BT Group plc
Pension Teach-in
27 November 2013
Agenda
UK schemes and valuation measures
Paul Rogers
IAS 19 pensions accounting
Glyn Parry
Actuarial valuation
– external landscape
Mike Smedley, KPMG
– BT position
Glyn Parry
Q&A
2
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BT Group plc
Section 1: UK schemes and valuation measures
Paul Rogers
Head of Pensions Risk
3
BT’s main UK pension schemes
BT Pension Scheme (BTPS)
– defined benefit
– investment risk with company
– closed to new entrants in 2001
BT Retirement Saving Scheme (BTRSS)
– defined contribution
– investment risk with employee
– new BT joiners enter BTRSS
– contract-based arrangement with Standard Life
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BTRSS – membership and benefits
Membership
– c.25,000 active1 members
BT contribution based on level of employee contributions
Employee
BT
4%
6%
5%
8%
6%
8.5%
7%+
9%
Employee choice over investment funds
Auto-enrolment requirements met from 1 November 2012
1
Currently employed by BT and earning benefits
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BTPS – membership
Three sections depending on member joining date
– Section A – joined before 1 December 1971
– Section B – joined between 1 December 1971 and 31 March 1986
– Section C – joined between 1 April 1986 and 31 March 2001
At 31 March
2013
1
2
Active
members
Deferred
members
Pensioners
Total
% total
liabilities2
Section A & B1
19,000
39,000
175,000
233,000
c.80%
Section C
25,000
41,500
18,000
84,500
c.20%
Total
44,000
80,500
193,000
317,500
Section A members have typically elected for Section B benefits at retirement and current active Section A members total <1,000
On an IAS 19 basis at 31 March 2013
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BTPS – benefits
Active members
Section B1
Section C
Deferred
members
Pre 2009 service: Benefits
based on Final Salary
Post 2009 service: Benefits
based on Career Average
Salary increasing at lower of:
• RPI
• The individual’s pay
increase
Fixed at
leaving, then
increased to
retirement,
based on CPI
Pensioners
Increases in
pensions in
payment based
on CPI
Increases in
pensions in
payment based
on RPI to max
5%
BT contributes 13.5% of pensionable pay (including employee
contributions) for benefits earned in year
– next reviewed at 30 June 2014 actuarial valuation
1
Section A members have typically elected for Section B benefits at retirement and current active Section A members total <1,000
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BTPS – governance & management: BT
BT Pensions Committee – responsibilities include:
– overseeing BT’s relationship with the Trustee
– considering significant pension policy and strategy matters for the
Group
– assessing BTPS investment strategy and monitoring performance
– reviewing the actuarial funding valuation
– reviewing and approving BT’s risk management activities for BTPS
– e.g. Pension Increase Exchange exercise
Chaired by Senior Independent Director, Rt Hon Patricia Hewitt
– other members: Sir Mike Rake, Tony Chanmugam, Clare Chapman
and Phil Hodkinson
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BTPS – governance & management: Trustee
Independent Trustee administers and manages scheme
– nine Trustee directors appointed by BT
– recognised trade unions agree Trustee Chairman appointment and
nominate four directors
Trustee sets investment policy after consulting BT
– assets managed by a range of investment managers
– including Hermes Fund Managers Ltd, owned by the BTPS
Trustee publishes a full Report and Accounts once a year
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BTPS – assets
Market value of assets £39.3bn at 30 September 2013
2003 target asset allocation
2013 target asset allocation
12%
17%
29%
9%
11%
16%
63%
12%
31%
Equities
Fixed interest
Equities
Fixed interest
Inflation-linked
Property
Inflation-linked
Property
Other
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BTPS – asset returns
Asset class
Trustee’s expected real return
