Examination of Witness (Questions 40-59)
MR DAVID
NORGROVE AND
MR LAWRENCE
CHURCHILL
22 MARCH 2006
Q40 John Penrose: You cannot talk
about Rentokil but, providing trustees are following the existing
rules, they might make their decision, like Rentokil did, without
you becoming involved at all?
Mr Norgrove: Exactly, yes.
Q41 John Penrose: I do not know if
you are going to be able to talk about Heath Lambert, where there
has been a degree of concern about the implications of that decision.
As I understand it the Pension Protection Fund took over 95% of
the £210 million deficit in the Heath Lambert pension scheme.
Is that roughly right?
Mr Churchill: Again, we are not
allowed to talk about individual numbers without the consent of
the trustees but the Heath Lambert transaction did go through
clearance and eventually came to us and it is one of the schemes
in our assessment period, yes.
Q42 John Penrose: Am I right in saying
that therefore that large deficit, whatever number it may be,
is now on your books effectively? You are dealing with that?
Mr Churchill: Indeed.
Q43 John Penrose: What I am really
trying to get at is, if you have got, let us say, a £200
million deficit and you have taken that on in exchange for shares
and securities in the reconstituted company, it having gone through
the process, what is the gap between the value of the shares and
debt securities that you have received and the value of the liabilities
that you took on?
Mr Churchill: It will always be
less, because if it was more then it would not come to the PPF
at all; there would be more assets available to the scheme than
would be required to pay out the PPF level of benefit. The issue
here is that for firms which are going bust anyway the hard choice
is that you can either have all of the liabilities without any
possibility of any recovery or you can have the liabilities with
some recovery. It will always be the case, I think, that the recovery
amount you are likely to get will be substantially less than the
liability.
Q44 John Penrose: I guess the question
from the public purse's point of view is whether or not a liquidation
would have resulted in a smaller net liability being taken on
by the Pension Protection Fund.
Mr Churchill: Precisely, and we
only get involved in any voluntary arrangement where the view
of our professional advisers is that liquidation would not produce
a better result. If liquidation would produce a better result
that would be the way we would go. We are actually quite commercial
on this. The only thing that we look at is what are going to be
the best returns for the pension scheme, and that is the route
that we follow. With regard to the type of asset security that
we take, again, as you say, the Heath Lambert commentary a year
or so ago featured highly on the equity stakes. That is only one
element. The truth of the matter is that we have a very strictly
thought out and regulated priority sequence for the type of assets
we want in recovery situations that sub-divides them into 12 categories,
and I will not burden you with all of those; I will not burden
myself with trying to remember all 12 of them, but broadly speaking
they are cash first: cash today or cash tomorrow; secondly, secured
debt—charges over property, mortgages, that sort of thing,
and only when you have exhausted all of that list do you go to
look at equity, be it on a preference share basis or on a straight
equity basis.
Q45 John Penrose: But do you publish
figures case by case on what the estimated net deficit you are
taking on is?
Mr Churchill: Not on a case by
case basis. The aggregate figures will be in our report and accounts
for the year to 31 March.
Q46 John Penrose: The point I am
driving at here is the potential moral hazard of companies which
are facing some sort of serious restructuring, or indeed insolvency,
coming to you guys cap in hand as one factor in some kind of bail-out
scheme, and clearly what you do not want to do is to create some
sort of an incentive for that to happen.
Mr Churchill: Absolutely.
Q47 John Penrose: How are you going
to avoid that if you are not being entirely transparent case by
case about the fact that the deal you have reached is still marginally
better than outright insolvency? How are you going to send the
right messages both to the public at large, to the taxpayer, as
well as to potential companies who might be coming to you cap
in hand otherwise?
Mr Churchill: The way we send
the message out is letting it be known and talked about within
the investment and banking community that we are very tough negotiators
indeed when it comes to recoveries in these distress situations:
that we are purely commercial: that we are looking only for the
best return for the pension scheme. We have experienced insolvency
practitioners working for us. We stretch the deal to breaking
point before coming to an agreement and, as you say, we always
have the option of walking away from it and saying "liquidation"
if we cannot get agreement on terms that seem to us to be satisfactory.
I think that is the way, over time, together with the aggregate
publication of what our solvency figures are, that will command
the confidence.
Q48 John Penrose: But if you are
tough and you are commercial what is the down side of publishing
the numbers?
Mr Churchill: With the trustees'
agreement, nothing. We just happen to be subject to a clause within
the Act that forbids us talking about the details of individual
cases without the trustees' consent, but in principle nothing.
Q49 John Penrose: If that clause
was not there would you see it as an advantage to be able to do
that?
Mr Churchill: Potentially. We
believe generically in disclosure but it is always possible that
people will take the wrong message from what you have disclosed
as well. As has been previously mentioned, the message you intend
to send out is not always the one that is received, so there is
an issue about that. Our whole stance is to be accessible to people
and to be transparent to the degree we possibly can be. We see
that as a strategic strength of the organisation, not a weakness.
Mr Norgrove: In terms of clearance,
the clause was put there for a good reason, and actually it is
the management's consent in that case. If a company going to undertake
a transaction or in the process of undertaking a transaction knew
that we were going to publish the details of that they would not
come, so I think that was a sensible thing for Parliament to have
done.
Q50 John Penrose: They would not
come to the PPF?
Mr Norgrove: They would not come
to us for clearance. If they knew that the details of a merger
or an acquisition or a capital restructuring the moment they came
to us for clearance we would be obliged to publish under agreement
or whatever, it would not happen.
Q51 John Penrose: Right. Is the fact
that somebody is not coming to lean on the public purse because
they are worried about disclosure a bad thing?
Mr Norgrove: Sorry, no; I am talking
about clearance here rather than the PPF.
Mr Churchill: There are two episodes:
the companies have already become insolvent and are coming to
us, in which case exactly the same confidentiality issue does
not arise because people do not come to us voluntarily. Just to
clarify the point about the public purse, there is no public purse
here to consider. The people who pick up the tab for the deficit
are other businesses.
Q52 John Penrose: You are absolutely
right, but this is mandated by Government on a levy that you are
levying. There is no choice about it.
Mr Churchill: No indeed, and that
is why it is important for us, and as has been the case for Parliament
to say that we should take the interests of the levy payers into
account at all times, including in our negotiations in recoveries.
Q53 John Penrose: If you are trying
to reduce the risks of situations leading to claims on the PPF
are you expecting at some point, hopefully not very often, to
require the closure of an existing scheme to new accruals? Can
you see that as something on the horizon somewhere?
Mr Norgrove: That is one of the
powers that Parliament has given us. When people fail to agree,
when the trustees and the employer fail to agree, we are empowered
to set a recovery plan, a funding target, and then potentially
to change future accruals.
Q54 John Penrose: I appreciate it
is one of your powers. The question is, is that one which you
are expecting to use often, infrequently, or do you see it as
a last resort?
Mr Norgrove: I do not know, is
the answer. We have not started yet. We will have to see when
we get there. I cannot think that it would be frequent. The trouble
with this is that the deficit always looks as if it is unchanged
by changing the future accruals, that deficits mostly relate to
past accruals, not to future accruals, but when you come in a
few years' time to look back you might wish that you had done
it, so that judgment is going to have to be made in each individual
case.
Q55 Michael Foster: May I ask you,
Mr Churchill, a bit about the sufficiency of the Protection Fund?
I note that this year you published a figure of £575 million
as your total levy for 2006-07. How did you come to that? Are
you going to publish the details of how you got to that figure?
Mr Churchill: How we come to the
figure is through a mixture of both quantitative and qualitative
methods, so it is both mathematics and then a judgment about those
mathematics. The way actuaries and risk managers typically assess
an uncertain future is through mathematical models built around
what is called stochastic modelling, which basically says, "Let
us not try to predict exactly what the future is going to be but
let us allow that it is uncertain and therefore we will use computers
to generate, in our case, over 20,000 different simulations of
the economic cycle and of the credit cycle", so you come
out with 20,000 different data points and so on. Then you group
those into clusters to see what pattern arises. We have used our
stochastic model over a five-year term because we believe trying
to forecast beyond that becomes increasingly hazardous and we
had the results of that mathematical model. We then used qualitative
judgment on the array of numbers that was produced by the model
to say, "What looks to be a number that looks appropriate
from many different viewpoints?" Clearly there is not one
single deterministic viewpoint that says, "This is the correct
view to take and all others must axiomatically be false".
There are some arguments for different types of view. How we got
to the eventual £575 million was more a matter of judgment
driven by the mathematics than it was any other particular form.
With regard to publication, as I have said, we believe in transparency
and it is our intention to make our mathematical models available
to the actuarial consultancies in due course.
Q56 Michael Foster: It is quite a
lot less than even the Government said, and they are going to
be a bit conservative on this one. They said you could go up to
£775 million before you needed to return to the Secretary
of State for any other order. There is a big gap. Was their model
less refined than yours?
Mr Churchill: I do not think the
Secretary of State in setting that particular ceiling actually
used a mathematical model of his own in competition or contrast
to ours. I think the way that the levy ceiling was set was to
take the judgment that we had come to and then look at the provisions
within the Pensions Act which say that we can increase the levy
by not more than 25% in any year. There is a desire, correctly,
to have an independent board distanced from Government in the
making of these decisions, and to allow therefore some headroom.
It was not the result of a separate calculation, is my understanding,
but it is a ceiling. They are not in competition to say it is
a better number or a worse number. They are saying you cannot
go above that number without coming back to the Secretary of State
and then a debate on the floor of the House for permission to
go above that.
Q57 Michael Foster: What came first?
Was it your desire not to impose a levy of more than 0.5% on anyone
or was it the figure that you needed and then you decided that
that was how you could afford it?
Mr Churchill: No. The two are
different. The figure that we needed, which we judged to be in
our levy estimate £575 million, was derived completely independently
from the question of, whatever figure we chose, how that should
be spread across the population, and it is in the latter case
that the 0.5% figure for distressed schemes operates. So the two
really are quite different figures, independent of each other,
not connected.
Q58 Michael Foster: Presumably the
0.5% is not going to help a scheme that is already in trouble.
Did you have any view about mitigating any levy against that sort
of scheme or do you think the whole purpose of the operation is
to not punish but reflect the weakness?
Mr Churchill: Parliament has asked
us to produce a levy that is based on risk, on insolvency risk
and so on, and we have not yet found any entities which we think
should be completely exempted from the levy whatever they do.
But, taking the spirit of the risk basis, for companies which
are perfectly capable of financing the deficit if they want to
we have said, "If you are funded to 125% of the PPF benefit
level, which broadly equates to the full promise of the pensions
benefit that you gave in the first place, then you do not need
to pay any risk based levy at all". So there are ways that
firms can pay zero but only through posing no risk to us.
Q59 Michael Foster: Do you think
the 80% risk element of the total is the right percentage or would
you prefer some other?
Mr Churchill: We do not have a
view. This was a matter for Parliament. When I was first connected
with the PPF it was 50% at the time that I took up my appointment
and then, through the debate that happened throughout 2004, Parliament's
better judgment was that 80% was a figure that they preferred
to 50 on the grounds that they saw more justice, I think, in the
amount people pay being related in some way or other to the risks
that they were posing.
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