Carillion's pension schemes, their deficits and the Pensions Regulator

analysisAccording to the House of Commons committees' May 2018 report, when Carillion entered liquidation in 2018 it had responsibility for funding 13 UK defined benefit pension schemes: the Carillion Group Section, Permarock Products Pension Scheme, Carillion 'B' Pension Scheme, The Carillion Staff Pension Scheme, Alfred McAlpine Pension Plan, Mowlem Staff Pension and Life Assurance Scheme, Planned Maintenance Engineering Limited Staff Pension and Assurance Scheme, Bower Group Retirement Benefits Scheme, The Carillion Public Sector Scheme, The Mowlem (1993) Pension Scheme, Prudential Platinum Carillion Integrated Services Limited Section, Carillion Rail (Centrac) Section and Carillion Rail (GTRM) Section; Carillion also had defined benefit obligations in Canada following acquisitions there. The regulatory intervention report of the Pensions Regulator (TPR) states that 19 of the roughly 350 entities in the group were participating employers in the 13 schemes. Carillion's annual reports describe 15 defined benefit schemes at the end of 2014 (13 in the UK, one in Canada and one in the Republic of Ireland), eight of them closed to future accrual and funded under deficit recovery plans agreed with the trustees, and 14 schemes at the end of 2016 (13 in the UK and one in Canada), plus other post-retirement benefits under four arrangements in Canada. In the 2016 report, five UK final-salary schemes operated under a single trust arrangement accounted for 83.2 per cent (£669.8 million) of the total deficit at 31 December 2016. ^{1 2 3 4}

analysisThe committees identify the Carillion Staff and Carillion 'B' schemes as Carillion's two main defined benefit schemes for its employees, the latter available only to executive directors and other senior employees; they were closed to further accrual in April 2009, after which employees could join a defined contribution plan. From the schemes' annual reports and accounts the committees put their combined deficits at £48 million in 2008, £165 million in 2011 and £86 million in 2013. The committees also give the deficits of two acquired companies' schemes: Mowlem had a year-end pension deficit of £33 million when it was purchased in 2006 and Alfred McAlpine a year-end deficit of £123 million when purchased in 2008, and by the end of 2011 the combined deficit on these two schemes had grown to £424 million. ¹

analysisCarillion (DB) Pension Trustee Limited was the single trustee of six Carillion defined benefit schemes: the Carillion Staff Pension Scheme, Carillion B Pension Scheme, Alfred McAlpine Pension Plan, Bower Group Retirement Benefits Scheme, Mowlem Staff Pension and Life Assurance Scheme, and Planned Maintenance Engineering Limited Staff Pension and Assurance Scheme. The committees date the formation of this single trustee board to 6 April 2011 and state that these schemes accounted for the large majority of Carillion's total pension deficit and membership. In a letter of 26 January 2018 its chairman, Robin Ellison, wrote that the company became trustee of the six schemes on 1 April (the year is not legible in the retained copy), that Robin Ellison had been chairman since then, and that the Trustee's lawyers were Sacker & Partners LLP. Membership figures in the sources differ by scope: the committees cite Trustee data of 20,587 members across the single-trustee schemes at the end of 2013 and Carillion's 2013 annual report figure of 28,785 members across all schemes; Carillion's 2016 annual report shows 28,561 members (609 active, 15,542 deferred and 12,410 pensioners) with a defined benefit obligation of £3,361.6 million at 31 December 2016; and the letter of 20 February 2018 from the Pension Protection Fund (PPF) refers to about 27,500 members of the 13 PPF-eligible schemes. ^{1 5 4 6}

analysisThe Trustee's letter of 26 January 2018 states that its board took advice from external covenant assessors for the triennial valuations and received quarterly reporting from Carillion on covenant metrics, but that until 2017 the information available to it was largely public and it had no legal power to require more. Its last formal covenant report, of May 2017, prepared for the 31 December 2016 valuation, indicated potential weaknesses in Carillion's debt position but concluded that Carillion had scope to increase its pension contributions. Discussions on the 2016 valuation were halted after the July 2017 profit warning while Carillion, with the assistance of EY, reviewed contracts and cash flow. ⁵