(above RPI) at 31 December 2012
Equities
4.4%
Fixed interest
0.7%
Inflation-linked
1.3%
Property
3.4%
Other
2.2%
Average
(based on target allocation)
2.5%
7.5% actual return in year to 31 December 2012
– 4.4% above RPI
8.3% pa actual return over last 10 years to 31 December 2012
– 5.0% above RPI
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BTPS – liabilities
Past service:
– value of benefits earned based on service to date
– discounted cash flow of forecast benefits payable
– compare to assets to determine if surplus or deficit
Future service:
– calculation of cost of next year’s benefits
– leads to current regular contributions of 13.5% (actuarial valuation)
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BTPS – liabilities
3,000
Forecast benefits payable by the BTPS, using IAS 19
assumptions at 31 March 2013
2,500
2,000
£m
1,500
NPV = £47.0bn
(at 31 March 2013)
1,000
500
0
2014
2024
2034
2044
2054
2064
2074
2084
 Forecast benefits calculated based on various assumptions
– e.g. inflation, salary growth, retirement age, life expectancy
 Present value of liabilities calculated using discount rate
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2094
Valuation – key measures
Purpose
IAS 19
BT’s median estimate
Actuarial
Prescribed accounting
measure, disclosed
quarterly
BT’s best estimate of
valuation
Used every 3 years to
set cash deficit
payments
Market yield curve for
AA corporate bonds
Expected future asset
returns in BTPS
Prudent view of
expected future asset
returns in BTPS
Approach
Discount rate
Other assumptions
(e.g. longevity, inflation)
Assets
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Future expectations
Market value
Prudent approach
overall required
Valuation – key measures
IAS 19 has historically been volatile
Fluctuations correlated with movements in real discount rate
2008/9
2009/10
2010/11
2011/12
2012/13
2013/14
4
4.5
2
4.0
3.5
0
3.0
-2
2.5
-4
2.0
-6
1.5
-8
1.0
-10
0.5
IAS 19 valuation (gross) (LHS)
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Real discount rate – IAS 19 (RHS)
Real discount rate %
Pension valuation £bn
Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
Valuation – key measures
BT’s median estimate continues to show surplus - £0.7bn at Q2
Difference between median estimate and actuarial valuation
reflects BT’s view on level of prudence within actuarial valuation
2008/9
Q3
Q4
2009/10
Q1
Q2
Q3
2010/11
Q4
Q1
Q2
Q3
2011/12
Q4
Q1
Q2
Q3
2012/13
Q4
Q1
Q2
Q3
2013/14
Q4
Q1
Q2
4
3.2
2
2.5
2.3
Pension valuation £bn
1.0
0
1.6
1.0
-0.2
-1.5
-2
-3.0
-3.9
-4
-6
-8
-9.0
-10
IAS 19 valuation (gross)
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BT’s median estimate (gross)
Actuarial valuation (gross)
0.7
BT Group plc
Section 2: IAS 19 pensions accounting
Glyn Parry
Director Group Financial Control
17
IAS 19 pensions accounting – overview
2012/13 IAS 19
(revised)
Defined
contribution
schemes
(incl BTRSS)
Defined
benefit
schemes
(incl BTPS)
Total
Operating charge
£136m
£263m
£399m
Net interest on
pensions (specific
item)
-
£117m
£117m
Income statement
Balance sheet
£4.5bn
-
IAS 19 at 31/3/13 net of
taxation
£4.5bn
£136m
£217m
£353m
-
£325m
£325m
Cash flow statement
Regular contributions
Deficit contributions
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IAS 19 pensions accounting – overview
IAS 19 balance sheet movements driven by several elements
Net pension Regular
interest contributions Deficit
Service
cost
contributions Actuarial
movements in
assets &
liabilities
Deficit
at start
of year
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Deficit
at end
of year
IAS 19 pensions accounting – overview1
Income
statement
Cash
contributions
Actuarial
movement
£6,258m
£5,856m
£1,313m
£263m
£117m
£217m
£2,448m
£325m
£2,688m
£4,543m
£575m
£1,873m
IAS 19
deficit at
1/4/12
Service
cost2
Net interest
on
pensions
Regular
contributions
Net of deferred tax
1
20
2
Under IAS 19 revised
Includes administration expenses and PPF levy
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Deficit
contributions
