BT will potentially have to pay twice as much as it now does every year to address a worsening deficit in its pension plan.
Analysts expect that a nine-month long review of its £47bn pension plan, which begins today, will probably conclude that the plan’s liabilities have increased since the previous review three years ago and that BT will need to inject equity to keep the deficit under control.
Analysts at Macquarie estimate that the pension deficit will be £8.1bn, which would mean BT would need “top-up” payments of £700-770m every year above existing payments of about £325m.
The difference is equivalent to 12 per cent of BT’s free cash flow targets, which Macquarie warned could limit the company’s appetite for an aggressive bid for future Premier League rights.
BT’s pension plan is a half bigger than its market capitalisation of £30bn and the largest private sector defined benefit pension plan in the UK.
The plan is a legacy of the company’s days as the state telecoms monopoly, but its massive size had caused analysts to describe the scheme as “the tail that wagged the dog”, with fears over the scheme’s deficit weighing on BT’s share price.
BT’s most recent annual report acknowledges the risks. “An increase in the pension deficit . . . may have an impact on the level of payments we are required to make,” the 2014 report says. “Indirectly it may also have an adverse impact on our share price and credit rating.”
This time BT is bigger and healthier than in recent triennial reviews, which means it may not get pulled down on its backside quite as hard as in the past, although the deficit is still a worry for analysts.
There is a wide disparity between estimates – with consensus assuming about £500m of annual contributions in future – which lies in the uncertainty around key assumptions used to calculate the deficit.
At March 2014, the IAS19 accounting deficit was £6.8bn – based off £39.9bn of assets and £46.7bn of liabilities. However, this number tends to fluctuate with the discount rate, and the trustees of the scheme instead use a valuation measured by an actuary that builds in certain assumptions.
The bad news for BT is a major factor remains the yield on government bonds, which are much below levels at the last funding valuation due to the UK’s quantitative easing programme. This would have a negative impact on the scheme’s expected rates of return.
On the positive side, the “prudence view” taken in the actuarial valuation includes an assessment of the financial position of BT itself, which has steadily improved on the back of well-placed investments in superfast internet services and sports TV.
The actuarial valuation is still expected by most analysts to show a significantly worse deficit. BT’s best estimate of a median valuation is a surplus of £700m, but the prudence assumptions taken by actuaries downgraded previous estimates by £6bn in 2008, and £6.4bn in 2011.
Adding to the uncertainty is the reaction of the plan’s trustees, who declined to comment. Under the 20 year plan of the last triennial funding valuation, BT’s repayment schedule would require annual top-ups if the deficit is higher than £1.7bn.
However, the trustees could agree a new set of rules pushing out the schedule, or negotiate an upfront cash injection in addition to regular payments.
John Ralfe, a pensions consultant, estimates an actuarial deficit of about £9bn, despite BT putting in £2.7bn in cash since 2011. He calculates that deficit contributions would have to increase to £1.5bn a year in this case, but adds that trustees could push the schedule to 2029, for example, This would still mean that deficit contributions would triple to £800m a year.
“Although BT is trying desperately to reinvent itself as a high-tech 21st century company, it will continue to carry a huge “old fashioned” pension scheme for many decades,” he says.
Still, the fact that the pension liability is not going to go away soon should come as no shock to the average BT shareholder. And there is a silver lining this time.
Two counts ago, BT’s free cash flow barely covered the cost of the payments. But this time, projected annual cash flow of more than £2.6bn should easily cover the liabilities – even if analysts worry that this could impinge on future investments.
Gavin Patterson, chief executive of BT, strikes a confident note. “BT’s free cash flow, alongside our ability to continue to reduce costs in the business, means we are able to support the pension scheme whilst reducing net debt, paying progressive dividends and investing in the future growth of the business.”
Pensions Regulator’s new approach could benefit BT
BT could benefit from the Pensions Regulator’s new, more employer-friendly approach as it enters into discussions with its pension plan’s trustees.
An updated Code of Practice from the Pensions watchdog, due to come into force this month, will direct trustees to take into consideration a business’s growth prospects when hammering out a deal over how much employers should pay into the company pension.
Other companies with significant pension liabilities will probably watch BT’s negotiations closely, since it is both the largest private sector defined benefit pension plan in the UK, and will also be the first negotiations conducted under the new code.
This new approach by the watchdog comes after the government set a new objective for the Pensions Regulator, to “minimise any adverse impact on the sustainable growth of an employer”.
“The old code talks about clearing deficits as fast as reasonably affordable,” said Darren Redmayne, UK chief executive of Lincoln International, the pension consultants.
“The new code will allow employers to put a case forward for a different or extended pension contribution plan if they can demonstrate cash flow is also needed to invest in certain areas to support the sustainable growth of the business.”
BT, which is expected to take part in the forthcoming auction of Premier League football rights and is turning its attention to its mobile phone business, said it was examining the new Code of Practice in detail.
“We welcome the recognition in the Pensions Regulator’s new Code that a strong employer is the best support for a pension scheme,” said a spokesman for BT.
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