Outlook: Pension deficits pile on the agony for corporate earnings

British Telecom's pension fund deficit was variously reported by the company yesterday as £1.4bn, £2.1bn and £6.3bn. The second of these figures is BT's own worst case estimate of the funding deficit, while the last would already have been deflated by £600m thanks to the bounce in the stock market over the past month and a half.

Confused? Whatever the real size of the deficit, there's nothing like the bottom line to concentrate minds. The upshot is that BT will have to find an extra £232m a year out of profits for the next 15 years on top of normal contributions to keep paying its pension liabilities. The previous estimate was £200m over just five years. BT had prepared the market for this shocker of an announcement, so the shares actually rose yesterday on relief that things weren't bleaker still.

Even so, they are quite bad enough. For a partial explanation of why the outlook for corporate earnings is so poor, look no further than announcements like these. Even for a large, strongly cash generative company like BT, this is a lot of money, yet it is a pattern being repeated to varying degrees across the stock market. Britain's funded final-salary pension arrangements used to be the envy of the world. So well funded did they seem that many companies took contributions holidays or creamed off the supposed surplus. As we now know, most of these schemes were not nearly as well funded as was assumed.

One of the distinguishing features of the present bear market is the way it has compounded the deficits in final-salary pension schemes, helping to create a downward spiral in share prices. Shares in once mighty industrial giants such as Rolls-Royce have become little more than a gamble on the wider state of the stock market as their massive pension fund liabilities bob up and down with the index.

As can be seen from BT's tortuous efforts to explain its pensions problem yesterday, all kinds of measures can be used to gauge the size of the pensions gap. The Accounting Standards Board wants everyone to use FRS 17, which gives a point in time measure of the current value of assets against assumed liabilities.

In BT's case, FRS 17 establishes the deficit at £6.3bn. In the Royal Mail's case, also reported yesterday, the equivalent number is £4.6bn. If the stock market recovers, most of these deficits will melt away, though perhaps not as quickly or completely as they once might have done as most pension funds have greatly reduced their exposure to equities over the last three years. Of the other two measures cited, one is the old standard of SSAP24 (£1.4bn), and the other is BT's own estimate of how much extra it will have to find to fund its pension liabilities, a measure that makes some relatively safe assumptions about rates of return, inflation, dividend growth and other variables.

But what's really clobbered the final-salary pension schemes is not so much the bear market, or even the Government's iniquitous imposition of tax on dividends, but increased longevity. Once upon a time, final-salary pensions were an affordable perk, but only because people died relatively soon after retirement.

Today pensioners are quite likely to last 20 years or more, hugely increasing what is in effect a deferred payroll cost. The National Association of Pension Funds reported yesterday that only one in five final salary pension schemes is still open to new entrants, as companies desperately attempt to cap the pension liabilities they have let themselves in for.

For most it will take many years to make a difference. The age profile of existing final-salary scheme members means that BT's total pensions bill continues to rise steeply until 2030, when it will peak out at about £1.75bn a year. It won't be until about 2070 that the scheme pays its last cheque, by which time BT in its present form is unlikely to exist at all.

Branson/Bishop

Sir Richard Branson has been trying to get a merger between Virgin Atlantic and Sir Michael Bishop's bmi British Midland to fly for years and yesterday his latest attempt again came down in flames. There are any number of reasons why a merger would make sense but the biggest obstacle remains the two principals themselves.

Virgin would get access to bmi's landing rights at Heathrow where it is the second-biggest operator after British Airways and bmi would get access, courtesy of Virgin, to the transatlantic - a market it has coveted for years. The resulting combination would give BA a real run for its money.

At present, Virgin does not have the headroom to expand at Heathrow to compete with BA, but bmi's 14 per cent share of slots at the airport would solve that overnight. Meanwhile, bmi would be able to start serving the US from Heathrow at long last. As things stand, its long-haul Airbus A330 aircraft are restricted to operating from Manchester where they lose money every time they take off.

Apart from the usual benefits of sharing marketing, ground handling and engineering costs, a merger might also get the two airlines out of their respective holes. Virgin would gain access to passengers on the short-haul network which bmi serves from Heathrow while bmi would get some respite from the bashing it has taken in the last two years from rival low-cost operators.

The deal comes unstuck on price and ego. In order to remain airborne, both Sir Richard and Sir Michael have reluctantly brought large minority shareholders on board. Singapore owns 49 per cent of Virgin while Lufthansa and SAS own 49.9 per cent of bmi. A merger would force one of the two airline knights to give up control. Sir Michael has no one to pass the business on to but that doesn't make him any keener to have Sir Richard as a surrogate son. Equally, it is hard to conceive of Virgin without its bearded boss.

If the merger talks were not already teetering, then yesterday's disclosure of them delivered the coup de grace. They may yet be resurrected but the reality is that flying pigs are more likely than a successful merger of these two businesses as long as Sir Richard and Sir Michael are around.

Elstein/BBC

The Conservative Party has appointed David Elstein, former head of Channel 5, to chair its advisory group on the future of the BBC. The whole exercise seems a little academic. A snowball in Hades would stand a better chance than the Tories of being back in power in time for renewal of the BBC's charter in 2006. None the less, the Government has asked for the widest possible debate and Mr Elstein is guaranteed to provide a lively contribution.

The Tory position on the licence hasn't yet been formulated, but Mr Elstein's is already quite clear; in its present form he thinks the fee both indefensible and doomed. The growth of digital, multi-channel TV certainly makes it seem increasingly archaic, but assuming we want to preserve public service TV and radio on the scale now provided, how could the revenues from what is in essence a flat rate tax be replaced?

Mr Elstein acknowledges that opening up the BBC to advertising wouldn't work. There is only a certain amount of advertising to go around and what there is already struggles to support the commercial sector even without the BBC muscling for a place at the table. Instead, Mr Elstein cites research which shows that large numbers of people would be prepared to pay for the BBC, many of them at a rate which would dwarf the present licence fee. This I doubt, and in any case the BBC would soon fragment if put on a subscription basis. Many bits of it wouldn't survive at all.

Mr Elstein may be right that digital, multi-channel TV will eventually undermine the BBC whatever happens to the licence fee, but I don't see his views gaining favour with this Government.

jeremy.warner@independent.co.uk