Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 40-59)

MR CHRISTOPHER DAYKIN, MR ANDREW JOHNSTON AND MR KEVIN DOWN

1 NOVEMBER 2006

  Q40  Mr Newmark: Although that says where government risk is versus corporate risk.

  Mr Daykin: I do not believe it has any relevance because it is purely the marginal transaction rate of those who happen to be buying and selling gilts in the open market on that day.

  Q41  Mr Newmark: Is what you are saying then that the choice of discount rate for pensions is just an academic nicety rather than anything that has a potential real impact in the future?

  Mr Daykin: You could say that for the FRS17 as well. It is an accounting device for putting a value on liabilities which are going to fall due over many years into the future. The accountants have decided that is an appropriate way to value it for the purposes of the balance sheet; it has many advantages in terms of objectivity; it has many disadvantages because that value has no real meaning in terms of actually paying the liabilities in the long term, and the approach within government has been to align with the private sector approach so as to have a similar measure.

  Q42  Mr Newmark: Neil Record, a former Bank of England economist, wrote: "By using too high a discount rate in its sums, the Treasury was able to undercharge state employers, such as the NHS, for their pension contributions—leaving more money for current improvements to public services but obliging future taxpayers to pick up the tab". Do you want to comment on that observation?

  Mr Daykin: I do not see that it has any truth in it because the method of financing and the method of determining—

  Q43  Mr Newmark: So Neil is completely wrong. Is that what you are saying?

  Mr Daykin: Neil has, let us say, some particular views, and we have had many conversations with Neil. I am not sure where he is coming from on that particular point because the long-term cost and the determination of contribution rates for public sector workers and for employers has been carried out on the basis of long-term assumptions, just as is the case in the private sector. That is not the FRS17 basis and would not be in the private sector either.

  Q44  Mr Newmark: So your view is, it is not an accounting device to shift, effectively, liabilities from one area to another? That is what he is saying, effectively.

  Mr Daykin: No, we have complete transparency in that area, and always have had.

  Q45  Mr Newmark: But we do not have transparency because a lot of it is off balance sheet. Anyway, I will go on to another question. How do you respond to the Institute of Economic Affairs' contention that their pensions have been under-priced when staff have transferred to the private sector, which has penalised those staff, benefited their employers and, presumably, also cost the taxpayer money?

  Mr Daykin: I will start and then I will pass it over to Andrew in a moment. I think one has to bear in mind there are two elements to the machinery of government transfers, PPP, PFI—all the different ways by which staff have been transferred out. Firstly, there is a government policy to achieve broad comparability in respect of future accrual of benefits. I do not think that that can be what you are referring to there because that is for the future; it is in terms of making sure that the benefit structure is comparable to that provided within the public service. The other element is the possibility that some past service liabilities may be transferred out, and give rise to credits in the receiving scheme. Those arrangements are subject to the whole process of negotiation, if you like, of the contract, of which pensions is only a part.

  Mr Johnston: The Government is quite clear it wants to be able to allow those who transfer employment through PPP or PFI to be able, in broad terms, to have year-for-year credits in the pension scheme to which they would be entitled in the private sector. In order to achieve that it is prepared to make available what are known as "book transfer terms" which are special transfer terms which reflect the costs on an ongoing basis of providing those benefits which are transferred. Indeed, as Mr Daykin says, those are part of the negotiations which take place when the contract is let. By and large, contractors accept the terms which are offered—terms, I might say, incidentally, which are agreed jointly with ourselves and Hewitt Bacon & Woodrow who advise PCSPS because they have a number of these transactions as well. Generally speaking, this is not a difficult area. Substantial sums have been paid in the past by government to private sector schemes and that continues to be the case as part of its policy of making sure that employees' pensions have this option available to them and can take advantage of it if they wish to do so.

  Q46  Mr Newmark: During the initial consultation on the Morris review, GAD argued that, in the context of PPP and PFI, only GAD should be responsible for signing off the assessments of broad comparability of new private sector employers' pension arrangements to those of existing public sector employers, because "most firms would be too conflicted" to undertake such assessments. Do such concerns about potential conflicts prevent GAD from seeking additional income in this area?

  Mr Johnston: I think "concern" remains the case. A lot of contractors these days are regular contractors (they apply for many contracts) and we developed a process which is now known colloquially as a passport system where contractors apply to us for pre-certification for broad comparability, so that element of the package is dealt with very economically for all concerned—we do not have to keep explaining—

  Q47  Mr Newmark: On the issue of conflict, which I am particularly interested in?

  Mr Johnston: We are free from conflict in this area, uniquely so. We are not advising contractors and their bidding process, which I think is the key element you were trying to elicit.

  Mr Daykin: Our concern was also that if a private sector firm were to offer such a passport facility it would be very difficult for them to avoid conflict because they would also be advising contractors, whereas we can offer the passport facility and, because we do not advise contractors, we do not have a conflict, and so it seems the most natural way forward. The problem will only arise if the contractors go down the route of seeking a passport from somebody other than us, which I guess they are free to do but then there will be a question as to whether the organisation contracting out the service would recognise such a passport.

  Q48  Peter Viggers: When you were responsible for the Principal Civil Service Pension Scheme you carried out your actuarial calculations on a basis which required a certain amount of money to be notionally reserved by government. When the transfer to a private sector actuary to be responsible for the actuarial service for that scheme took place and the actuarial system known as Superannuation Contributions Adjusted for Past Experience was introduced it was not the initiative of the private sector actuary, it was a Treasury initiative. Can you confirm that?

  Mr Daykin: Yes, the SCAPE system was a Treasury initiative which was applied to all the public service schemes.

  Q49  Mr Gauke: May I ask how have GAD's sources of income changed since the implementation of the Morris review?