analysisIn a letter of 26 January 2018 to the chair of the Work and Pensions Committee, Robin Ellison, chairman of Carillion (DB) Pension Trustee Limited, distinguished four deficit measures. The company accounting deficit, which covers all of the company's defined benefit schemes, was in the Trustee's understanding the £587 million figure quoted by the committee. The Trustee's technical provisions basis, used for the statutory triennial valuations, gave a deficit of £508 million for the five largest single-trustee schemes (excluding the Bower scheme) at the 31 December 2013 valuation, while for the 31 December 2016 valuation the Trustee had tabled a proposal that would lead to a deficit of about £990 million across the five main schemes, mainly because of lower interest rates. On the PPF basis the deficit of the six schemes at 31 December 2016 was about £0.8 billion, and on the buy-out basis it was nearer £2 billion. The 2016 valuations had not been completed when Carillion plc was put into compulsory liquidation on 15 January 2018. ¹

analysisCarillion's accounts measure the pension deficit under IAS 19, the international accounting standard on employee benefits. At 31 December 2014 defined benefit scheme assets of £2,320.4 million stood against funded obligations of £2,808.2 million and unfunded obligations of £10.6 million; with a minimum funding requirement of £11.3 million, the total IAS 19 deficit was £509.7 million (2013: £370.1 million), or £406.2 million net of deferred tax (2013: £295.1 million). The five-year review in the 2014 report shows that net figure at £182.1 million in 2010, £229.3 million in 2011, £269.9 million in 2012, £295.1 million in 2013 and £406.2 million in 2014. Employer contributions were £58.5 million in 2014 (2013: £48.9 million); the 2014 report states that deficit recovery payments of £46.0 million in 2014 were in line with the 2014 agreement with the Trustee of the main schemes for the three-year period to 2016, and that committed funding payments for all defined benefit schemes in 2014, 2015 and 2016 were around £50 million a year. By 31 December 2016 IAS 19 pension liabilities were £3,377.5 million (2015: £2,695.9 million) against scheme assets of £2,572.7 million (2015: £2,302.4 million), an IAS 19 deficit of £804.8 million (2015: £393.5 million) before deferred tax and £663.2 million (2015: £317.6 million) after it, using a discount rate of 2.70 per cent (2015: 3.95 per cent); actuarial losses from changes in financial assumptions were £724.8 million. Employer contributions in 2016 were £51.6 million (2015: £54.3 million) and deficit recovery payments £46.6 million (2015: £47.4 million), reflecting the current agreement with the trustees of the main schemes. ^{2 3}

analysisCarillion's 2017 half-year report states that its pension deficit net of taxation fell by £76 million to £587 million at 30 June 2017 (31 December 2016: £663 million) because of higher asset values and lower inflation rates; the IAS 19 defined benefit obligation was £3,313.7 million and scheme assets £2,621.3 million, a net pension liability of £711.4 million before tax. Deficit pension contributions in the first half were £21 million (first half of 2016: £22 million). The report added that since the half year Carillion had given notice to the pensions trustee that discretionary pension increases would be withdrawn, reducing the deficit by a further £80 million, and was in discussions with its principal pensions trustee on changes including basing future increases on the consumer prices index (CPI) rather than the retail prices index (RPI), which could potentially reduce the deficit by a further £120 million. According to the Trustee's letter of 26 January 2018, no final decision on moving pension increases from RPI to CPI had been taken by 15 January 2018, when Carillion plc was put into compulsory liquidation. ^{4 1}

analysisThe committees, citing an analysis of scheme valuation reports that excludes the Bower scheme because it had a different valuation cycle, give combined deficits for the main Carillion schemes of £327 million at 31 December 2008, £617 million at 31 December 2011 and £439 million at 31 December 2013, and state that for the 31 December 2016 valuation, which was overtaken by events, the Trustee expected a total deficit of around £990 million. Set side by side, the sources give different figures because they use different bases and scopes, and some differences are unexplained. For 31 December 2013 the committees give £439 million for the main schemes excluding Bower (basis not stated), the Trustee £508 million on its technical provisions basis for the five largest schemes excluding Bower, and Carillion's 2014 annual report an IAS 19 deficit of £370.1 million for all group schemes; for 31 December 2011 the committees give £617 million while reporting the Trustee's calculation of £770 million and Carillion's of £620 million. Later figures on the accounting, PPF, buy-out and section 75 bases (section 75 being the buy-out measure that becomes due on insolvency) are set out by source, date and scope in the table in this section. What is not established is the basis of the committees' £439 million and £617 million figures and why they differ from the Trustee's £508 million (2013) and £770 million (2011) figures; figures on different bases or scopes are not comparable and are not combined here. ^{5 2 3 6 7 8 9 1}

