View from City Road: Keep an eye on the pension fund accounts

'I was stunned. I almost fell off my chair.' So said a close observer of BT in the City.

He was not the only one to be taken aback by the disappearance of BT's pounds 1.2bn pension fund surplus and its replacement with a shortfall of pounds 750m in one year. After all, it is not as if Maxwell had been at work. BT's pounds 13.4bn pension assets are safe.

His reaction was, however, nave. Had he and others read the recent pension fund accounts, they would have seen that the surplus had all but disappeared already and another valuation was under way that might throw up a deficit. Warning bells would have rung.

The BT experience illustrates once again the way in which the finances of a pension fund are - legitimately - intertwined with those of a sponsoring company. It also serves as a useful reminder that surpluses can disappear in the time it takes an actuary to sign his name.

About pounds 500m of BT's surplus was used to fund early retirements for those who have been made redundant and are 45 years old or more. But another pounds 500m - about 6 per cent of the UK equity portfolio - was absorbed by Budget changes to the tax on dividends and the same amount by changes to the actuaries' expectations for dividend growth.

Thanks to the wonder of accounting standards the effect on BT's profits is small, pushing up pension costs from pounds 160m to pounds 250m a year. But even this will be offset by a conveniently timed change to depreciation that will save pounds 40m this year and pounds 100m next. The balance sheet will be hit by the pounds 800m cost of topping up the pension fund.

Actuaries' ability to change their view is surprising and unsettling, especially given their reputation for being dull and boring. In 1979 R Watson thought BT would not have to contribute to its pension fund for another 10 years. As it turned out they had to restart their contributions last month.

This is not just because of redundancies, which Watson could not have anticipated, but also because it has come to appreciate that people are living longer and that dividends are falling rather than rising. (Except in the case of BT, which has lifted its payout by 8 per cent.)

As they are to value the fund each year, we should be prepared for more frequent changes of heart. The lesson for investors is that they should study the accounts of pension funds almost as closely as those of companies.