David Prosser: Grim reality in small print of BT results

Outlook Did you read the fine print, last time you changed telecoms provider? If you're with BT, let's hope so – anyone who didn't read the fine print of its first-quarter results yesterday probably wouldn't have noticed the small matter of a £3bn increase in its pension fund deficit.

Many companies are these days looking upon their pension schemes as more of a burden, as life expectancy rises, stock markets underperform and, above all, accounting rules require much greater transparency about liabilities. For BT though, burden does not do the scale of the pension problem justice.

The grim reality of the finances of BT's pension scheme were not spelled out until almost the final paragraph of its quarterly results presentation – a case of saving the worst for last. BT's pension deficit, after tax, has doubled from £2.9bn at the last valuation to £5.8bn today.

The figures might have made even tougher reading. For one thing, the fund made a £1.1bn gain on its investment portfolio over the three months to the end of June, mitigating the deficit increase. Also, plenty of analysts, including the Pensions Regulator, remain concerned that BT is not being conservative enough about the way it values its pension scheme.

The nub of the matter is the discount rate, essentially the return which the scheme assumes it will make over the years until it has to pay out pension benefits. BT has just cut its scheme's discount rate, in line with falling corporate bond yields, which is the main reason why its deficit has increased so dramatically. But its critics say the cut wasn't big enough and that were it being more realistic with its assumptions, the deficit would be even larger.

The argument is not purely academic, since the Pensions Regulator has powers to force BT to do more, if it is so minded. That showdown will come sooner rather than later. BT is in the middle of its formal triennial review, during which its scheme valuation must be finalised and agreed with the regulator – the deadline for completion of this review is the end of March, but all parties want to get there sooner.

In practice, BT could be forced to increase its pension contributions by even more than it already has – it agreed earlier this year to raise the company's payments to the fund to £525m a year for the next three years – in order to address the problem. That three-year agreement is now a done deal, but there will be a further debate about what happens once this period concludes.

The scale of BT's pension deficit forced the company to admit yesterday that its assets are now worth £3.2bn less than its liabilities. Remarkably, BT contends that this makes no difference to its ability to pay dividends, though it has, of course, already been forced to slash payments thanks to the travails at its Global Services business.

It is difficult to see, however, how the pension fund can be anything other than a restraint on dividends as the business goes forward, or how the problem is ever likely to be resolved. After all, every penny BT's staff make for their company in the first six months of each year now goes to pay the pension contribution.

The taxpayer should be concerned, too. Underpinning BT's pension scheme is a Crown Guarantee, a pledge that the state will pick up the tab in the event of the company going under. The promise, which dates back to BT's privatisation 25 years ago, is theoretical and does not cover all workers, but it cannot simply be forgotten.

BT is not yet in the dire position occupied by Royal Mail, with which it used to share a pension fund when both organisations were publicly owned and which now finds itself unable to spend on modernisation, so great is its scheme deficit.

However, the telecoms giant is, in all its key markets, large and small, competing with businesses that do not share its legacy problems. None of its rivals has to operate on the principle that half the free cash flow they produce will have to be sunk into a bottomless pension pit. Put another way, as BT fights for its future, it is doing so with one hand tied behind its back.