BAE under fire as cost of closing pension deficit climbs to £2bn

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BAE Systems, the UK's biggest defence contractor, is set to pay a bill of almost £2bn to fill the hole in its pension schemes, it emerged yesterday.

News of the bigger-than-expected pension costs and cautious comments about the outlook for the group's defence businesses overshadowed a 16 per cent rise in operating profits to £900m last year and a record £60bn order book, and BAE shares slipped 6 per cent.

Disclosing that its overall pre-tax pension deficit increased by £1bn last year, to £4.2bn, BAE gave details for the first time about how it plans to close the hole in its main UK pension fund. The deficit stands at £2.4bn on a post-tax actuarial basis and will be met 60 per cent by the company and 40 per cent by employees.

BAE said it would make an immediate one-off contribution of £350m this year into the fund in cash and property. In addition, it will increase annual payments to £110m for the next 10 years and provide a £500m letter of credit to cover future contributions.

George Rose, BAE's finance director, said a broadly similar approach was likely to be taken towards tackling the deficit in its remaining UK and US schemes, which stands at about £400m on a post-tax actuarial basis.

This means the total contribution from the company is likely to amount to about £1.8bn, while employees will have to forego about £1bn in retirement benefits to fill the remainder of the hole. This will be achieved by reducing benefits for employees who retire early, lowering pensions so that they are based on average salaries over the final three years and adjusting entitlements as life expectancy rises.

Dick Olver, BAE's chairman, identified resolving the pensions deficit as one of the company's key achievements during the year, alongside the signing of a new Al Yamamah arms-for-oil deal with Saudi Arabia, which could be worth £10bn to BAE, and the £2.2bn purchase of United Defense Industries, the US maker of the Bradley fighting vehicle.

Mike Turner, the chief executive, cautioned that BAE was unlikely to see profits from the latest Saudi deal, which involves supplying the kingdom with 72 Eurofighter Typhoon aircraft, until towards the end of this decade.

BAE also struck a cautious note about the prospects for its defence businesses this year, saying they would achieve only "modest organic growth".

Airbus, in which BAE has a 20 per cent stake, is expected to increase profits further in the next 12 months after lifting earnings before interest, tax and depreciation 40 per cent last year to £273m. But BAE's commercial aircraft business will be held back by running losses of £50m in its regional aircraft division.

Mr Turner said BAE was keen on further expansion into the US, which accounts for about one-third of group sales of £15bn, but would not overpay.