obligations include:

PENSION FUNDS

The composition of pension funds at December 31, 2008 is as follows:

The composition of pension funds at December 31, 2007 was as follows:

The principal features of the pension plans in existence at December 31, 2008 are as follows:

• Germany - Tyre sector: this is an unfunded defined benefit plan based on the most recent remuneration. It guarantees another pension besides the government pension. The plan was closed in October 1982; consequently, the participants in the plan are employees who were hired prior to that date;
• USA – Tyre sector: this is a funded defined benefit plan based on the most recent remuneration. It guarantees another pension besides the government pension. The plan is under the administration of a trust. The plan was closed in 2001 and frozen in 2003 for those employees who changed over to a defined contribution scheme. None of the current participants in the plan are in service;
• UK: these are funded defined benefit plans based on the most recent remuneration. They guarantee another pension besides the government pension. The plans are under the administration of a trust. The plans were closed in 2001; consequently, the participants in the plan are employees who were hired prior to that date.

The movements during the year in the present value of the liabilities for pension funds (funded and unfunded) are as follows:

The changes during the year in the fair value of the pension plan assets are as follows:

The assumptions made to compute the expected return of the pension fund assets are based on the expected returns of the underlying assets (shares, bonds and deposits). The expected return originates from the general average of the expected returns by the assets for every class of separately identified investments, with reference to an effective or objective composition of the assets.

The expected return of each class of investment originates from the market yields available at the balance sheet date. Specifically, the expected return of equity shares originates from a risk-free rate of return with the addition of an adequate premium for the risk.

The composition of the funded pension plan assets is presented in the following table:

The effective return of pension plan assets is as follows:

The costs recognized in the income statement for pension funds are as follows:

The amounts recognized in the income statement are included in “Personnel costs” (Note 31) .

The contributions which are expected to be paid for pension funds during 2009 amount to Euros 23,337 thousand.

EMPLOYEES’ LEAVING INDEMNITY

The movements during the year in employees’ leaving indemnity are as follows:

Discontinued operations refer to the deconsolidation of the Integra FM B.V. group (formerly Pirelli RE Integrated Facility Management B.V.) and PGT Photonics S.p.A., after the stakes held in these companies were sold to third parties.

The movements through the income statement during 2008 relate only to the interest expense accrued on employees’ leaving indemnity at December 31, 2007. Following the leaving indemnity reform introduced by Italian Budget Law 2007, employees’ leaving indemnity was in fact transformed into a defined contribution plan.

Movements through the income statement are recorded in “Personnel costs” (Note 31).

MEDICAL CARE PLANS

The composition of medical care plans is as follows:

The medical care plan in existence in the United States (Tyre sector) covers white-collars and blue-collars, in service and retired.

The plan is structured according to “pre-medicare” and “post-medicare”, with the latter referring to participants over the age of 65.

Contributions are paid in both by the employer and the employee.

The movements during the year in the liabilities recognized in the financial statements for medical care plans are the following:

The effect of a one percentage point increase or decrease in the estimated rates for the costs of medical care is as follows:

The costs recognized in the income statement for medical care plans are as follows:

The amounts recognized in the income statement are included in “Personnel costs” (Note 31).

OTHER INFORMATION

Net actuarial losses referring to 2008 recognized directly in equity amount to Euros 85,058 thousand (net gains of Euros 2,589 thousand in 2007).

The cumulative amount at December 31, 2008, equal to a net loss of Euros 150,460 thousand (net loss of Euros 64,326 thousand in 2007), is made up as follows:

The breakdown of the cumulative amount at December 31, 2007 by country was as follows:

The main actuarial assumptions used at December 31, 2008 and also to determine the estimated cost for the year 2009 are as follows:

The main actuarial assumptions used at December 31, 2007 and also to determine the estimated cost for the year 2008 were as follows:

The discount rates are used in the measurement of the obligation and the financial component of the net current expense. The Group has chosen such rates based on the yield curves of fixed-rate securities (corporate bonds) of leading companies (with an AA+ rating) at the measurement date of the plans.

The medical care cost trend rate represents the expected increase in medical care costs. The rate is determined on the basis of the specific experience of the sector and the various trends, including specific inflation projections in the health care sector.

The initial rate used represents a trend for a short-term period based on recent experience and the prevailing market conditions. The final rate used is an assumption of the long-term period which takes into account, among other things, inflation in the costs of health care on the basis of the general inflation trend, incremental medical inflation, technologies, new drugs, average age of the population and a different mix of medical services. The change in the average trend in the rate of growth of medical care costs in 2008 was determined based on the recent change in medical care costs.

The expected return on plan assets reflects the estimates on the medium- and long-term return performance of the pension fund assets for the entire duration of the obligation. The expected return is set for each class of assets (equity shares, bonds, cash and real estate) and is net of expected administrative costs. The historical trend and the correlation of returns, the estimate on future trends and other relevant financial factors are analyzed in order to check reasonableness and consistency.

The adjustments based on historical experience made to defined benefit plans are the following:

The adjustments to liabilities represent the change in the actuarial liability that is not generated by changes in the actuarial assumptions. These typically include changes in the demographic and remuneration structure. Experience adjustments do not include changes in the plan regulations (past service cost).

The adjustments to assets represent the difference between the effective return of the assets and the expected return at the start of the year.

