BTPLC Annual Report 2005 - Consolidated Fianancial Statements

28.

Pension costs

Background

The group continues to account for pension costs in accordance with UK Statement of Standard Accounting Practice No. 24 “Pension Costs” (SSAP 24). In addition, disclosures have been presented in accordance with Financial Reporting Standard No. 17 “Retirement Benefits” (FRS 17).
     The group offers retirement 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. The BTPS is funded through a legally separate trustee administered fund. This scheme has been closed to new entrants since 31 March 2001 and replaced by a defined contribution scheme. Under this defined contribution scheme the profit and loss charge represents the contribution payable by the group based upon a fixed percentage of employees’ pay.
The total pension costs of the group expensed within staff costs in the year was £465 million (2004 – £404 million, 2003 – £322 million), of which £430 million (2004 – £376 million, 2003 – £306 million) related to the group’s main defined benefit pension scheme, the BTPS. The increase in the pension cost in the 2005 financial year reflects the introduction of Smart Pensions, a salary sacrifice scheme under which employees elect to stop making employee contributions and for the company to make additional contributions in return for a reduction in gross contractual pay. As a result there has been a switch between wages and salaries and pension costs of £99 million in the year. The increase in the pension cost in the 2004 financial year reflects the amortisation charge for the pension deficit partly offset by a reduction in the number of active members of the BTPS and the interest credit relating to the balance sheet prepayment. This total pension cost includes the cost of providing enhanced pension benefits to leavers, which amounted to £nil (2004 – £1 million, 2003 – £60 million).
     The pension cost applicable to the group’s main defined contribution schemes in the year ended 31 March 2005 was £11 million (2004 – £7 million, 2003 – £4 million) and £1.2 million (2004 – £0.7 million, 2003 – £0.4 million) of contributions to the schemes were outstanding at 31 March 2005.
     The group occupies four properties owned by the scheme on which an annual rental of £7 million is payable. 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 2005, the UK equities included 17 million (2004 – 33 million, 2003 – 37 million) ordinary shares of the company with a market value of £36 million (2004 – £58 million, 2003 – £58 million).

BT Pension Scheme

Funding valuation

A triennial valuation is carried out for the independent scheme trustees by a professionally qualified independent actuary, using the projected unit method. The purpose of the valuation is to design a funding plan to ensure that present and future contributions should be sufficient to meet future liabilities. The triennial valuation as at 31 December 2002 forms the basis of determining the group’s pension fund contributions for the year ending 31 March 2005 and future periods until the next valuation is completed. The funding valuation is performed at 31 December because this is the financial year end of the BTPS.

	The valuation basis for funding purposes is broadly as follows:
	scheme assets are valued at market value at the valuation date; and
	scheme liabilities are measured using a projected unit method and discounted at the estimated rate of return reflecting the assets of the scheme. The last three triennial valuations were determined using the following long-term assumptions:



	2002 valuation %		1999 valuation %	1996 valuation %	2002 valuation %		1999 valuation %	1996 valuation %

Return on existing assets, relative to market values	4.52		2.38	3.80	7.13		5.45	7.95
(after allowing for an annual increase in dividends of)	1.00		1.00	0.75	3.53		4.03	4.78
Return on future investments	4.00		4.00	4.25	6.60		7.12	8.42
Average increase in retail price index	–		–	–	2.50		3.00	4.00
Average future increases in wages and salaries	1.50	*	1.75	1.75	4.04	*	4.80	5.82
Average increase in pensions	–		–	–	2.50		3.00	3.75-4.00

*There is a short term reduction in the real salary growth assumption to 1.25% for the first three years.

The mortality assumption reflects improvements in life expectancy since the 1999 valuation and incorporates further future improvements.
The assumed rate of investment return, salary increases and mortality all have a significant effect on the funding valuation. A 0.25 percentage point change in these assumptions would have the following effects on the funding deficit:



	Increase £bn		Decrease £bn

0.25 percentage point change in:
Investment return	(0.9	)	0.9
Wage and salary increases	0.2		(0.2	)

An additional year of life expectancy would result in a £0.7 billion increase in the deficit.
     At 31 December 2002, the assets of the BTPS had a market value of £22.8 billion (1999 – £29.7 billion) and were sufficient to cover 91.6% (1999 – 96.8%) of the benefits accrued by that date, after allowing for expected future increases in wages and salaries but not taking into account the costs of providing incremental pension benefits for employees leaving under release schemes since that date. This represents a funding deficit of £2.1 billion compared to £1.0 billion at 31 December 1999. The funding valuation uses conservative assumptions whereas, had the valuation been based on the actuary’s view of the median estimate basis, the funding deficit would have been reduced to £0.4 billion. Although the market value of equity investments had fallen, the investment income and contributions received by the scheme exceeded the benefits paid by £0.3 billion in the year ended 31 December 2002. As a result of the triennial funding valuation the group agreed to make employer’s contributions at a rate of 12.2% of pensionable pay from April 2003 and annual deficiency payments of £232 million. This compared to the employer’s contribution rate of 11.6% and annual deficiency payments of £200 million that were determined under the 1999 funding valuation. In the year ended 31 March 2005, the group made regular contributions of £376 million (2004 – £284 million, 2003 – £278 million) and additional special contributions for enhanced pension benefits to leavers in the year ended 31 December 2003 of £6 million (2004 – £130 million, 2003 – £129 million) and deficiency contributions of £nil (2004 – £612 million, 2003 – £200 million) as a result of the early payment of £380 million made in the 2004 financial year that was scheduled for payment in subsequent years.
     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 whilst the agreed funding plan addresses the deficit over a period of 15 years. The group will continue to make deficiency payments until the deficit is made good.
     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 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.