analysisAccording to the committees' May 2018 report, based on correspondence with TPR and scheme reports, Carillion and the trustees failed to agree the 2008 valuation within 15 months, mainly because Carillion pushed for more optimistic investment-return assumptions than the trustees considered prudent. The trustees considered contributions of £35 million a year necessary and affordable as a minimum, while Carillion said it could not afford more than £23 million, and Carillion wanted a 15-year recovery plan, which the trustees noted exceeded the 10-year maximum the Regulator suggested. The valuation and recovery plans were agreed in October 2010, seven months late, with payments averaging £26 million over 16 years. The Trustee's own letter confirms that for the 2008 and 2011 valuations agreement was not reached by the statutory due date because the Trustee (and, for 2008, the schemes' former trustees) sought a more prudent funding approach than the company considered it could afford, that this was reported to TPR, and that TPR decided not to exercise its powers; it also records that Carillion repeatedly told the Trustee in valuation discussions that it was constrained in agreeing higher contributions by cash-flow constraints connected with its business model. In its response published by the committees on 12 July 2018, TPR accepted the report's criticisms of how quickly it sought to use its powers in its engagement with the sponsoring employer and trustee at the 2008 and 2011 valuations. ^{1 2 3}

analysisFor the 2011 valuation, the committees report, the Trustee calculated the deficit at £770 million and requested annual recovery payments of £65 million for 14 years, while Carillion, using more optimistic assumptions, put the deficit at £620 million and presented annual contributions of £33.4 million for 15 years as a take-it-or-leave-it offer; Richard Adam, as Finance Director, argued that the company could not afford such high contributions. The Trustee's covenant adviser, Gazelle Corporate Finance, advised that Carillion could increase annual contributions to above £64 million without a significant impact on available cash flow and noted that it had historically prioritised other demands on capital ahead of deficit reduction; despite annual dividend increases, the company refused the Trustee's requests to link the level of dividends formally to pension contributions. These are the committees' findings and characterisations, drawing on Trustee correspondence and Gazelle's advice; the two deficit figures are the parties' competing calculations for the same valuation. The outcome, according to the committees, was a compromise reached in early 2014 on a new valuation date of 31 January 2013 that left initial annual contributions at £33 million, in line with Carillion's original offer and £30 million less than the Trustee had requested. ¹

analysisThe committees report that TPR wrote to both sides in June 2013 that contributions of £33 million to £39 million would not be 'acceptable based on the evidence we have seen', but Carillion refused to increase its offer. In the early 2014 compromise, on a valuation date of 31 January 2013 (as printed in the committees' report) when improved markets had reduced the deficit to £605 million, the Trustee reluctantly accepted initial annual contributions of £33 million, scheduled to rise to £42 million from 2022; the group would guarantee payments only up to the end of 2017, after which the schemes would have recourse only to individual sponsoring companies; and the next valuation, at 31 December 2013, was to use the same assumptions. The committees described the outcome as a victory for Carillion in minimising its contributions; Carillion's 2014 annual report states that the valuations as at 31 December 2011 and 31 December 2013 for five schemes were concluded with the trustees in 2014. According to the committees, Carillion's directors rejected accusations that they did not care about funding the pension schemes and repeatedly referred to meeting their pension obligations, meaning fulfilling the deficit recovery plan. In its response published by the committees on 12 July 2018, TPR accepted that it should have reached a decision more quickly to bring its powers to bear at the 2011 valuation. ^{1 4 3}

analysisThe pensions note of Carillion's 2016 annual report states that the triennial valuations at 31 December 2013 for five schemes, including the three largest (Carillion Staff, Mowlem Staff and Alfred McAlpine Staff), were concluded with the trustees in 2014 with a revised recovery plan under which deficit recovery payments could continue until 2029 if required; that the five schemes' assets at the valuation date were £1.8 billion, a funding level of 76 per cent; that the 31 December 2016 valuation was under way; and that the group expected to pay £50.2 million to defined benefit schemes during the following financial year. A longevity swap entered into in 2013 by five schemes covered around 9,000 pensioners and around 40 per cent of total defined benefit liabilities, and had a fair value of a £26.9 million liability at 31 December 2016 (2015: £1.4 million liability). ⁵

