british american tobacco p.l.c. annual report 2008 - Notes on the accounts: 12 of 31

ANNUAL REPORT 2009

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12 Retirement scheme benefits

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 85 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:

The total accumulated net actuarial losses taken through other comprehensive income at 31 December 2009 were £886 million (2008: £591 million) for subsidiaries, and £296 million (2008: £357 million) net of tax for associates and joint ventures.

In Jamaica, the pension scheme holds shares in Carreras Group Ltd (a Group subsidiary) with a fair value of £3 million (2008: £4 million). In 2008, a pension scheme in Switzerland owned a property with a fair value of £19 million part of which is occupied by British American Tobacco Switzerland SA.

The above charges are recognised within employee benefit costs in 2009 and 2008 in note 3(a) and include £11 million in 2009 (2008: £2 million) in respect of pension costs reported as part of the restructuring costs charged in arriving at profit from operations (see note 3(e)).

The movements in scheme liabilities are as follows:

The actuarial losses and gains in both years principally relate to changes in assumptions regarding discount rates and inflation rates.

The movements in funded scheme assets are as follows:

The actuarial gains and losses in both years principally relate to movements in the market value of scheme assets.

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 2010 are expected to be £198 million for pension schemes and £9 million for healthcare schemes, compared to £214 million and £6 million respectively in 2009.

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

During the year, £75 million (2008: £nil) was recognised in respect of minimum funding obligations in relation to pension schemes in Canada.

Movements in unrecognised scheme surpluses and minimum funding obligations are recognised in other comprehensive income.

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 2018.

For the remaining pension schemes, typical assumptions are that real salary increases will be from 0 per cent to 5 per cent per annum and discount rates will be from 1 per cent to 7 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 2018.

For the remaining pension schemes, typical assumptions are that real salary increases will be from 0 per cent to 4 per cent per annum and discount rates will be from 1 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, the yield on government bonds is used.

Mortality assumptions are subject to regular review. In the UK, Canada, Germany, Switzerland and the Netherlands the same tables were used for both years. In the UK, for post-retirement mortality assumptions PXA92 (year of birth) table rated up two years for active and deferred members, with a 1.2 per cent underpin on future improvements and PXA92 (year of birth) table rated up three years for current pensioners with no underpin on future improvements, all with the medium cohort effect, have been used. In Canada UP94 tables, in Germany Heubeck tables 2005G, in Switzerland EVK 2000 mortality tables and in the Netherlands GBM/V 2005-2050 tables 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 1 per cent to 10 per cent.

For the remaining pension schemes, typical expected long-term real rates of return ranged from 1 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 8 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 judgments about uncertain future events. Sensitivities in respect of the key assumptions used to measure the principal pension schemes as at 31 December 2009 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 2010. The effect on scheme assets and liabilities is as at 31 December 2009.

A 1 percentage point change in healthcare inflation would have the following effects: