APPENDIX 14
Memorandum by Royal Mail Group plc
1. EXECUTIVE
SUMMARY
1. Royal Mail Group welcomes the Trade and
Industry Select Committee's continuing attention to developments
in the fully liberalised UK postal services sector and important
issues relating to our business in particular.
2. Fundamentally, our business needs to
be strong so that we can take on the competition and win. Success
in the future will be based on our transformation from a monopoly
operator to a modern, ambitious business that can thrive in a
competitive market.
3. During 2005-06, Royal Mail Group delivered
a year of record high quality of service to its customers. Financial
performance was outstanding, especially in the face of competition,
with an operating profit of £355 million—an increase
of 17.5% compared with the previous year—on record revenues
of more than £9 billion.
4. We have come a long way since 2002 when
the Group was losing well over £1 million a day and we were
struggling to hit many of our customer service targets.
5. It's encouraging that the building blocks
we need are beginning to slot into place. A vital part of our
plans was securing, after lengthy negotiations with Postcomm,
a tough but fair price control that allows significant investment
in the Royal Mail letters business and gives us the ability to
increase the cash payments into our pension fund.
6. Good financial results and record quality
of service have resulted in the Government—our shareholder—agreeing
in principle to our case for commercial investment in Royal Mail
Group.
7. The task now is to transform the company
into a modern, world-class postal operation able to compete in
an increasingly tough market. A key part of this change will be
to make sure we give our people the necessary incentive and the
right reward for their part in future success. We believe giving
everyone a real stake in the business will be critical to implementing
our investment plans. It is our postmen and women who have helped
put in place a strong platform on which to build and we know this
is something they want and would respond to. This wouldn't be
privatisation under another name but a real chance for our people
to own a part of the business and help drive our success.
8. The investment package now being discussed
in detail with the Government will enable Royal Mail Group to
embark on its major modernisation programme. It will also help
to secure the company's pension fund, giving the business more
time to plug the funding gap of £5.6 billion which will require
a cash payment of £735 million this year, growing with inflation.
9. With such a large branch network and
customer base, the Post Office® is well aware of the responsibility
that comes from our unique role at the heart of communities across
the United Kingdom. Post Office Ltd however is losing £2
million every week. This year the loss is expected to rise to
£4 million a week which is clearly unsustainable long-term.
10. Government business undertaken through
the Post Office® branch network has declined and the contract
for the Post Office® card account will not be renewed when
it expires in 2010. We continue to discuss with the Government
the best ways of creating a stable, sustainable Post Office®
network.
11. Our vision remains—to be demonstrably
the best and most trusted mail company in the world. The key to
achieving our goals is to ensure that our investment plan is successfully
implemented.
2. INQUIRY ON
ROYAL MAIL
GROUP
12. In the Committee's Press Notice issued
on 5 June 2006 the following three areas were outlined for consideration
during its follow-up inquiry on Royal Mail Group:
— the extent to which the refinancing
package announced by the Government will help Royal Mail to pay
for modernisation and deal with its pension fund deficit;
— the structure of the "shares"
scheme proposed by Royal Mail managers, and its implications for
the future of Royal Mail Group; and
— the future of the Post Office®
card account and the effects on the Post Office® network.
13. The Committee has correctly identified
these three important areas each of which is currently the subject
of ongoing discussions between Royal Mail Group and the Government
both as our shareholder and as a major client. By their nature
these are private discussions involving commercially sensitive
issues which require confidential treatment.
14. We are proud of Royal Mail Group's unique
role in reaching everyone in the UK through its mails, Post Office®
and parcels businesses—which directly employ almost 193,000
people in the UK.
15. Every working day Royal Mail collects,
processes and delivers around 84 million items to 27 million addresses
for prices that are amongst the lowest in Europe; each week we
serve nearly 28 million customers through our network of 14,376
Post Office® branches and each year our domestic and European
parcels businesses—General Logistics Systems and Parcelforce
Worldwide—deliver some 337 million parcels.
NEW FINANCING
FRAMEWORK FOR
ROYAL MAIL
GROUP
16. It is our understanding that the Committee's
inquiry was prompted by the Government announcement made on 18
May 2006 of a new financing framework for Royal Mail Group. In
a news release issued by the Department for Trade and Industry
(DTI) it was stated:
17. "The proposed financial structure
includes:
— the release of £850 million
of the Royal Mail Reserve for the company to transfer into a pension
escrow account that may be drawn on by the pension trustees in
the unlikely event that the company should fail;
— in principle agreement by Government
to extend the existing debt facilities so that £900 million
is available for use by Royal Mail on commercial terms; and,
— expenditure for Post Office
Limited, including Social Network Payments for the next two years
and any funding after 2008, will be met by the Government rather
than from Royal Mail Reserves. The level of any support after
2008 will depend on decisions on the future of the Post Office
network."
18. In the "Notes to Editors"
section the same DTI news release explained:
"1. The Government intends to exercise
its powers under section 72 of the Postal Services Act 2000 to
release the £850 million of reserves that Royal Mail has
built up through past profitable performance so that the company
can transfer those funds to a special account, the pension escrow
account, which the pension fund trustees could draw on in the
unlikely event that Royal Mail should fail as a business.
