View from City Road: Sting in the tail that wags the dog

Reed Elsevier's promptness in quantifying the cost to its pension fund of the ACT changes introduced in last March's Budget is to be commended. But it serves to underline how many companies have yet to come clean about the damage likely to be done to their profits by the decision to cut the tax credit on dividends from 25 to 20 per cent.

For pension funds - which do not pay tax - that in effect represents a cut in income of about pounds 1bn a year. Since the corporate sector stands behind most of those funds, it is fair to say that companies face a bill of equivalent proportions.

Reed is one of those lucky companies making money out of its fund. It has such a large surplus in its scheme that it will be able to take a credit in its profit and loss account in respect of it each year until the end of the decade.

The change in the tax regime simply means this credit will shrink to pounds 9m this year instead of last year's pounds 28m. But the tax credit is only part of the problem. Dividend income has plummeted through the recession. When the actuaries run their slide rules over many of the pension funds attached to UK plc they will find a shortfall.

So which companies are most vulnerable to a rise in their pension liabilities? NatWest Securities, which has been pondering the subject, says a fund's solvency ratio - the margin of error by which its liabilities are covered by its assets - is one guide.

But it suggests that the most important indicator is probably the size of a company's fund relative to its market capitalisation - the average FT-SE pension fund clocks in at about 23 per cent.

This is because if the fund is big relative to the size of the company even a small drop in its value can require relatively large increases in contributions to compensate.

Take a look at the corporate sector and - surprise - the companies that turn out to be the most vulnerable are large, old ones, especially those that have been privatised. British Steel, British Airways and Rolls-Royce all have pension funds larger than the market worth of the company.

British Aerospace's pension fund is almost three times as large as its market capitalisation. Doesn't that look like a very large tail wagging a very small dog?