APPENDIX 20
Clarification statement by Royal Mail,
25 November 2005 (asterisks mark those places from which commercially
in confidence text has been omitted)
KEY POINTS
— By 2009-10, under Postcomm's current
proposals, the USO area will make an annual operating loss before
exceptional items, even before we pay our pensions deficit costs
for the year or any Share of Success to our people.
— Our current annual pension deficit
cash contribution will rise from the current level of £140-150
million to between £400 and £500 million as a result
of the need to reduce the repayment period from an unsustainable
40 year span, a reduction in the proportion of volatile equities
in the scheme and the impact of higher salaries and longer life
expectancy.
— For 12 years until 2001 the main
pension scheme (POSSS) had a surplus funding level.
— The position of the main Royal Mail
scheme moved from actuarial surplus to deficit during 2002-03,
principally because of falling equity values and strengthening
of actuarial valuation assumptions, including mortality.
1. UNIVERSAL
SERVICE OBLIGATION
In Q17 and Q18 in the uncorrected evidence,
Mr Crozier and Mr Leighton agreed to provide the Committee with
some figures which give "detailed turnover costs and profits
for the universal service obligation under the current agreement"
We would like to request that you provide these figures.
We would also like to request a breakdown
of the future turnover, costs and profits for the universal service
obligation under the proposed price control agreement, as alluded
to in comments made by Mr Crozier in the foreword to Royal Mail's
submission (where it is suggested the proposed price control "may
result in it becoming uneconomic to provide the universal service
at all")?
Our published and audited Regulated Accounts
for 2004-05 show that the USO area[14]
made a profit from operations of £427 million from a turnover
of £6,016 million. This profit is before payment of pension
deficit charge and other exceptional operational items totaling
£148 million (which breaks down as a pension deficit charge
of £114 million, redundancy costs resulting from Royal Mail's
Renewal Plan of £32 million and other costs of £2 million),
and the relevant proportion of Share in Success payment to our
people of £181 million.
For items weighing between 0-100g—nearly
90% of USO letters—we actually made a loss of £212
million—before the costs of pension deficit and Share in
Success. This equates to a loss on First Class stamps of 5p and
in Second Class stamps of 8p. If the costs of pension deficit
and Share in Success are included these loses rise to 7p on First
Class and 9.5p on Second. It is a small volume of heavier items
(above 100g) that are clearly vulnerable to competition because
of the higher prices we currently have to charge, which subsidise
stamped mail.
* * *[15]
Were Royal Mail's proposed prices accepted by
Postcomm—raising the price of a First Class stamp to 39p
by 2009-10—the USO would remain in overall profit.
Nonetheless there remains a risk to Royal Mail
in any scenario under which we are unable to bring prices for
the small number of heavier items into line with costs, opening
up an easy cherry picking opportunity for our competitors.
A table showing these projections is attached
at Annex A.
2. PRICE CONTROLS
In Q45, Mr Crozier states: "The most
basic thing that needs to be right is that prices need to be cost
reflective. Any customer has the right to expect that the price
that they pay bears some resemblance to the cost of providing
the service that they are buying. It cannot be right that people
currently pay 30 pence for a service that costs 35 pence, and
the true economic cost is probably 45 pence, so clearly there
is a difference there. Our proposals are very clear that by 2009-10
we would like to see a first-class stamp price of 30 pence."
while in Q46 the cost is clarified as 39 pence. Could you further
clarify which price is correct?
The correct price referred to is 39p
3. PENSIONS DEFICIT
In reply to Q59, Mr Crozier suggests that
"We [Royal Mail] currently pay £400 million a year into
the pension fund, about £140-150 million of which is historical
deficit. With the change to FRS17 that payment will go up next
year to about £800 million, with somewhere between £400-500
million a year of that being historical pension deficit."
We would be grateful if you could clarify exactly how the change
if FRS 17 has led to a "£4 billion deficit", how
it will mean that Royal Mail will have to increase annual payments
into the fund from £400 to £800 million, and how the
"historical" pension deficit will increase from £140-150
to £400-500 million a year?