analysisGazelle, covenant adviser to the Trustee, told the committees that Carillion may have set out to 'manage' the Trustee so that it did not present an effective negotiating counterparty, partly through the 'dominating influence' on the Trustee board of Carillion employees, who faced an inherent conflict of interest, and also cited Carillion's budgetary control over the Trustee and pressure on the scheme actuary at trustee meetings. Robin Ellison, the Trustee chair, disagreed, stating that 'all the directors of the trust company were independently-minded'. The committees, reporting Gazelle's allegations, found that the Trustee nonetheless pushed Carillion hard for additional contributions, consistently acted on TPR's advice, and agreed the 2008 and 2011 valuations well outside the statutory 15-month deadline while seeking a better deal; they concluded that the pension trustees were outgunned in negotiations with directors intent on paying as little as possible. ⁶

analysisAccording to the committees, TPR's involvement in the 2008 valuation was 'less intense' than its 'proactive engagement' on the 2011 valuation, during which it referred in correspondence to its section 231 power to impose a schedule of contributions on seven occasions between June 2013 and March 2014 without using it; the committees noted that TPR had not used that power once in 13 years. TPR argued that its involvement increased Carillion's contributions by £85 million across the recovery period, comparing Carillion's initial offer of £33.4 million with the agreed plan rising from £25 million in 2013 to £42 million by 2022, whereas the Trustee had sought an additional £342 million through annual contributions of £65 million. The £85 million is TPR's own estimate, and the committees said the extent of TPR's responsibility for the increase was unclear; they describe the initial £33.4 million offer as for 15 years in one chapter and for 16 years in their comparison of TPR's figure. Gazelle called the intervention 'disappointing'; the Trustee wrote to TPR requesting 'formal intervention' on the 2013 valuation and recovery plan, and Robin Ellison argued that the agreements were effectively 'imposed'. The Trustee's letter of 26 January 2018 states that for all three valuations (2008, 2011 and 2013) TPR decided not to exercise its powers. In its response published by the committees on 12 July 2018, TPR accepted the report's criticisms of how quickly it had sought to use its powers in its engagement with the sponsoring employer and trustee at the 2008 and 2011 valuations, and said that it should have reached a decision more quickly to bring its powers to bear at the 2011 valuation and taken more decisive action. ^{1 2 3}

analysisThe committees also found that TPR was willing to accept recovery plans for the Carillion schemes significantly longer than the average of 7.5 years, the plans agreed by Carillion and the Trustee averaging 16 years in both 2008 and 2011, and that there was little evidence of TPR seriously challenging Carillion's dividend policy, although in April 2013 TPR told the company and the Trustee that it was 'not comfortable with recovery plans increasing whilst dividends are being increased'. These are the committees' findings. TPR told the committees that it did not want its approach to be perceived as focused too heavily on recovery-plan length, that longer plans may be appropriate where liabilities are based on prudent assumptions, that Carillion's ratio of dividend payments to pension contributions was better than other FTSE companies, and that it 'cannot and should not prevent companies paying dividends, if that is the right thing to do'. In its response to the committees' report, published by the committees on 12 July 2018, TPR described itself in that period as too reliant on educating and enabling those it regulated when much bolder intervention was needed, while arguing that it was wrong to extrapolate the committees' criticisms to its current culture and leadership. ^{1 3}

analysisAfter the July 2017 profit warning, Carillion asked its pension trustee in early August 2017 to defer contributions as part of its discussions with lenders on additional facilities. According to the Trustee's letter of 26 January 2018, the Trustee joined the negotiations with Carillion and its lenders towards the end of September, understood that the banks saw its agreement as an integral part of their providing new money and, considering that a refusal would lead to the banks not lending and the group becoming insolvent, agreed, subject to protections, to defer eight months of contributions, to be repaid in full with interest by the end of January 2019 at the latest. The term sheet was agreed at the end of September 2017 and the final agreement documented on 24 October 2017. The committees put the deferred contributions at £25.3 million, due between September 2017 and April 2018. The agreement fell away when Carillion plc went into compulsory liquidation, and the deferred contributions became due to the schemes. ^{1 2}

analysisOther bodies describe the 2017 deferral of pension contributions. The PPF says that between August and October 2017, while not directly involved, it was kept informed by TPR of discussions on the proposal to defer deficit recovery contributions and conveyed to TPR its discomfort with the proposal, which related to whether the deferred contributions would eventually be made and to the schemes' treatment against other creditors; it considered it probable that 'PPF drift' would add cost for the period from the deferral agreement to insolvency, but could not quantify it. The committees report that TPR took part in a series of meetings on the deferral and that EY helped negotiate the agreement to defer £25 million of deficit recovery contributions. TPR's later report states that scheduled deficit repair contributions were paid until three months before the group's liquidation. ^{3 4 5}

