BT is seeking changes to its final salary pension schemes, including raising the retirement age from 60 to 65 and basing benefits on the average, rather than the final salary, earned before retirement.
BT confirmed that talks with its unions had been under way since May and said the moves were unrelated to the 19 per cent fall in its share price on Friday after the group warned that earnings would fall in 2008-09 because of problems at its division serving multinationals.
Analysts speculate that BT may need to cut dividends, in part because it may need to step up significantly contributions to its pension scheme. However, with only 69,000 active members out of a total of 344,000, the changes to the scheme will do little to alter aggregate liabilities.
According to John Ralfe, an independent pensions consultant, these were roughly three times BT’s market value after Friday’s share price fall to its lowest since privatisation in 1984.
Meanwhile, Mr Ralfe, in a report to be released on Monday, says that if BT’s interpretation of terms of the privatisation are correct, British taxpayers could be on the hook for about £16bn of its pension shortfall if it should suddenly become insolvent.
Mr Ralfe concluded that the recent plunge in stock markets had increased the potential liability from the company’s own estimate of £11bn in December.
BT has interpreted a guarantee in respect of its scheme members to cover not only all pension benefits earned before privatisation, but also benefits earned by those who remained after going public.
However, on Friday, the Department for Business, Enterprise and Regulatory Reform said the government continued to dispute BT’s interpretation of the Crown Guarantee and said the documentation of its terms remain sketchy. BT said the guarantee would only apply in the unlikely event of insolvency.
The company has an investment grade debt rating and like other European telecoms providers, has greatly reduced its leverage since the bursting of the internet bubble earlier this decade. brought several of them to the brink of collapse.
BT closed its final salary scheme to new members in 2001.
Analysts said they expected BT to have to cut its dividend to cope with a deteriorating position in its pension scheme. BT’s 15.8p dividend for 2007-08 was worth £1.2bn, and the company is now expecting its free cash flow for 2008-09 to be less than £1.5bn.
BT said the scheme was set for its triennial valuation beginning in January and that new calculations of the deficit would ill be prepared. Trustees will also have to agree a new scheme-specific funding arrangement with BT in which it makes annual contributions to fill the shortfall within 10 years.
Among the issues that trustees need to consider is whether the scheme has been sufficiently conservative in estimating the number of years each retiree will draw a pension.
The company’s most recent accounts show, for example, that BT trustees believe that life expectancy, which has been rising by more than two years per decade, will improve more slowly at a rate of one year per decade.
The Pensions Regulator has warned trustees they must behave like bank creditors in setting terms of repayments. If employers seek to cut payments or fill deficits more slowly, trustees are urged to ensure that other creditors and shareholders are treated similarly.
BT’s scheme is one of many that have relied on heavy investments in equities and alternative assets to meet shortfalls that would have otherwise had to be paid by company contributions.
Until late last year, that appeared to be a good strategy and BT had a surplus on an accounting basis at the time of its last annual report. But Mr Ralfe said that the investment strategy had actually exposed shareholders to much higher risks.
BT’s pension difficulties are particularly acute because it has insisted on maintaining a heavy weighting in equities and hedge funds that can produce higher returns than bonds but, unlike bonds, do not rise and fall in line with liabilities.
Because BT’s liabilities are so heavily those of pensioners or deferred members whose liabilities fall due relatively soon, it should be much more heavily invested in less risky assets, Mr Ralfe said.
Indeed, he said that because of the Crown Guarantee in respect of BT’s shortfall, Mr Ralfe said the government should insist BT adopt a much less risky investment strategy.
BT is hardly alone in facing a sudden, sharp deterioration in its pension scheme because many schemes have similar investments.
Many schemes have reduced their exposure to equities, but many hold far higher proportions of risky assets relative to their liabilities than would be allowed for, say, insurance companies offering annuities.
The Pension Protection Fund, which insures retirement benefits said in its most recent monthly report that because of movements in stock and bond markets, the aggregate deficit of schemes it insured as at the end of September was £80.3bn while in September 2007, it had a surplus of £75.1bn, a change of more £150b.