As the market waits with bated breath for an update on British Airways’ triennial review of its pension scheme, we note some parallels with another leviathan of UK corporate pension deficits — BT.
The telephone company released its second-quarter earnings last month, which showed its post tax pension deficit had increased from £2.9bn at the end of March 2009 to £6.8bn at the end of September. The post tax deficit now accounts for a whopping circa 60 per cent of BT’s market cap. Eek.
And that 2009 increase in the deficit occurred even after BT’s pension assets increased 11 per cent in the period. Double eek.
But of course, assets are only one side of the pensions equation. The other is liabilities — and that is determined by something called the discount rate.
For UK companies the discount rate is based on AA-rated corporate bond yields. When the discount rate increases, pensions liabilities decrease, and vice versa. The yield on AA-rated corporates fell from 6.7 per cent in March to 5.5 per cent in September, which meant BT’s pension liabilities increased by about 25 per cent.
You can see the yield action in the below chart — from UBS’s accounting expert Dennis Jullens:
But there seems to be a bit of flexibility when it comes to the discount rate, which could have a rather massive effect on a pension fund’s liabilities.
As Jullens notes:
A popular view is to ignore the accounting position of the pension scheme and focus on the triennial actuarial review that is currently ongoing at BT. We would like to highlight that there is a risk that the triennial actuarial review will result in a higher pension liability and deficit than the accounting calculation. This because the UK Pension Regulator in its Regulatory Code of practise states that ‘it is a legislative requirement that trustees must follow the principles set out in legislation with regards to ‘prudence’ when choosing the actuarial assumptions to be used in the calculation’. If pension trustees interpret this to mean using the yield on gilts as the discount rate rather than the yield on AA corporate bonds then the pension liability can actually come out materially higher than the accounting number (assuming all other assumptions such as longevity and inflation being equal). Using the yield on gilts to calculate the IAS 19 pension liability would lead to close to doubling of the accounting post tax deficit from the current £6.8bn to in excess of £12bn.
There’s been some speculation before that British Airways’ pension trustees could get creative with the discount rate, in order to help decrease the size of the airline’s pension liabilities — especially ahead of any merger with Iberia, for which the pensions issue has been something of a sticking point.
But the idea that the the trustees may choose, or feel obligated, by regulatory guidance, to use gilt yields — which have been much lower than those of AA-rated corporates in recent months — could put additional pressure on the deficit, and by extension, a merger with Iberia.
Who knew pensions accounting could be so exciting?
Related links:
One way to stop juggling pension conflicts at BA – FT
In pension trustees BA trusts – FT Alphaville
QE and exploding pensions – FT Alphaville