Actuarial
gains on
assets
Deferred tax asset
Actuarial
losses on
liabilities
IAS 19
deficit at
31/3/13
IAS 19 pensions accounting – income statement
 Represents cost of benefits
members have earned during the
period, under IAS19 assumptions
 Includes allowance for PPF levy
and administration expenses
 Disclosed within operating costs as
part of staff costs
£263m
£117m
£2,448m
£575m
 Notional calculation required under
IAS 19 (non-cash)
 Net interest calculated based on
deficit and discount rate at the start
of the year, adjusted for cash flows
£1,873m
–
IAS 19
deficit at
1/4/12
Service
cost
Net interest
on
pensions
i.e. broadly equivalent to
£2,448m x 4.95% = £121m
 Treated as a specific item
Income statement
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Net of deferred tax
Deferred tax asset
IAS 19 pensions accounting – cash contributions
 Cash contributions,
mainly based on 13.5%
of active BTPS
members’ pensionable
pay
£217m
£325m
 Difference between
regular contributions and
service cost -appears in
‘other’ in normalised free
cash flow
 As per 2011 triennial
funding valuation
contribution
agreement
IAS 19
deficit at
1/4/12
Service
cost
Net interest
on
pensions
Regular
contributions
Income statement
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Net of deferred tax
Deficit
contributions
 Excluded from
normalised free cash
flow
Cash contributions
Deferred tax asset
IAS 19 pensions accounting – actuarial movement
 Reflects c.12% return in
BTPS over FY, included
in Statement of
Comprehensive Income
£6,258m
 Reflects assumption
changes and liability
experience over the
year, included in
Statement of
Comprehensive Income
£1,313m
£2,688m
IAS 19
deficit at
1/4/12
Service
cost
Net interest
on
pensions
Income statement
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Regular
contributions
Deficit
contributions
Cash contributions
Net of deferred tax
£5,856m
Actuarial
gains on
assets
£4,543m
Actuarial
losses on
liabilities
Actuarial movements
Deferred tax asset
IAS 19
deficit at
31/3/13
IAS 19 pensions accounting – actuarial movement
£6,258m
c.£150m
c.£1,450m
c.£4,650m
Actuarial
losses on
liabilities
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Liability experience over the year
Change in assumed future inflation
– e.g. RPI increased from 3.05% to 3.30%
Reduction in nominal discount rate
– fall from 4.95% to 4.20%
IAS 19 pensions accounting – sensitivity
IAS 19 sensitivity at 31 March 2013
Decrease /
(increase) in
liability (£bn)
0.25 percentage point increase to:
- discount rate
1.7
- inflation rate (RPI, CPI and salary all move by 0.25%)
(1.5)
- salary increases
(0.3)
One year increase in life expectancy
(0.9)
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BT Group plc
Section 3: Actuarial valuation
Mike Smedley
Pensions Partner, KPMG
Glyn Parry
Director Group Financial Control
26
Pension funding landscape
Components of pensions financing
Benefits
Company
contributions
Assets and
returns
Covenant &
prudence
© 2013 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.
27
Pension funding landscape
Regulatory framework and the Pensions Regulator (tPR)
Legislation
Trustees
■ Requires prudence in
overall assumptions for
Scheme Funding
■ Judgement applying
Scheme Funding
legislation
■ New statutory objective
for Pensions Regulator "to minimise any adverse
impact on the sustainable
growth of an employer”
■ Negotiate valuation
assumptions and
outcome with Company
■ Legally control
investment strategy
TPR
■ Wants deficits met –
subject to “affordability”
and balance with other
stakeholders
■ Protect against
deterioration in covenant
(particularly actions in
M&A etc)
■ Moving towards integrated
frameworks for funding,
investment and covenant
© 2013 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.
28
Pension funding landscape
Current issues in funding valuations
■ Low gilt yields / QE
Discount rates
■ Expected asset returns vs. bond yields
■ Future investment strategy, not just today
■ Assumptions reaching a plateau?