  Mr Daykin: I think the short answer to that is not by very much. The income sources fluctuate slightly from year to year because of large projects in different areas, but the broad analysis between the different sectors has remained unchanged. Perhaps I can ask my Finance Director to comment briefly on how it does break down.

  Mr Down: The areas that were really affected by the Morris review that transferred out were the areas that were funded through the Parliamentary grant. So in terms of our fee income from clients, that has remained fairly much the same. Broadly, about 75% of our income comes from the public sector and the remaining 25% from the private sector and overseas work. There have been a few things around the margins but in terms of percentage points we are talking about one or two percentage point changes in any area. So it has held up.

  Q50  Mr Gauke: Are your clients effectively the same institutions, or have you gained a few, lost a few?

  Mr Down: It is effectively the same institutions. The competition that we expect may eventually come from this has not kicked in yet.

  Q51  Mr Gauke: Would it be fair to deduce from that that GAD has been pretty competitive in what it does, given that government departments can go elsewhere now?

  Mr Daykin: I believe we have always been competitive, and the extent to which we have had massive demand over the last year or two suggests that our potential customers still think that we are (a) competitive and (b) providing the sort of service they are looking for. Within the UK public sector our client base is pretty constant. It varies from year to year because sometimes there will be a major activity going on in one area and sometimes in another. Internationally, it is a bit more fluctuating because we have some projects which we gain through open competition, and then it is a particular project, and then we will get another one and another one. So the actual mix of clients will change a bit, although again in the international field we have some constants of substantial clients who are using our services year after year.

  Q52  Mr Gauke: Peter mentioned earlier the fact you have lost the Principal Civil Service Pension Scheme job. What assessment have you made as to your prospects of retaining your role as scheme actuary with regard to other large public sector pensions?

  Mr Daykin: It is difficult to make a probability assessment. I think the probability is good. We consider that if we continue to give good service and good value for money then many of our public sector clients—and, hopefully, most of them—will remain with the GAD. However, because there is always the possibility that they might go elsewhere we feel it is incumbent on us to broaden our base as far as possible, to have an objective of softly marketing our services so as to be able to expand our demand, and to work with clients to give them more services and to encourage them to use us for different purposes. So I think we feel that the future is pretty secure but, of course, we cannot be sure.

  Q53  Mr Gauke: Are there any jobs which are particularly big which would have a substantial impact upon your finances were you to lose them?

  Mr Daykin: There are some government departments for whom we do a very large amount of work I suppose the National Health Service is one of our largest clients. We do a huge amount of work for the Department for Work and Pensions but it is spread over a number of different issues. We have worked on the basis that our future is most secure if we are diversified and if we have a wide range of clients, and we are working to achieve that.

  Q54  Mr Gauke: Just looking at the performance targets in your Spring 2006 Departmental Report, it looks like a fairly substantial increase in administration costs of 17% at the same time as relatively modest growth in the number of central government and wider public sector clients. How do you expect to generate the extra income to cover the growing admin costs?

  Mr Daykin: I do not think our admin costs are growing significantly. There was a bump-up because of the increased cost of accommodation when we were thrown out of New King's Beam House and had to find our own accommodation, but generally speaking we have been making savings on our administration costs. That is part of the efficiency savings. We have some shared services activity where we are providing services to other organisations. So the overhead costs should in the future fall as a proportion.

  Q55  Mr Gauke: The figure I have here is total gross administration costs, a planned increase of 17% on GAD's admin expenditure for 2006-07; a 29% increase over two years to 2007-08.

  Mr Daykin: You are looking at the Spring Departmental Report.

  Q56  Mr Gauke: Table 5.

  Mr Daykin: Maybe I misunderstand you. The gross administration costs in that table are mostly the salaries of actuaries, and the more actuaries we have the more income we gain and the more profit we make. So the bigger we can get that number in the future the more profitable we will be. I think you were, perhaps, thinking of them in terms of an overhead. That is not the overhead, that is the total salary cost, the vast majority of which is actuaries and actuarial staff who are giving consultancy advice.

  Q57  Mr Gauke: Can I ask about charge-out rates? How do you compare to your private sector actuarial competitors?

  Mr Daykin: That is quite difficult to determine because our competitors are not very open in telling us what their charge-out rates are. Our understanding is that our charge-out rates are competitive across the board, and certainly at the top end we charge significantly less per hour than many of our competitors. Anecdotal evidence suggests that is also true at the non-qualified actuary level. One of the difficulties of comparison is that our clients are mostly using us for pure actuarial services whereas our competitors in the private sector are not usually selling unbundled actuarial services; they are selling actuarial services, consulting services, investment services, communication services and that enables them sometimes to disguise their costs in a different way. If it comes to pure actuarial services we believe we are cost-effective.

  Q58  Mr Gauke: Do you distinguish in your charge-out rates between private sector clients and public sector clients?

  Mr Daykin: We are not able to do that; under Treasury fees and charges rules we have to charge the same hourly rates to all our clients.

  Q59  Mr Todd: About 20% of your business is with overseas customers. What are the risks and potential liabilities of that part of your business? I think the Morris review raised some concerns about this.

  Mr Daykin: The Morris review did raise a concern but they also suggested that that was one of our major areas that we should be expanding, and that is also the message that we have had over the years, that if we need to expand our client base then we should expand it internationally as well as in the UK. There are obvious potential risks with any consultancy work that things could result in a complaint by the client. In our main central departmental work in the UK that risk is small because it is all part of the Crown, all part of central government. The wider work we do in the UK as well as that overseas is more of a risk. We have explored the possibility of taking out professional indemnity insurance, as would a private firm, and have been instructed by the Treasury that that would not be an appropriate thing to do.


 
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