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BT’s share price dropped by a hefty 9 per cent on Thursday, reflecting investor concern about possible disagreement between the company and the pensions regulator as much as the absolute size of the retirement fund deficit.
There are no hard and fast rules about how deficits are calculated, with individual scheme advisers – and the regulator – left to deal with the uncertainty of how much a payment stream over the next 40 to 60 years may cost when expressed in today’s money. The answer depends on assumptions about inflation, investment returns and life expectancy, among other things.
And it is this, as well as the timetable for remedying the deficit in BT’s pension scheme, that is likely to be at the heart of tensions with the regulator.
The regulator is charged with first seeing to it that company pension promises are honoured in full, and second, that claims on the industry-funded insurance scheme are limited.
It is insisting on the use of “prudent” assumptions for retirement fund valuations. That way, if the plan sponsor were suddenly forced into bankruptcy, at least there would be enough in the scheme to pay promised retirement benefits.
But there are no hard and fast rules about what is “prudent” and, indeed, the actuarial profession has long resisted defining the term.
“What the regulator is most concerned about is companies presenting a fairy tale,” said Clive Fortes, head of the corporate consulting practice at Hyman Robertson, the actuarial firm. The first order of business must be for trustees to recognise just how big the deficit is. “If it will take you 15 years to fill it, it will take you 15 years,” added Mr Fortes.
Jeremy Dell, partner at Lane Clark & Peacock, another actuarial firm, said the starting point from the regulator’s point of view is “the trustees shouldn’t kid themselves that there isn’t a problem”.
Pension experts generally agreed that the assumptions used by BT in its pension scheme valuation are not completely out of line with other companies.
The triennial funding valuation of BT’s defined benefit scheme, conducted by its trustees with the help of advisers, found an actuarial deficit of £9bn at December 31 2008.
The market value of the scheme’s assets was £31.2bn, while the present value of the scheme’s liabilities was £40.2bn, after using a post-inflation discount rate of 2.5 per cent. The deficit is to be dealt with through annual top-up payments by BT of at least £500m over 17 years.
John Ralfe, an independent pensions adviser, said he would be surprised if the regulator’s concerns were about the assumptions underpinning BT’s pension valuation.
“It is more likely to be the length of the recovery plan that is the problem,” said Mr Ralfe. “It is that 17 years is too long for a company that is not in trouble.”
Several advisers said companies now seek permission to stretch deficit-repair payments out longer than the 10 years urged by the regulator. “We are seeing quite a lot of understanding from the trustees and the regulator on this point,” said Mr Fortes.
However, he – and several other advisers – said those seeking a longer payment term are clustering around 12- to 15-year horizons. “It is unusual to see schemes seeking longer than 15 years,” said a legal adviser.
But advisers noted that two companies with similar deficits could use very different technical assumptions and still satisfy the regulator. A company with a strong balance sheet and conservative investment strategy is likely to be able to use somewhat less prudent assumptions. By contrast, a group with a weak credit rating and limited cash flow will have to use very prudent methodology that give rise to a much larger deficit calculation.
BT, which has an investment-grade credit rating, is a utility-style cash generator that may be more able than many companies to plug its pension deficit quickly.
BT and the trustees to its pension scheme sounded like they are prepared to dig in for a long battle with the regulator.
Rod Kent, chairman of the trustees, said he and his colleagues had “spent exhaustive effort over the last 18 months in detailed analysis”.
Ian Livingston, BT’s chief executive, said the trustees and the company had agreed on a “prudent valuation” for the scheme.
He said if the regulator objected, and the trustees stood by the agreement with the company, the matter could go to a tribunal, followed by an lengthy appeals process. He highlighted how, by the time of issue was resolved, the next triennial valuation could be well under way.