SSAP 24 accounting valuation

The SSAP 24 valuation is broadly on the following basis:

scheme assets are valued at market value; and

scheme liabilities are measured using the projected unit method and discounted at the estimated rate of return reflecting the assets of the scheme.

The pension cost for the 2003 financial year was based on the SSAP 24 valuation at 31 March 2000. At 31 March 2000 there was a SSAP 24 deficit of £0.2 billion and the regular cost for the 2003 and 2002 financial years was 11.6% of pensionable salaries. The SSAP 24 valuation at 31 March 2000 was based on the same assumptions as the December 1999 funding valuation, with the exception that, over the long term, it has been assumed that the return on the existing assets of the scheme, relative to market values, would be a nominal 5.6% per annum which equates to a real return of 2.5% per annum.
The pension costs for the 2005 and 2004 financial years were based upon the SSAP 24 valuation at 31 March 2003. At 31 March 2003 there was a SSAP 24 deficit of £1.4 billion, before taking account of the balance sheet prepayment and the regular cost is 11.3% of pensionable salaries. The SSAP 24 valuation at 31 March 2003 is based on the 31 December 2002 funding valuation rolled forward, and uses the same assumptions as set out above, with the following exceptions:

return on existing assets is assumed to be a nominal 7.1% per annum, which equates to a real return of 4.7%;

average increase in retail price index is assumed to be 2.25% per annum; and

the average future increases in wages and salaries is assumed to include a short term reduction in the real salary growth assumption to 0.75% for the first three years, before returning to 1.5%.

The cumulative difference since the adoption of SSAP 24 between the cash contributions paid by the group to the pension scheme and the profit and loss charge is reflected on the balance sheet. The cumulative cash contributions exceed the profit and loss charge and the resulting difference is shown as a prepayment on the balance sheet. At 31 March 2005 the prepayment was £1,118 million (2004 – £1,172 million).
The pension charge to the profit and loss account will also include the amortisation of the combined pension fund position and pension prepayment over the average remaining service lives of scheme members, which amounts to 13 years, and the cost of enhanced pension benefits provided to leavers.

FRS 17 – Retirement benefits

The group continues to account for pensions in accordance with SSAP 24. Full implementation of FRS 17 has been deferred by the Accounting Standards Board and would have applied to the group for the 2006 financial year. However, in the 2006 financial year the group will adopt International Financial Reporting Standards (IFRS). The requirements for disclosure under FRS 17 remain in force between its issue and adoption of IFRS, and the required information is set out below. FRS 17 specifies how key assumptions should be derived and applied. These assumptions are often different to the assumptions adopted by the pension scheme actuary and trustees in determining the funding position of pension schemes. The accounting requirements under FRS 17 are broadly as follows:

scheme assets are valued at market value at the balance sheet date;

scheme liabilities are measured using a projected unit method and discounted at the current rate of return on high quality corporate bonds of equivalent term to the liability; and

movement in the scheme surplus/deficit is split between operating charges and financing items in the profit and loss account and, in the statement of total recognised gains and losses, actuarial gains and losses.

The financial assumptions used to calculate the BTPS liabilities under FRS 17 at 31 March 2005 are:



	2005 %		2004 %		2003 %		2005 %		2004 %		2003 %

Average future increases in wages and salaries	1.00	*	1.00	*	1.50	*	3.73	*	3.63	*	3.78	*
Average increase in pensions in payment and deferred pensions	–		–		–		2.70		2.60		2.25
Rate used to discount scheme liabilities	2.63		2.83		3.08		5.40		5.50		5.40
Inflation – average increase in retail price index	–		–		–		2.70		2.60		2.25

*There is a short term reduction in the real salary growth assumption to 0.75% for the first year (2004 – two years, 2003 – three years).