24. Borrowings from banks and other financial institutions

Borrowings from banks and other financial institutions are analyzed as follows:

These payables are secured by real guarantees (liens and mortgages) for Euros 19,107 thousand (Euros 179,380 thousand at December 31, 2007).

If the negative fair value change of derivatives hedging the exchange rates of financial payables (classified in “Derivative financial instruments”) of Euros 43 million is added to the total, the gross payable is equal to Euros 2,114 million, reported in the net financial position.

The carrying amount of current payables is regarded as approximating fair value.

The current payables include the current portion of long-term financial payables of Euros 414,330 thousand (Euros 531,200 thousand at December 31, 2007).

The fair value of non-current payables, compared to the carrying amount, is as follows:

At December 31, 2008, the breakdown of payables by interest rate and currency of origin is as follows:

The percentage of floating-rate payables at December 31, 2008 increased compared to the prior year mainly as a result of repayments of fixed-rate bond issues (Euros 500,000 thousand) in October 2008. However, the intention is to bring the fixed/floating ratio in line with the Group’s policies which call for an objective 60/40 proportion for fixed-/floating-rate payables.

At December 31, 2007, the situation was as follows:

The fixed-rate payables above include payables denominated by contract at fixed rates and payables denominated by contract at floating rates hedged by derivatives.

The Group’s exposure to interest rate changes on financial payables in terms of either the type of rate or the date of resetting the rate can be summarized as follow:

Bonds refer to those issued in 1999 by Pirelli & C. S.p.A. for Euros 150,000 thousand at a fixed rate of 5.125 percent, maturing April 7, 2009.

The reduction from 2007 is due to the repayment of the bonds issued on October 21, 1998 by Pirelli & C. S.p.A. for Euros 500,000 thousand at a fixed rate of 4.875 percent and repaid in a one-off payment at maturity on October 21, 2008.

The bonds are not covered by financial covenants or clauses which could cause the early repayment of the bonds due to events other than insolvency.

With regard to negative pledge clauses, there is a commitment on the bonds requiring that real guarantees are not to be provided on the Relevant Debt (bonds and similar securities destined for listing) with the exception for real guarantees on existing debt.

With regard to the existence of financial covenants on credit lines drawn down (included in payables to banks) the following financing lines should be noted, all of which are revolving lines:

Corporate:

• Barclays Capital, BNP Paribas, HSBC Bank plc, J.P. Morgan plc, The Royal Bank of Scotland plc (as the Mandated Lead Arrangers), for Euros 800,000 thousand, drawn down for Euros 100,000 thousand, expiring December 2011 for Euros 155,000 thousand and December 2012 for Euros 645,000 thousand, for which Pirelli & C must maintain a specific level of consolidated debt and a specific ratio between consolidated net debt and gross operating profit. These parameters are complied with at December 31, 2008.

As far as negative pledges are concerned, real guarantees must not granted above the ceiling of Euros 75,000 thousand, relating to the Relevant Debt (bonds and similar destined for listing), with the exception for real guarantees on existing debt or debt which replaces it, to be provided by law, relating to export and project finance arrangements and low-rate financing;

Tyre:

• syndicated line (granted to Pirelli Tyre S.p.A. and Pirelli International Limited), in which 12 banks participate for a total of Euros 675,000 thousand, drawn down for Euros 600,000 thousand, expiring February 2012, carries no financial covenants. There is a negative pledge clause not to grant real guarantees, beyond a set ceiling defined as the higher of Euros 100,000 thousand and 3 percent of total assets (as defined in the consolidated financial statements of Pirelli Tyre S.p.A.), relating to the Relevant Debt (bonds and similar destined for listing) with the exception for real guarantees on existing debt or debt which replaces it, to be provided by law, relating to export and project finance arrangements and low-rate financing;

Real Estate:

• The Royal Bank of Scotland plc, for Euros 50,000 thousand, completely drawn down, expiring December 2009, for which Pirelli & C. Real Estate S.p.A. must maintain, in reference to the consolidated financial statements, a specific amount of net tangible assets (defined as the difference between total equity and the amount resulting from the sum of intangible assets and any asset balance between deferred tax assets and liabilities);
• West LB AG, for Euros 50,000 thousand, fully drawn down, expiring May 2011, for which Pirelli & C. Real Estate S.p.A. must maintain a specific level of consolidated equity;
• Unicredit Corporate Banking S.p.A., for Euros 100,000 thousand, fully drawn down, expiring January 2010, which can be renewed for another 18 months, for which Pirelli & C. Real Estate S.p.A. must maintain a specific level of consolidated equity.

As for the financing lines granted to Pirelli Real Estate, the fact of considering the capital increase described in the report on operations and previously announced to the financial community brings the balance sheet requirement and conventional requirement of net tangible assets, which can be influenced by the group’s performance in the absence of the above capital increase, above the minimum contractually agreed levels.

On the other credit lines, Pirelli Real Estate is not required to comply with any covenants.

The other financial payables in existence are not covered by financial covenants or clauses which could cause their early repayment due to events other than insolvency.

There are no significant negative pledge clauses.

In addition to liquidity and securities held for trading of Euros 369,705 thousand, at December 31, 2008 the Group has unused committed credit lines for Euros 785,000 thousand (Euros 2,672,000 thousand at December 31, 2007). Expiration dates are the following:

As for finance lease payables, reference should be made to Note 8.1 “Finance leases”.