Royal Mail is currently paying around £140-150
million per annum in deficit payments. This level was agreed with
Trustees following the Actuarial Valuation in March 2003. This
valuation uses a different set of rules for valuation to FRS 17,
and produced a deficit figure of £2.5 billion. The next such
valuation will take place in March 2006 and we expect substantially
higher payments because:
— We expect to move to a quicker repayment
period. We are currently repaying the deficit on the basis of
a 40 year period. This is the longest period legally permitted
(under the Trust Deed) and is out of step with normal practice
and with the expected impact of new legislation and the Pensions
Regulator. The Pensions Regulator has made clear this week that
pressure will be placed on Trustees to seek short deficit correction
periods, with anything over ten years triggering a query from
the Regulator. Current normal practice is to meet deficits over
a period equivalent to the average remaining service life of employees—12
years for Royal Mail. A shorter time frame means higher annual
payments.
— We expect to reduce the proportion
of equities in the Plan to reduce the pension plan's exposure
to risk, in line with similar schemes. This decreases volatility,
but has a lower long term investment return which increases the
level of deficit.
— We are paying our people higher salaries,
which has added further liabilities over those assumed in the
March 2003 valuation. Nonetheless, improving the pay of our people
has been an essential and successful part of our Renewal Plan.
— Life expectancy is increasing, which
will result in a higher deficit and related deficit payments.
Our best assumption of the impact of these four
factors is an increase to the annual payment to meet deficits
to between £400-500 million. * * *
* * *
The FRS 17 deficit reported in our March 2005
Report and Accounts was £4.0 billion. This is valued in a
different way to our actuarial deficit which was £2.5 billion
at March 2003.
As further information the movement in the actuarial
valuation from 2000 to 2003 is shown in the table at Annex D.
This table shows that the principal RMPP scheme (created by the
merger of the POSSS and POPS schemes in 2000) would have expected
to be in a surplus position in March 2003 had it not been for
the fall in equity values and future assured dividend yields and
the strengthening of mortality.[16]
* * *
Footnote 17[17]
below explains why an increase in the stock market may not result
in an equivalent improvement in the deficit.
In Q68 Mr Smith suggests that "The pension
fund was in surplus until 2001, and in fact it was 105% funded,
which means the company could not put any more money into it.
So it was the 13 years prior to 2001 when the pension fund was,
I believe, in surplus for the whole period." Could you tell
us under what "rules" or legislation the "company
[Royal Mail] could not put any more money into it [the pension
fund]"?
The Post Office Staff Superannuation Scheme
(POSSS)[18]
has been in a surplus situation since 1988 (the point at which
gains in the equity markets eradicated the deficit position that
the scheme has been in since inception), and therefore it made
little economic sense to continue contributions, bearing in mind
there was reasonable conservatism built into assumptions used
by the plan actuary.
Under the Prescribed Basis (set out in Schedule
22 to the Income and corporations Taxes Act 1988), employers have
to take action to utilise any surplus assets above the 105% funding
level on this basis either to improve benefits or take a contributions
holiday. The intention was to control the funding of the plan
to below the Prescribed Basis. It did not make economic sense[19]
to continue making contributions, only to take a contributions
holiday enforced under this legislation. As at 31 March 1991,
the level of asset cover on the Prescribed Basis was just under
95%.
POSSS was closed to new entrants in 1987 and
the actuary advised that as the scheme was closed to new members,
it was important not to over-fund the prospective benefits.
For your information, set out below is the plan's
funding position:
|
| Date of Actuarial Valuation |
| Funding level
(%)
| Surplus
(£m)
| * * * |
|
| 31 March 1988 | POSSS
| 103.6% | 219
| * * * |
| 31 March 1989 (interim) | POSSS
| 109.6% | —[20]
| * * * |
| 31 March 1990 (interim) | POSSS
| 122.8% | —
| — |
| 31 March 1991 | POSSS
| 122.4% | 1,442
| * * * |
| 31 March 1994 | POSSS
| 104.0% | 374
| * * * |
| 31 March 1997 | POSSS
| 101.9% | 206
| * * * |
| 31 March 1998 | POSSS
| 106.9% | 865
| * * * |
| 31 March 2000 | POSSS
| 106.1% | 890
| * * * |
| 31 March 2003 | RMPP
(POSSS
and POPS
| 82.5% | (2,500)
Deficit
| * * * |
|
POSSS continued to provide benefit accrual for existing members
and the Post Office Pension Scheme (POPS),[21]
was established from 1 April 1987 for all new employees. Royal
Mail has always made contributions to this scheme. The POSSS and
POPS plans were merged to become the Royal Mail Pension Plan (RMPP)
on 1 April 2000.
The POPS scheme, now referred to as Section C of RMPP, moved
into deficit at March 2000 and annual deficit payments of some
£47 million started in March 2001, increasing by a further
£5 million from March 2002 as a result of an interim valuation
showing an additional shortfall.
The POPS scheme funding is set out below:
|
| Valuation Date | Funding level
(%)
| Surplus
(£m)
| * * * |
|
| 31 March 1989 | 130.8%
| 11.14 | * * *[22]
|
| 31 March 1992 | N/a[23]
| | |
| 31 March 1995 | N/a
| | |
| 31 March 1998 | 100%
| 0 | * * *
|
| 31 March 1999 (interim) | 94%
| (120) | * * *
|
| 31 March 2000 | 94.9%
| (130) | * * *
|
| 31 March 2003 | Merged with POSSS
and included with previous figures.
| | |
|
In Q71, Mr Leighton offered to provide the Committee with
figures of how the "current position of £4 billion"
has been arrived at. We would be grateful if you would provide
us with this evidence. If possible we would like to see a run
of data showing the pension fund liabilities (deficit/surplus)
and any subsequent payments made into the pension fund as far
back in time as possible? The Committee would also be grateful
if Royal Mail would provide us with the assumptions, which were
used to calculate the size of the pension fund liabilities and
any analysis you could provide on how the current deficit would
change should these assumptions be relaxed?
The £4 billion deficit is the March 2005 FRS 17 deficit
and is shown in note 19 to the Royal Mail Holdings plc statutory
(and audited) Report & Accounts. There is a specified methodology
to calculate the FRS 17 liability which requires a set of assumptions.
The assumptions used by Royal Mail are broadly consistent with
those used by many of the FTSE 100 companies. The calculation
is prepared by the company's actuary and audited as part of the
year end Report & Accounts.
For the first time in 2005-06 the FRS 17 liability will need
to be recognised on our balance sheet—which will therefore
show that Royal Mail has liabilities in excess of its assets.
The FRS 17 calculation was first undertaken in March 2002, and
showed the scheme to be in surplus. By March 2003 that surplus
had become a deficit, because of an Actuarial loss for the year
in excess of £5 billion—mainly made up of falling equity
values and an increase in liabilities due to lower assumed bond
rates.
The tables at Annex B show:
— The move from surplus in March 2002 to the current
position.
— The assumptions used by Royal Mail.
— A breakdown of the FRS 17 Actuarial gain/loss
from 2002 to 2005.
4. EMPLOYEE MOTIVATION
In Q82 and Q83, Mr Leighton offers to provide the Committee
with evidence that refutes the claim that "employee share-ownership
is not preferable to profit-sharing in terms of motivation of
employees"? We would be grateful if you could provide such
evidence.
I enclose a useful document, published by Job Ownership Ltd,
an independent association of employee owned and trust owned businesses,
which the Committee may find interesting. Please note that Royal
Mail did not make an input to this publication.
Royal Mail believes that, in addition to Presstream, all business
bulk mail should be removed from the Universal Service and that
in the longer term the Universal Service should include only stamped
mail.
For a scheme fully funded on the Prescribed Basis, therefore,
an additional payment would mean improving the level of benefits
paid to members or their beneficiaries—for example by increasing
lump sum benefits, or improving the accrual rate applied to members"
pensionable service—or reducing contributions. This is not
a practical step to take—a downturn in the funding of the
pension scheme, due to external market factors, would require
a reduction in member benefits (or an increase in contributions),
requiring negotiation, or would create an even bigger deficit.
Improvement of benefits would also have represented a substantial
increase in overall remuneration, almost certainly, for the time
period in question, at odds with public sector pay policy. The
only other course of action available was to suspend contributions.