The expected nominal rate of return and fair values of the assets of the BTPS at 31 March were:


	31 March 2005					31 March 2004						31 March 2003

		Expected long- term rate of return (per annum)	Asset fair value				Expected long- term rate of return (per annum	)	Asset fair value				Expected long- term rate of return (per annum)	Asset fair value
		%		£bn	%		%			£bn	%		%		£bn		%

UK equities		8.0		9.6	32		8.2			9.2	34		8.2		7.4		34
Non-UK equities		8.0		9.0	30		8.2			8.1	30		8.2		6.4		30
Fixed-interest securities		5.4		4.6	16		5.3			4.0	15		5.2		3.1		14
Index-linked securities		4.4		2.8	10		4.4			2.3	9		4.3		1.7		8
Property		6.8		3.6	12		6.8			3.3	12		7.0		3.3		15
Cash and other		4.0		–	–		4.0			–	–		4.0		(0.4	)	(1	)

Total		7.1		29.6	100		7.3			26.9	100		7.4		21.5		100

The long-term expected rate of return on investments does not affect the level of the deficit but does affect the level of the expected return on assets within the net finance cost charged to the profit and loss account under FRS 17.
The net pension deficit set out below under FRS 17 is as if this standard was fully applied. The fair value of the BTPS assets, the present value of the BTPS liabilities based on the financial assumptions set out above, and the resulting deficit, together with those of unfunded pension liabilities at 31 March 2005 and 31 March 2004 are shown below. The fair value of the BTPS assets is not intended to be realised in the short term and may be subject to significant change before it is realised. The present value of the liabilities is derived from long-term cash flow projections and is thus inherently uncertain.



	Assets £m	Present value of liabilities £m	Deficit £m		Assets £m	Present value of liabilities £m	Deficit £m

BTPS	29,550	34,270	4,720		26,900	32,000	5,100
Other liabilities	26	87	61		–	36	36

Total deficit			4,781				5,136
Deferred tax asset at 30%			(1,434	)			(1,541	)

Net pension liability			3,347				3,595

If the above amounts had been recognised in the financial statements, the group’s net assets and profit and loss reserve at 31 March would be as follows:

	2005 £m		2004 £m	^a

Net assets (deficiency)
Net assets as reported	3,851		3,066
SSAP 24 pension prepayment (net of deferred tax)	(776	)	(820	)
SSAP 24 pension provision (net of deferred tax)	31		25
Net pension liability under FRS 17	(3,347	)	(3,595	)

Net deficiency including net pension liability	(241	)	(1,324	)

	2005 £m		2004 £m

Profit and loss reserve
Profit and loss reserve, as reported	2,416		1,632
SSAP 24 pension prepayment (net of deferred tax)	(776	)	(820	)
SSAP 24 pension provision (net of deferred tax)	31		25
Net pension liability under FRS 17	(3,347	)	(3,595	)

Profit and loss reserve including net pension liability	(1,676	)	(2,758	)

^a	Restated – see note 1

On the basis of the above assumptions and in compliance with FRS 17 the amounts that would have been charged to the consolidated profit and loss account and the statement of total recognised gains and losses for the year ended 31 March 2005 would be as follows:

	2005 £m		2004 £m

Analysis of amounts that would be charged to operating profit on an FRS 17 basis
Current service cost	540		438
Past service cost	–		1

Total operating charge	540		439

Amount that would be charged (credited) to net interest payable on an FRS 17 basis
Expected return on pension scheme assets	(1,918	)	(1,560	)
Interest on pension scheme liabilities	1,720		1,615

Net finance (income) expense	(198	)	55

Amount that would be charged to profit before taxation on an FRS 17 basis	342		494

Analysis of the amount that would be recognised in the consolidated statement of total recognised gains and losses on an FRS 17 basis
Actual return less expected return on pension scheme assets	1,664		4,130
Experience losses arising on pension scheme liabilities	(437	)	(290	)
Changes in assumptions underlying the present value of the pension scheme liabilities	(933	)	(500	)

Actuarial gain recognised	294		3,340

The net pension cost of £342 million for the year ended 31 March 2005 (2004 – £494 million) under FRS 17 is £123 million lower (2004 – £90 million higher) than the profit and loss charge recognised under SSAP 24.
The movements in the net pension liability, on an FRS 17 basis, during the year were:

	2005 £m		2004 £m

Deficit at 1 April	5,136		9,033
Current service cost	540		438
Contributions	(413	)	(1,051	)
Past service costs	–		1
Other finance (income) expense	(198	)	55
Acquisitions	10		–
Actuarial gain recognised	(294	)	(3,340	)

Deficit at 31 March	4,781		5,136

Net pension liability, post tax, at 31 March	3,347		3,595

The history of experience gains (losses) which would have been recognised under FRS 17 were:

	2005		2004		2003

Difference between expected and actual return on scheme assets:
Amount (£m)	1,664		4,130		(6,995	)
Percentage of scheme assets	5.6%		15.4%		32.5%
Experience gains and losses on scheme liabilities:
Amount (£m)	(437	)	(290	)	1,056
Percentage of the present value of scheme liabilities	1.3%		0.9%		3.5%
Total amount recognised in statement of total recognised gains and losses:
Amount (£m)	294		3,340		(7,599	)
Percentage of the present value of scheme liabilities	0.9%		10.4%		24.9%

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