bat plc annual report 2007 - Notes on the accounts: Note 12

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12 Retirement benefit schemes

The Group’s subsidiary undertakings operate around 160 retirement benefit arrangements worldwide. These arrangements have been developed in accordance with local practices in the countries concerned. The majority of scheme members belong to defined benefit schemes, most of which are funded externally, although the Group also operates a number of defined contribution schemes.

The liabilities arising in the defined benefit schemes are determined in accordance with the advice of independent, professionally qualified actuaries, using the projected unit credit method. All schemes are formally valued at least every three years.

The principal pension schemes are in the UK, Germany, Canada, the Netherlands and Switzerland. Together these schemes account for over 88 per cent of the total obligations of the Group’s defined benefit schemes.

In addition, the Group operates significant schemes in Canada which provide employees with certain other retirement benefits such as healthcare. The liabilities in respect of these benefits are also assessed by qualified independent actuaries, applying the projected unit credit method.

The amounts recognised in the Balance Sheet are determined as follows:

In Jamaica, the pension scheme holds shares in Carreras Group Ltd. with a fair value of £7 million (2006: £6 million). In Switzerland, a pension scheme owns a property with a fair value of £11 million (2006: £10 million), part of which is occupied by British American Tobacco Switzerland SA.

The amounts recognised in the Income Statement are as follows:

The above charges are recognised within employee benefit costs in 2007 and 2006 (note 3(a)) and include £13 million in 2006 in respect of pension schemes reported as part of the restructuring costs charged in arriving at profit from operations (note 3(e)).

The reduction in the amounts recognised in the Income Statement in 2007 is principally due to the change in the impact of costs related to the restructurings noted above and the effect on pension costs of restructurings in recent years, along with the recognition of previously restricted funded scheme surpluses and higher investment returns.

The movements in scheme liabilities are as follows:

The actuarial gains in both years principally relate to increases in discount rates.

The movements in funded scheme assets are as follows:

Contributions to defined benefit schemes are determined after consultation with the respective trustees and actuaries of the individual externally funded schemes, taking into account regulatory requirements. Contributions in 2008 are expected to be £124 million for pension schemes and £8 million for healthcare schemes, compared to £138 million and £7 million respectively in 2007.

The movements in the unrecognised funded scheme surpluses are as follows:

In 2007, a surplus apportionment scheme in South Africa was approved by the relevant regulatory authority, resulting in the recognition of a previously restricted surplus.

The movements in the net unrecognised actuarial (gains)/losses are as follows:

The principal actuarial assumptions (weighted to reflect individual scheme differences) used in the following principal countries are as follows:

For healthcare inflation in Canada, the assumption is 10 per cent reducing to 5 per cent by 2013.

For the remaining pension schemes, typical assumptions are that real salary increases will be from 1 per cent to 4 per cent per annum and discount rates will be from 2 per cent to 5 per cent above inflation. Pension increases, where allowed for, are generally assumed to be in line with inflation.

For healthcare inflation in Canada, the assumption is 10 per cent reducing to 5 per cent by 2012.

For the remaining pension schemes, typical assumptions are that real salary increases will be from 2 per cent to 4 per cent per annum and discount rates will be from 2 per cent to 5 per cent above inflation. Pension increases, where allowed for, are generally assumed to be in line with inflation.

Discount rates are determined by reference to normal yields on high quality corporate bonds at the balance sheet date. For countries where there is not a deep market in such corporate bonds then the yield on government bonds is used.

Mortality assumptions are subject to regular review. In Canada, Germany and Switzerland the same tables were used for both years. In the UK, for post-retirement mortality assumptions at 31 December 2007 the table PXA92 (B=1965) rated up one year for active and deferred members and PXA92 (B=1935) table rated up three years for current pensioners, all with the medium cohort effect, have been used. At 31 December 2006, the same tables are used, along with the medium cohort effect, however active and deferred members are rated up two years and current pensioners are rated up four years. In the Netherlands at 31 December 2007 GBM/V 2006-2050 tables with an age setback of one year for both males and females have been used. In the Netherlands at 31 December 2006 GBM/V 1995-2000 tables with an age setback of two years for males and one year for females have been used. In Canada UP94 tables, in Germany Heubeck tables 2005G, and EVK 2000 mortality tables in Switzerland, have been used.

Based on the above, the weighted average life expectancy, in years, for mortality tables used to determine benefit obligations is as follows:

The expected rates of return on scheme assets in the following principal countries are as follows:

For the remaining pension schemes, typical expected long term real rates of return ranged from 2 per cent to 8 per cent.

For the remaining pension schemes, typical expected long term real rates of return ranged from 2 per cent to 7 per cent.

For the remaining pension schemes, typical expected long term real rates of return ranged from 2 per cent to 7 per cent.

Expected rates of return are determined taking into account the current level of expected returns on risk-free investments, the historical level of risk premium associated with other invested assets, and the expectations for future returns on such assets.

The major categories of assets as a percentage of the total fair value of scheme assets are as follows:

Other assets principally comprise hedge funds, cash and reinsurance contracts.

Valuation of post-retirement schemes involves judgements about uncertain future events. Sensitivities in respect of the key assumptions used to measure the principal pension schemes as at 31 December 2007 are set out below. These sensitivities show the hypothetical impact of a change in each of the listed assumptions in isolation, with the exception of the sensitivity to inflation which incorporates the impact of certain correlating assumptions such as salary increases. While each of these sensitivities holds all other assumptions constant, in practice such assumptions rarely change in isolation and the impacts may offset to some extent.

The effect on the profit before taxation reflects the impact on current service cost, interest cost and expected return on scheme assets where relevant, for 2008. The effect on scheme assets and liabilities is as at 31 December 2007.

A one percentage point change in healthcare inflation would have the following effects, which were similar in 2006:

The history of the present value of the scheme liabilities, fair value of the scheme assets, the scheme net deficits and experience gains and losses are as follows: