Notes to the consolidated financial statements

29. RETIREMENT BENEFIT PLANS
Background
The group offers retirement benefit plans to its employees. The group’s main scheme, the BT Pension Scheme (BTPS), is a defined benefit scheme where the benefits are based on employees’ length of service and final pensionable pay. This scheme has been closed to new entrants since 31 March 2001 and replaced by a defined contribution scheme, the BT Retirement Plan (BTRP). The total pension cost of the group for the year, included within staff costs, was £643 million (2006: £603 million, 2005: £540 million).

Defined contribution schemes
The income statement charge in respect of defined contribution schemes represents the contribution payable by the group based upon a fixed percentage of employees’ pay. The total pension cost for the year in respect of the group’s main defined contribution scheme was £28 million (2006: £19 million, 2005: £11 million) and £3 million (2006: £2 million, 2005: £1 million) of contributions were outstanding at 31 March 2007.

Defined benefit schemes
BT Pension Scheme Trustees Limited administers and manages the scheme on behalf of the members in accordance with the terms of the Trust Deed of the scheme and relevant legislation. Under the terms of the trust deed of the BTPS, there are nine trustee directors appointed by the group, five of which appointments are made with the agreement of the relevant trade unions, including the Chairman of the Trustees. Four trustee directors other than the Chairman are appointed by BT on the nomination of the relevant trade unions. Two of the trustee directors will normally hold senior positions within the group, and two will normally hold (or have held) senior positions in commerce or industry. Subject to there being an appropriately qualified candidate, there should be at least one current pensioner or deferred pensioner of the BTPS as one of the trustee directors. Trustee directors are appointed for a three-year term, but are then eligible for re-appointment.

Measurement of scheme assets and liabilities – IAS 19
Scheme assets are measured at market value at the balance sheet date. The liabilities of the BTPS are measured by discounting the best estimate of future cash flows to be paid out by the scheme using the projected unit method. Estimated future cash flows are discounted at the current rate of return on high quality corporate bonds of an equivalent term to the liability. Actuarial gains and losses are recognised in full in the period in which they occur in the statement of recognised income and expense.

The financial assumptions used to measure the net pension obligation of the BTPS at 31 March 2007 are as follows:

The average life expectancy assumptions, after retirement at 60 years of age, are as follows:

			2007			2006
			Number of years			Number of years
Male in lower pay bracket			22.6			22.5
Male in higher pay bracket			25.0			24.7
Female			25.6			25.4
Future improvement every 10 years			1.0			1.0

Amounts recognised in respect of defined benefit schemes
The net pension obligation is set out below:

Amounts recognised in the income statement on the basis of the above assumptions in respect of pension obligations are as follows:

			2007			2006			2005
			£m			£m			£m
Current service cost (including defined contribution schemes)			643			603			540
Total operating charge			643			603			540
Expected return on pension scheme assets			(2,292	)		(2,070	)		(1,918	)
Interest on pension scheme liabilities			1,872			1,816			1,720
Net finance income			(420	)		(254	)		(198	)
Total amount charged to the income statement			223			349			342

An analysis of actuarial gains and losses and the actual return on plan assets is shown below:

			2007			2006			2005
			£m			£m			£m
Actuarial gains and losses recognised in the year			1,409			2,122			294
Cumulative actuarial gains and losses			3,825			2,416			294
Actual return on plan assets			3,285			6,925			3,582

Changes in the present value of the defined benefit pension obligation are as follows:

			2007			2006
			£m			£m
Opening defined benefit pension obligation			(38,187	)		(34,435	)
Service cost			(600	)		(568	)
Interest cost			(1,872	)		(1,816	)
Contributions by employees			(18	)		(21	)
Actuarial gain (loss)			416			(2,733	)
Benefits paid			1,477			1,385
Exchange differences			5			1
Closing defined benefit pension obligation			(38,779	)		(38,187	)

The present value of the obligation is derived from long term cash flow projections and is thus inherently uncertain. The benefits payable by the BTPS are expected to be paid as follows:

Changes in the fair value of plan assets are as follows:

			2007			2006
			£m			£m
Opening fair value of plan assets			35,640			29,628
Expected return			2,292			2,070
Actuarial gains			993			4,855
Regular contributions by employer			406			398
Deficiency contribution by employer			520			54
Contributions by employees			18			21
Benefits paid			(1,477	)		(1,385	)
Exchange differences			(2	)		(1	)
Closing fair value of plan assets			38,390			35,640

The BTPS assets are invested in UK and overseas equities, UK and overseas properties, fixed interest and index linked securities, deposits and short-term investments. At 31 March 2007, the UK equities included 14 million (2006: 15 million) ordinary shares of the company with a market value of £43 million (2006: £33 million). The group occupies two properties owned by the BTPS scheme on which an annual rental of £0.1 million is payable (2006: £2 million).
     The expected long term rate of return and fair values of the assets of the BTPS at 31 March were:

		2007												2006
			Expected long- term rate of return (per annum)		Asset fair value							Target			Expected long- term rate of return (per annum)		Asset fair value							Target
			%			£bn			%			%			%			£bn			%			%
UK equities			7.4			9.8			26			23			7.4			9.9			28			25
Non-UK equities			7.4			11.2			29			31			7.4			10.8			30			32
Fixed-interest securities			4.7			6.5			17			16			4.9			5.6			16			16
Index-linked securities			4.4			3.3			9			10			4.1			3.2			9			10
Property			5.8			4.7			12			13			5.8			4.4			12			12
Cash and other			4.8			2.8			7			7			4.0			1.7			5			5
			6.4			38.3			100			100			6.5			35.6			100			100

The assumption for the expected return on scheme assets is a weighted average based on the assumed expected return for each asset class and the proportions held of each asset class at the beginning of the year. The expected returns on fixed interest and interest linked securities are based on the gross redemption yields at the start of the year. Expected returns on equities and property are based on a combination of an estimate of the risk premium above yields on government bonds and consensus economic forecasts of future returns. The long-term expected rate of return on investments does not affect the level of the obligation but does affect the expected return on pension scheme assets within the net finance income.

The history of experience gains and losses are as follows:

The group expects to contribute approximately £748 million to the BTPS, including £320 million of deficiency contributions, in the 2008 financial year.

Sensitivity analysis of the principal assumptions used to measure BTPS scheme liabilities
The assumed discount rate, mortality rates and salary increases all have a significant effect on the measurement of scheme liabilities. The following table shows the sensitivity of the valuation to changes in these assumptions:

–

scheme assets are valued at market value at the valuation date; and,

–

scheme liabilities are measured using a projected unit credit method and discounted to their present value.

The last three triennial valuations were determined using the following long-term assumptions:

At 31 December 2005, the assets of the BTPS had a market value of £34.4 billion (2002: £22.8 billion) and were sufficient to cover 90.9% (2002: 91.6%) of the benefits accrued by that date. This represented a funding deficit of £3.4 billion compared to £2.1 billion at 31 December 2002. The funding valuation uses conservative assumptions whereas, had the valuation been based on the actuary’s view of the median estimate basis the scheme would have been in surplus. The market value of equity investments had increased and the investment income and contributions received by the scheme exceeded the benefits paid. In the three years ended 31 December 2005, however, the deficit had not improved by the same amount as the assets because the liabilities included longer life expectancy assumptions and used a lower discount rate.
     Following the valuation the ordinary contributions rate increased to 19.5% of pensionable salaries (including employee contributions of 6%) from 18.2%, with effect from 1 January 2007. In addition, the group will make deficiency payments equivalent to £280 million per annum for ten years. The first three years’ instalments are to be paid up front; £520 million was paid in the 2007 financial year and £320 million was paid in April 2007. Subsequently, annual payments of £280 million will be made, with the next payment due in December 2009. This compared to annual deficiency payments of £232 million that were determined under the 2002 funding valuation.
     In the year ended 31 March 2007, the group made regular contributions of £402 million (2006: £396 million). Deficiency contributions of £520 million were also made (2006: £54 million), and a further £320 million was paid in April 2007. Accordingly no further deficiency payments are due until after the 31 December 2008 valuation.
     The intention is for there to be sufficient assets in the scheme to pay pensions now and in the future. Without any further contribution from the company, it is estimated that as at 31 December 2005, the assets of the scheme would have been sufficient to provide around 70% of the members’ benefits with an insurance company.
     If the group were to become insolvent, however, there are a number of additional protections available to members. Firstly, there is the Crown Guarantee which was granted when the group was privatised in 1984. This applies, on a winding up of the group, to pension entitlements for anyone who joined the scheme before 6 August 1984, and to payments to beneficiaries of such persons. Secondly, the Pension Protection Fund (PPF) may take over the scheme and pay certain benefits to members. There are limits on the amounts paid by the PPF and this would not give exactly the same benefits as those provided by the scheme.
     Under the terms of the trust deed that governs the BTPS, the group is required to have a funding plan that should address the deficit over a maximum period of 20 years. The agreed funding plan addresses the deficit over a period of ten years. The BTPS was closed to new entrants on 31 March 2001 and the age profile of active members will consequently increase. Under the projected unit credit method, the current service cost, as a proportion of the active members’ pensionable salaries, is expected to increase as the members of the scheme approach retirement. Despite the scheme being closed to new entrants, the projected payment profile extends over more than 60 years.