How To Analyse Pension Fund Liabilities

Published in Investing on 22 September 2009

When we inspect a company's accounts these days, we often need to pay particular attention to its pension fund.

When I started my occasional series on how to understand company reports, I mentioned that a lot of seasoned investors will tell you that the best way to approach a report is from the back, because that's where all the detailed 'Notes to The Accounts' are to be found. They explain all kinds of things that will affect a company in the future, even if they haven't had much impact on the bottom line yet.

So over the next few 'investing basics' articles, I'll be digging into a few of these notes, and a few other bits and bobs around a company report that we really should investigate, and I'll illustrate them with some actual examples.

Today, I'll be considering a potential timebomb that Tony Luckett has written about recently, the pension fund deficit problem. I'll use BT Group (LSE: BT-A) as my illustration, and we'll see how BT's 2009 annual report deals with it. The report can be obtained from the BT's web site -- my references here are to the downloaded PDF of the full report.

Whence the problem?

Tony provided a great explanation of how the pensions deficit problem, which is affecting a number of companies right now, arose in the first place. Just about everyone knows that BT has ongoing problems with its own pension fund, and this year slashed its dividend to help make up its shortfall. So let's see what the BT report notes say about it.

The place to find the meat is Note 29, "Retirement benefit plans", on page 121 of the report (and which extends to four and a half pages!) It looks quite intimidating, but there's some useful opening information regarding the problematic BT Pension Scheme (BTPS), which was a defined benefits scheme and which has been closed to new entrants since 2001, and the replacement BT Retirement Plan (BTRP).

There's a lot of stuff about how the pension fund value is calculated, in actuarial terms, which might not interest many people, but the chart at the top of page 123, showing the forecasts for future annual payments to pensioners is interesting. Although pension payments for 2010 are expected to come in at over £1.5bn, payments won't peak until sometime around 2033, when BT expect an annual outgoing of around the £3bn mark -- and that really shows what a long-term problem it is.

They're living longer

The last few of BT's defined benefit pensioners are not expected to die off until after 2079, when the youngest entrants in 2001, who presumably started work aged 16, will be 94 -- using an estimate of an increase in longevity of 1 year every decade, BT is allowing for its pensioners to hang on for 7 years longer by 2079. That little chart does quite nicely illustrate the scale of BT's future pensions liabilities.

On the same page, we see a breakdown of BT's calculation of its defined benefit pension obligations (the amount it would need in assets now, to meet the entire estimated future costs of payments from the scheme) and its fund assets. 

The obligations figure comes in at £33.3bn, but the assets total only £29.4bn. So that's a deficit of £3.9bn, which, when adjusted for tax (see the third table on page 122), gives us the net £2.9bn deficit that made the headlines at the time, and which is quoted on page 42 of the report. 

After the annual results were announced, BT subsequently reported that its pension fund deficit had ballooned to £5.8bn in the three months ending June 2009.

Independent review

The allocation of the pension fund's assets is there on page 124, so those interested in asset allocation theory can decide if they think the diversification is right, but for most of us, the next meaty stuff is on page 125, where the triennial regulatory pension fund re-evaluation is discussed. The December 2008 review, under the watchful eye of the Pensions Regulator, was keenly anticipated.

Although the 2008 review had not been completed at the time of the annual results, we can at least see the details of the decision for BT to increase its pension fund payments by £525m per year for the next three years (until the next re-evaluation), which brings expected total contributions (see page 124, near the bottom) to £775m for 2010.

That comes on the back of the 2005 deficit having stood at £3.4bn (up from £2.1bn in 2002), and while the final figure from the regulatory review wasn't available at the time (and was still not available at the time of the first-quarter results in June), we could at least see that it was growing, and we can see quite a good explanation of past, present, and expected future pensions fund contributions.

Overall, we can see that the amounts relating to the pension fund are scarily large compared to BT's current market capitalisation of £10bn, and thanks to Note 29, we can get a handle on where the big numbers came from.

Next time, I'll look at some more issues from the notes that might hide serious potential future impacts on profits.

More Investing Basics from Alan Oscroft:

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Comments

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theRealGrinch 22 Sep 2009 , 1:44pm

indeed pensions are somethign to read up on in the notes. to gauge the size of the pension liabilities what is the best indicator to compare it against as a £10m deficit for one company may be easier to handle than a £1m for another?

acid test (CA vs CLs less stock), TNAV are the two others I check out first.

Abesimon 11 Jul 2012 , 2:10pm

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