Mortality
■ Long term risk remains
Contributions
Long term
planning
■ Growing flexibility in funding plans where deficits
seen as ‘inflated’ by gilt yields
■ More focus on long-term targets or “journey plans”
© 2013 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.
29
Actuarial valuation – 2011 agreement
£3.9bn triennial deficit at 30 June 2011
– 2.0% real discount rate (single equivalent rate above RPI)
– actuarial valuation discount rate typically sits between median
estimate discount rate (expected return on assets) and gilt yields
Real discount rate
31 Dec 2008
30 Jun 2011
BT’s median estimate
3.4%
2.7%
Actuarial valuation
2.5%
2.0%
15 year index-linked gilt yields
0.8%
0.6%
Actuarial valuation takes prudent view of future returns on
expected asset portfolio
– assumes asset portfolio de-risks over time into lower risk/return
asset classes
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Actuarial valuation – 2011 agreement
£0.8bn
£0.8bn
£1.6bn
£1.3bn
£9.0bn
£4.2bn
£0.7bn
£3.9bn
Gross deficit Net interest
at 31 Dec
on pensions
2008
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Benefits
earned
Regular
Deficit
contributions contributions
Actuarial
gains on
assets
Actuarial
Gross deficit
gains on
at 30 Jun
liabilities
2011
including
move to CPI
Actuarial valuation – 2011 agreement
10 year recovery plan
– £2bn lump sum payment in March 2012
– 2 payments of £325m in March 2013 & March 2014
– 7 payments of £295m from March 2015 to 2021
– total cash payments of £4.7bn, NPV of £3.9bn
– no investment outperformance assumed in recovery plan
Valuation documentation submitted to the Pensions Regulator
– final Court decision on Crown Guarantee will inform the Regulator’s
next steps with regard to the valuation of the Scheme
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Actuarial valuation – 2011 agreement
At 2014 valuation, present value of remaining 2011 recovery
plan is c.£1.7bn (using 2011 discount rates)
£m
2011 triennial
deficit payments
Additional payments if deficit exceeds NPV of
remaining 2011 recovery plan by
£nil
£1.0bn
£2.0bn
£2.9bn
March 2015
295
-
199
273
360
March 2016
295
-
205
282
371
March 2017
295
-
211
289
381
A new agreement would cover additional contributions if these
are required
Similar mechanism of additional contributions based on deficit
agreed at the 2017 valuation
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Actuarial valuation – 2011 agreement: other features
Shareholder distributions
– matching contributions if distributions exceed deficit contributions
from 1 March 2012 to 30 June 2015 (excluding buybacks due to
employee awards)
Disposals and acquisitions
– if BT generates >£1bn from disposals (net of acquisitions) in any
year, BT contributes one third of net cash proceeds
Negative pledge
– any secured financing above a £1.5bn threshold would require BT
to provide equivalent security to the BTPS
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Actuarial valuation – 2014 process
Key actions
– collate and check membership data at 30 June 2014
– review legal, demographic and economic changes
– review company covenant
– determine any changes to assumptions / prudence level / approach
– audit asset value at 30 June 2014
– actuarial calculations of updated position
– agree contribution schedule and any other protections
– Scheme Actuary finalises documents and certification
– valuation documents submitted to Pensions Regulator
– 15 month statutory deadline, i.e. by 30 September 2015
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Actuarial valuation – 2014 key factors
Market conditions at 30 June 2014
- affects asset values and future assumptions
(e.g. investment returns, inflation)
Assessment of company covenant
Level of prudence
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BT Group plc
Q&A
37
BT Group plc
Appendix
38
Further information
BT 2013 Annual Report (p132-141)
– www.btplc.com/annualreport
BTPS Trustee website
– www.btps.co.uk
Quarterly results
– www.btplc.com/results
Replay and transcript of this presentation (available from 28 Nov)
– www.btplc.com/Sharesandperformance/Presentations/Teach-ins
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BTPS – Crown Guarantee, current position
Overview
– when privatised, the Government gave a guarantee that it would
stand behind BT’s obligations to the BTPS, if BT became insolvent
Legal proceedings
– High Court findings in 2010 and 2011, together with various
concessions made by Government, mean that:
– the Crown Guarantee covers liabilities for members who joined the
BTPS both before and after privatisation (subject to some limited