analysisThe PPF's letter of 20 February 2018 to the Work and Pensions Committee states that its first direct engagement with Carillion's representatives was in early December 2017, when it said that any restructuring proposal would need to meet its published criteria. At a meeting on 8 January 2018 the company and the group's advisers discussed options including a potential Regulated Apportionment Arrangement (RAA); on 9 January the PPF and TPR received an initial, high-level RAA proposal, which the PPF told the company on 11 January failed its published criteria, while offering further dialogue. No revised proposal was received before the insolvency on 15 January, and by then, the PPF wrote, an RAA was increasingly unviable and would not, in isolation, have changed the end result. The committees state that Carillion sought to offload its pension schemes into the PPF in a bespoke deal, though it had far from sufficient funding to produce a proposal attractive to the Trustee, TPR or the PPF. ^{1 2}

analysisIn its letter of 20 February 2018 the PPF stated that Carillion plc had 13 PPF-eligible defined benefit schemes with about 27,500 members, 12 of which had entered PPF assessment, the remaining one to follow when the last of its sponsoring employers was put into liquidation, and one further defined benefit scheme that would not enter assessment. On its initial estimate at the point of insolvency, based on a roll-forward of scheme information from TPR and subject to revision, the eventual claim would be in the region of £800–900 million, possibly one of its biggest since it opened in 2005. TPR's report states that the 15 January 2018 liquidation triggered PPF assessment for the 13 schemes, and the committees' May 2018 report that all but two of the 13 UK schemes were likely to enter the PPF, which estimated the aggregate deficit for PPF purposes at around £800 million, the largest ever hit on its resources. In a letter published by the committees on 12 July 2018, the PPF's chief executive put the funding shortfall at the point of insolvency at about £800 million on a PPF basis for about 27,500 members, said that most schemes had entered assessment, and reported indicative completion dates for some of the schemes at the end of 2019. ^{1 2 3 4}

analysisThe committees concluded in May 2018 that TPR failed in all its objectives regarding the Carillion pension schemes: members would receive reduced pensions, the PPF and its levy payers faced their biggest bill, and the PPF expected to take on 11 of Carillion's 13 UK schemes with a funding shortfall of around £800 million. They also stated that Carillion collapsed with net pension liabilities of around £2.6 billion, which their footnote describes as the provisional estimate of the schemes' deficit on a section 75 basis, the buy-out measure that becomes due on insolvency. These are the committees' findings and characterisation. TPR accepted the criticism of its approach at the 2008 and 2011 valuations but disputed that it applied to its current culture (response published on 12 July 2018). TPR had opened an anti-avoidance investigation into the Carillion Group on 18 January 2018, after Carillion PLC entered compulsory liquidation on 15 January 2018, focused on whether there were grounds to use its anti-avoidance powers, in particular a Contribution Notice; in May 2018 the committees questioned its timing. In its regulatory intervention report TPR concluded that there was no prospect of securing a Contribution Notice, that no Financial Support Direction could be issued because the whole group was insolvent, and that the criminal offence relating to false or misleading information (section 80 of the Pensions Act 2004) was not made out, and it closed the investigation, being satisfied that there was no basis for using its powers. The retained copy of the report is undated; it refers to the Official Receiver's January 2022 High Court claim against KPMG and to TPR's Annual Report and Accounts 2018 to 2019. In its letter published by the committees on 12 July 2018 the PPF said that the majority of the schemes had entered PPF assessment and that it expected the final scheme to follow. ^{5 4 3}

analysisTPR's report sets out its conclusions on the statutory test for a material-detriment Contribution Notice. It found that disposals between 2013 and 2017, including PPP assets and a real estate business, provided essential liquidity that enabled the group to keep paying deficit repair contributions, so the schemes were not detrimentally affected. It also considered whether misleading financial information published between July 2015 and July 2017, and the resulting dividends, caused material detriment, and concluded that they did not: the contract losses before and during 2016 were so great that the group was arguably facing inevitable insolvency by the end of that year; had the 2015 and 2016 dividends not been paid, the directors would reasonably have used the cash to pay down debt rather than increase scheme payments, given trade creditors of about £2 billion and bank debt just below £1 billion in the interim 2017 accounts; and earlier disclosure would most likely have brought the collapse forward, so the schemes would not have received the contributions they did in 2016 (£47 million) and 2017 (£29 million). TPR said that it supported the action taken by other agencies against the parties involved where alleged failings had been identified. ³