Pensions deficit will be close call for BT

By Alex Brummer, August 27, 2009

As chief executive of British Telecom, Ian Livingston is having a baptism of fire. The main focus of his first year in office has been cleaning up the mess at “global services” — the group’s growth business which foolishly underpriced communications contracts to big corporate and government clients.

Glasgow-born Livingston, 44, acted quickly to clear up that problem and put global services back on a sounder footing. He is now having to deal with an even bigger and more troublesome legacy — the group’s pension fund.

BT has the largest pension fund in the FTSE100, having inherited a huge staff from its days in the public sector.

At the last count it had 180,529 pensioners, 96,304 deferred members (those who have left the company but have yet to draw down pensions) and 63,621 contributing members.

When the company reported its first quarter financial results in July, indicating that it was beginning to come out from under the global services cloud, it was disclosed that the gross deficit in the pension fund had climbed from £4bn to £8bn in just three months. While much of this can be put down to technical factors, the fact remains that the shortfall in BT’s pension fund almost equals the company’s stock market value.

It has become a real case of the tail wagging the dog. BT is not alone in this. Several other large companies, including the aerospace and defence giant BAE Systems and carrier British Airways — both formerly in public ownership — find themselves with similar problems.

But pension experts and regulators have come to see the BT pension fund as something of a test case. Among the reasons for the concern is that the BT fund has an untested “Crown Guarantee” which — in the unlikely case of insolvency — would mean responsibility for the pension fund deficiency falling back on the taxpayer.

The chief executive of the Pensions Protection Fund (PPF) Alan Rubenstein (formerly of investment bankers Lehman Brothers) is monitoring developments in the BT pensions fund closely. It is his job to make sure that the pensions of companies in wind-up are paid and he has the right to impose a levy on healthy funds to make good the arrears in those under stress.

He recognises that a problem at BT could throw all his calculations out and put severe stress on the PPF, which already has built its own deficit as a result of the administrations at Woolworth, Lehman et al.

BT also is involved in an ongoing discussion with the Brighton-based Pensions Regulator David Norgrove (former chair of the Marks & Spencer pension fund trustees) about the company’s plans to deal with the pension liability.

The current plan as announced by BT and agreed with the regulator is to deal with the problem by transferring £525m from profit and loss each year to close the gap.

BT also points out that the volatility in the accounting deficit and the need to “mark to market” the funding of the scheme makes it highly volatile. There is no question that changes in the rate of inflation and bond yields — which are used to assess the liabilities of the fund — can make an enormous difference to quarter-to-quarter valuations.

But what is also beyond dispute is that when a longer term actuarial valuation of the BT pension fund is completed, the deficit is likely to look a great deal bigger than the £8bn latest figure. Experts believe that the true deficit could be as large as £11bn or £12bn, although a final number has still to be agreed.

BT has already has taken a series of bold steps to deal with its pensions liabilities. Last November it secured agreement with the Communications Workers Union to curb liabilities by lifting the retirement age to 65 years old and to slow the build-up of pension rights. This was a better deal than that achieved by Labour Cabinet Minister Alan Johnson in 2005 when he sought to curb public sector pensions on behalf of the government.

The concern for BT’s army of private shareholders as well as big battalion investors must be that the Pensions Regulator may yet demand tougher terms from BT on meeting the pensions fund deficit. It can make a number of recommendations to the company including the enforcement of a more cautious dividend policy and higher future payments into the pension fund.

Neither of these solutions is likely to improve the stock market view of BT as a long-term investment. The pension fund has become the elephant in the room for BT.

Even if Livingston is successful in repairing “global services” and in building on the group’s faster speed broadband roll-out, it is going to make it that much harder to accumulate shareholder value.

BT prefers to play down the threat from its pension fund which, according to the latest accounts, has assets of £31.3bn. In its current state the fund reckons that were the company to become insolvent then it could afford to provide 57 per cent of members’ benefits. The standard of the Pensions Protection Fund is payment of 90 per cent of expected benefits.

It is an enormous black hole and explains why the government and regulators are focused on this particular problem. It is Livingston’s greatest challenge. But who said life at the top of BT was ever going to be easy?

Alex Brummer is City Editor of the Daily Mail

Last updated: 11:45am, August 27 2009