exclusions)
Next steps
– court judgments being appealed by Government
– date of hearing is 30 April 2014
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BTPS – life expectancy assumptions
Life expectancy assumptions under IAS 19, after retiring at
age 60
At 31 March, number of years
2012
2013
Male in lower pay bracket
25.8
25.9
Male in higher pay bracket
27.5
27.6
Female
28.3
28.4
Average improvement for member
retiring at 60 in 10 years’ time
1.0
1.0
Life expectancy assumptions at actuarial valuations, after
retiring at age 60
At date of valuation, number of years
Dec 2008 valuation
June 2011 valuation
Male in lower pay bracket
25.5
26.0
Male in higher pay bracket
27.7
27.8
Female
28.3
28.5
Average improvement for member
retiring at 60 in 10 years’ time
1.1
1.2
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Glossary
Active members
Members of a BT pension scheme that are currently employed by BT and
earn benefits
Other assets
Include commodities, hedge funds, credit opportunities and emerging
market bond investments
CPI
Consumer Prices Index - a measure of UK inflation published monthly by
the Office for National Statistics. It measures the change in the cost of a
basket of retail goods and services. Typically lower than RPI as it takes
the geometric mean of prices rather than the arithmetic mean used by
RPI.
Career Average Salary
pension
Pension built up based on a Career Average Revalued Earnings basis.
BTPS benefits typically built up on 1/80th of pensionable salary each year
(plus cash lump sum), and revalued each subsequent year based on the
lower of RPI or salary increase
Defined benefit scheme
Pension arrangement under which the members receive a pension at
retirement dependent on factors such as age, years of service and
pensionable pay, not dependent on contributions made into the scheme
Defined contribution
scheme
Pension arrangement where pension benefits are linked to contributions
paid in
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Glossary
Deferred members
Those members of the BTPS that are no longer employed by BT, but
have yet to retire and take a pension
Fixed interest assets
Investments on which a fixed rate of interest is received
IAS 19
Accounting standard published by the International Accounting Standards
Board that outlines the accounting requirements for employee benefits,
including short-term benefits (e.g. wages and salaries, annual leave),
post-employment benefits such as retirement benefits, other long-term
benefits (e.g. long service leave) and termination benefits
Inflation-linked assets
Assets providing expected returns linked to the rate of inflation
Liability experience
The impact of allowing for actual scheme experience over a period
compared to expectations, e.g. mortality, pay increases, rate of leavers
Normalised free cash
flow
Free cash flow before specific items, purchases of telecommunications
licences, pension deficit payments and the cash tax benefit of pension
deficit payments
PPF
Pension Protection Fund - a fund established by the Government to pay
compensation to members of eligible defined benefit pension schemes,
where there is a qualifying insolvency event in relation to the employer
and where there are insufficient assets in the scheme to cover Pension
Protection Fund levels of compensation
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Glossary
Pensionable pay
A member’s basic annual pay including certain allowances but excluding
overtime
Pensions Regulator
Body established under the Pensions Act 2004 with effect from 6 April
2005. Main statutory objectives are to: protect the benefits of members of
work based pension arrangements; keep calls on the Pension Protection
Fund to a minimum; and, facilitate good pension administration.
RPI
Retail Prices Index – a measure of UK inflation published monthly by the
Office for National Statistics. It measures the change in the cost of a
basket of retail goods and services. Typically higher than CPI as it takes
the arithmetic mean of prices rather than the geometric mean used by
CPI.
Target Asset Allocation
The strategic allocation of assets between different classes of
investment, reviewed regularly by the Trustee
Trustee
A person or company, acting separately from the employer, who holds
assets in trust for the beneficiaries of the scheme. Trustees are also
responsible for the administration and running of the pension scheme, in
accordance with the Trust Deed and Rules.
Yield curve
A curve charting interest rates, at a set point in time, of bonds at different
durations
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