2. When the pension fund deficit has been
recovered and Royal Mail's balance sheet strengthened by successful
operation, it is expected that the escrow fund will be released
and surplus cash returned to the Government as shareholder.
3. Royal Mail already has undrawn borrowing
facilities of £844 million and these will be rolled forward,
amended and increased to £900 million whilst remaining on
commercial terms. This will allow the company to embark on an
investment programme so that it can transform its effectiveness,
secure the efficiency improvements required under the regulatory
settlement and successfully compete in a newly liberalised market.
Borrowing facilities will be provided by Government."
19. The biggest hurdles by far for Royal
Mail Group are tackling the £5.6 billion pension deficit
in our accounts whilst ensuring that the Group has an appropriate
financing package to permit Royal Mail to invest in its network
and provide a long-term sustainable solution to Post Office Ltd's
loss-making branches.
20. We have made good progress in our discussions
with the Government—our shareholder—on our investment
case for the future. We put a commercial plan to the Government
which we are confident will enhance the value of the organisation
for the shareholder. It is not a Government subsidy but a clear
investable case for our shareholder and we have reached agreement
in principle with Government on this investment case as a whole.
21. Since the Government's 18 May announcement
we have been discussing the huge amount of detail to be worked
through, including ensuring we get the right incentive scheme
in place for our people. We await the outcome of these discussions
with the Government.
22. We have also made significant progress
on putting in place another important building block for the future.
A vital part of our plans was securing, after lengthy negotiations
with Postcomm, a price control for 2006-10 that allows significant
investment in the business and gives us the ability to increase
the cash payments into our pension fund.
TACKLING THE
PENSION FUND
DEFICIT
23. Royal Mail Group plc is the sponsoring
employer for the Royal Mail Pension Plan (RMPP), the Royal Mail
Senior Executive Pension Plan and the Royal Mail Retirement Savings
Plan.
24. The RMPP is the sixth largest pension
scheme in the UK in asset terms. As at 31 March 2006:
— The plan had 170,000 people
paying into the scheme and 174,000 retired members receiving a
pension and 105,000 deferred members who have left Royal Mail
Group plc but not yet started to draw their pensions.
— During the year 2005-06 the
scheme assets have grown by £4.5 billion to £21.8 billion.
Our assets are made up of shares, bonds, properties and other
investments: equities £17.4 billion, bonds £2.8 billion,
property £1.6 billion.
— Scheme liabilities (the expected
amount we will pay to our pensioners in today's money) have also
grown to £27.4 billion, generating our deficit of £5.6
billion, as recorded in our accounts.
25. Our RMPP trustees comprise an independent
body of 10 people including employees, union representatives,
pensioners and independent members. In addition, there is an independent
chairman. They take external professional advice and are responsible
for full and interim valuations and agreeing with Royal Mail appropriate
funding for the pension schemes. The pension trustees now face
increasing regulation from the pensions regulator, which was created
in the Pensions Act 2004.
26. Looking back at the past performance
of the company's main pension fund, for just under 13 years until
2003 the main pension scheme "The Post Office Staff Superannuation
Scheme" (POSSS) had a surplus funding level. It made little
economic sense however to continue contributions during this period,
bearing in mind there was reasonable conservatism built into assumptions
used by the plan actuary.
27. Employers have to take action to utilise
any surplus assets above the 105% funding level either to improve
benefits or take a "contributions holiday" (under the
"Prescribed Basis" set out in Schedule 22 to the Income
and Corporations Taxes Act 1988).
28. In essence, companies cannot simply
pump money into fully funded schemes without allocating the funds
to a benefit/liability which will in due course need to be paid
out. Surplus assets cannot be returned to the employer.
29. During 2002-03 the position of the main
Royal Mail scheme RMPP (created by the merger of the POSSS and
the Post Office Pension Scheme (POPS) in 2000) moved from actuarial
surplus to deficit, principally because of changes in asset valuations,
changes in the independently appointed actuary's assumptions,
a fall in the expected long-term investment returns and increased
life expectancy of employees and pensioners.
30. As for the current situation, the pension
fund deficit recorded in our accounts has increased this year
from a liability of £3,958 million in 2005 to £5,588
million. The increase in the deficit is principally due to the
lower discount rate assumption driven by market movement in "AA"
Bond rates and revised mortality assumptions.
31. To put this deficit into stark perspective,
it outstrips the Group's pre-deficit net asset value of £2.3
billion by £3.3 billion.
32. The current Group management has reached
an agreement in principle with the pension scheme trustees on
how we fund the pension scheme going forward and any related deficit.
During 2005-06 the regular employer contribution rate amounted
to some £340 million and we paid some £140 million to
clear the pension deficit—in 2006-07 the total contributions
are expected to be £735 million.