14
These figures, and those at Annex A, relate to the existing definition
of the Universal Service. This includes the majority of business
as well as consumer mail. The USO comprises Standard Letter Tarriffs
(eg stamps, meter and account services), pre-sorted mail (eg Cleanmail,
Mailsort, Walksort, Packetpost, Response Services), registered
mail (eg Special Delivery), some international services (eg Airmail
outbound) and some other miscellaneous services, including Articles
for the blind. The service for magazines (Presstream) is not part
of the Universal Service. Back
15
Turnover is likely to increase over last year, although this
is driven principally by a below inflation price increase-volumes
of addressed mail are now in decline. The fall in profit forecast
is a result of the volume decrease and the changing mix of mail-First
and Second Class mail, posted by businesses as well as consumers,
is falling, as are Mailsort services. Access services (where Royal
Mail delivers mail collected and sorted by competitors) and unaddressed
door drops are increasing-but both are much lower margin products
for Royal Mail. Back
16
The mortality assumptions used when determining the £4 billion
deficit under FRS17 as at March 2005 were the same mortality assumptions
that were adopted for the 31 March 2003 funding valuation of the
RMPP. These mortality assumptions were set by finding a "best
fit" for the plan's actual mortality experience for existing
pensioners over the period since the previous funding valuation
within the range of standard mortality tables produced by the
Continuous Mortality Investigation Bureau (CMIB). For both pensioners
and non-pensioners an allowance for projected mortality improvements
(ie increases in life expectancy in the future) was also included.
Mortality rates appear to be reducing at a faster rate than currently
assumed-which may mean a further increase in liabilities in the
2006 Actuarial Valuation. Back
17
Whilst the stock market had risen between March 2003 and March
2005, the dividend yield on the FTSE All-Share Index, and the
yields on gilts/bonds, fell over the same period which meant that
for actuarial valuation purposes the assumed prospective real
rate of return available on the scheme's assets also fell. All
other things being equal, this in itself would lead to a lower
discount rate being used to value the liabilities in the scheme
actuary's funding valuation which, in turn, would lead to a higher
value being placed on those liabilities. Consequently, a rise
in the stock market doesn't necessarily mean that the funding
deficit would be reduced to the same extent. Over the period March
2003 to March 2005, the Trustee also changed the strategic asset
allocation, moving out of UK equities and more into property and
fixed-interest gilts. This change in asset allocation * * *also
led is expected to lead to a lower discount rate being adopted
as at March 2005 than might otherwise have been the case (and
hence a higher liability value). The interim valuation should
also take this into account. Back
18
POSSS is a final salary scheme. It was established on 1 October
1969 under the terms of the Post Office Act 1969, when the Post
Office ceased to be a Government department and became a public
corporation. A full valuation was carried out by an actuary as
at 30 December 1972, which showed a deficit of £1,092 million.
By the 31 March 1976 Actuarial Valuation, the deficit had increased
to £1,920 million. A previously published history of the
funding position of POSSS is attached as a separate document. Back
19
In essence, companies cannot simply pump money (tax free) into
schemes fully funded on the Prescribed Basis 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
under POSSS. Back
20
The dashes indicate that the figures are not available. The scheme
actuary has not typically stated the amount of surplus or deficit
when producing interim funding assessments (ie annual reviews
at dates other than the dates of the formal triennial valuations),
instead simply expressing the result as a percentage funding level
(ie a ratio of assets to the value placed on the liabilities,
so that a figure of over 100% indicates a surplus). The funding
level percentages indicate that the POSSS scheme was in surplus
at the 31 March 1989 and 31 March 1990 interim valuations. Back
21
POPS is a final salary scheme which provides a pension of 1/60th
of contributory pay (which is base pay plus certain allowances
less the lower earnings deduction, currently £3,328) for
each full or part year completed. Back
22
The POPS Plan rules required the total joint contribution rate
to be split 60/40% between employer and member. Back
23
Different valuation method was used which does not show the figures
in the same way as the method used from 31 March 1998 onwards.
The method changed from Entry Age Method to the Projected Unit
Method. Back
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