NEED FOR
INVESTMENT IN
MODERNISATION
33. Crucially, we need to embark swiftly
on the modernisation of Royal Mail. This is the key challenge
the whole organisation is facing. It's an even more daunting task
than the three-year Renewal Plan we accomplished from 2002-05.
34. We need to be more efficient. In the
Royal Mail letters business, we need a £2 billion investment
programme with financing both from the Government and internal
cash we generate from turnover. We have to replace ageing and
obsolete equipment and put in place new technology giving us the
efficiencies, capabilities and a more flexible cost base in order
to compete successfully and provide the service our customers
need.
35. With competition intensifying and clear
signs that the letters market may well decline further, the need
for Royal Mail to drive efficiency changes is unmistakable. Improving
efficiency in a declining market is much tougher than making productivity
gains in a growing one. A key challenge we face is to make rapid
progress by investing in new technology and modernising the way
we work.
36. Putting in new technology and replacing
obsolete equipment, in time and to budget; further streamlining
our operations and bringing our people with us at all times; increasing
the focus on customers so that we deliver even better service
in a market where rivals are after our business—all this
will be incredibly stretching. It will mean a great deal of hard
work.
IMPORTANCE OF
THE PROPOSED
EMPLOYEE SHARES
SCHEME
37. In a company made up of 193,000 employees
we know taking our people with us is critical to our plans. We
believe giving them a stake in the company is a necessary incentive
to achieve the efficiency gains essential if we are to compete
successfully to retain and win customers in the face of tough
competition and importantly we know this is something they want
and would respond to.
38. We believe that a stake in Royal Mail
Group—an equal stake for everyone—will motivate our
people and help deliver the transformation we need. Our people
are fundamental to our modernisation plans and we have stressed
their role in the commercial investment plan we have submitted
to the shareholder.
39. Under the proposals Royal Mail Group
people working in the UK would own a significant share of the
company, with the rest held by the Government. The proposals have
nothing to do with privatisation.
40. An invitation to our people to express
their interest in a company share scheme sparked one of the biggest
responses in Royal Mail's history. Within two weeks more than
85,000 people had signed and returned their forms.
41. We are determined that we make further
improvements to benefit our people. We want everyone to enjoy
working for the company and that means ensuring they are motivated,
they have the right working environment, the tools to do the job
and they are treated properly at all times. The commitment of
all our stakeholders to reform and revitalise the company, long
term rewards and a real stake in our future success are crucial.
POST OFFICE®
NETWORK AND
THE POST
OFFICE® CARD
ACCOUNT
42. The Department for Work and Pensions
(DWP) has decided not to renew the contract with Post Office Ltd
for the Post Office® card account (POCA) after March 2010
when the contract expires. The Post Office® network's income
from Government—in the past one of its main sources of revenue—fell
by £168 million in 2005-06 as more benefits were paid directly
into bank accounts. In five years' time less than 10% of Post
Office Ltd's income will come from the Government.
43. Post Office Ltd made an operating loss
of £111 million for 2005-06 but this was a £12 million
improvement on the previous year and represented a real achievement
as it showed solid progress in the business's drive to replace
lost revenue from pension and benefit book payments.
44. The loss of the traditional benefits
income of £168 million during the year 2005-06 was partly
offset by attracting new revenue streams, primarily from Telephony,
Banking and Financial Services activity, together with continued
improvements in overall cost efficiency.
45. The most pressing issue for the Post
Office® network involves creating a sustainable future for
the rural service, where the majority of the 7,854 branches are
fundamentally loss-making and have depended on the £150 million
of funding made available by the Government to stay open. The
rural branches make up more than half the total number of branches
in the network, but they account for less than 10% of total business.
Some 1,000 branches serve fewer than 50 customers each week.
46. We await a decision on future funding
for the rural branch network from the Government. It is down to
us however to give the 500 directly managed branches in high streets
and shopping malls—currently losing £50 million a year—a
much stronger financial base, as well as making the busiest urban
branches—directly managed or privately owned—much
more attractive to visit by our customers.
47. Post Office Ltd is currently in discussions
with the DWP as to how we can continue to serve as many as possible
of the current 4.3 million POCA customers in the future. We are
also discussing with the DWP their evaluation of the results of
the Department's pilot schemes to test ways of moving existing
customers away from the POCA to other payment channels for receipt
of their pensions and benefits, as well as not making the POCA
available as a payment option to some new customers.
48. Post Office Ltd is determined to retain
and continue serving as many of the current POCA customers as
possible. We are considering how we can utilise and develop our
current range of banking and financial products, although these
will not be suitable for all customers.
49. We do believe however, there is a need
for a product that would enable individuals who, even after some
further encouragement to open a bank account, choose for whatever
reason not to do so. It is likely that there will be a cost to
the Government to make benefit payments to this group of individuals
and we understand they will be required to put that work out to
competitive tender. In that situation Post Office Ltd will make
every effort to tender for and win that business although of course
we accept there are no guarantees.
50. Whilst we are keen to retain as many
customers as is possible, clearly some will inevitably stop using
the Post Office® and we are working with DWP to try to keep
this to as small a number as possible.
July 2006
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