House of COMMONS
MINUTES OF EVIDENCE
OF THE CHANCELLOR'S DEPARTMENTS
MR ROBERT STHEEMAN, MS JO WHELAN, MR JIM JUFFS and MS JOANNE PEREZ
USE OF THE TRANSCRIPT
Taken before the Treasury Committee
(Treasury Sub- Committee)
Mr Michael Fallon, in the Chair
Mr Andrew Love
Mr Mark Todd
Witnesses: Mr Robert Stheeman, Chief Executive, Ms Jo Whelan, Deputy Chief Executive and Joint Head of Policy & Markets, Mr Jim Juffs, Chief Operating Officer and Ms Joanne Perez, Joint Head of Policy & Markets, Debt Management Office, gave evidence.
Q1 Chairman: Let us make a start. Mr Stheeman welcome back to the Sub-Committee. Could you introduce your team please?
Mr Stheeman: Certainly. On my right is Jo Whelan, the Deputy Chief Executive of the DMO and the Joint Head of Policy and Markets. Next to her is Jim Juffs, our Chief Operating Officer. Next to me is Joanne Perez who, together with Jo, is also Joint Head of Policy and Markets. I am Robert Stheeman. I am the Chief Executive.
Q2 Chairman: You have already planned some £37 billion in total of gilts and Treasury bill sales. What, in layman's terms, after the last week is the new total you are going to have to plan for?
Mr Stheeman: The original remit at the time of the Budget was set out, to be precise, as exactly £80 billion in gilts. What was announced yesterday was that we would be doing this extra £37 billion to which you have referred and that is being split into £30 billion in gilts and £7 billion in Treasury bills. We have also said that we intend to raise that amount by the end of this calendar year.
Q3 Chairman: What is the rationale for this split between £30 in gilts and £7 in bills?
Mr Stheeman: The amount employed is obviously a very large amount and we want to try to raise this within a short period of time. Given the amount we are already issuing, given the patterns of demand in the market, given also the volatility and stresses that there are in markets at the moment, we think it is right to focus on the short end of the market so that was our advice to ministers. There has been a very large flight to quality in terms of buying of government assets, safe-haven assets, over the last weeks. In addition, in terms of the market's ability to absorb paper in a very short period of time, short paper is much more easily distributed into the market at speed than non-dated or even inflation paper would be.
Q4 Chairman: It has been suggested to us that the market is fairly saturated at the moment. Are you confident of getting all this stuff away?
Mr Stheeman: We are confident. I am not complacent about that. It is certainly a record amount, but we are confident that demand exists, in particular for government assets. I say that advisedly because at the moment we have seen enormous demand over the last weeks and months for gilts. In general also it is fair to say that the gilt market has developed much greater depth over the last years. As it has grown, as liquidity has improved, it has been able to absorb ever-increasing amounts of supply from us. I am not complacent about that; I am well aware that we will be challenged in that process, but that is one of the reasons why we also advise focusing so much on the short end because that is the safest area of market for us to access.
Q5 Chairman: What is the impact of the additional public borrowing now, the additional so-called £50 billion on the average interest rate that you are likely to have to pay?
Mr Stheeman: That depends. The impact does not derive so much on the borrowing amount that we are going to have to issue; in other words, I personally do not believe that there is an easy link between the supply and the price. The market tends to be influenced and yields in the market tend to be influenced by much greater macroeconomic factors, in particular, in the short term, interest rate expectations are likely to influence the market more than our issuance would.
Q6 Chairman: Nonetheless, the additional borrowing of this order must have some impact on the average interest rate you are paying.
Mr Stheeman: It will certainly have an impact in terms of interest costs; clearly overall interest costs for Government will rise. However, in terms of the actual interest rate the one thing I would say is that there is academic evidence, analytical evidence, which suggests that when governments are in deficit and when governments are borrowing strongly, you tend to see, if anything, a steepening of the yield curve. In other words, longer-dated borrowing costs could potentially rise and that has been speculated about in the press. There has been academic evidence to suggest that would be the case.
Q7 Chairman: If the Government do not in the end need to buy the extra shares in RBS and HBOS Lloyds TSB because in fact private investors decide to buy them, will you not have raised an awful lot of money unnecessarily?
Mr Stheeman: We committed to raising the £37 billion and so we shall certainly do that. In the event that was not needed, we would be managing that position as part of our overall cash management operations. We continuously, every day, manage very large cash management flows in and out of the exchequer. What we would effectively be doing would be potentially reducing then some of the cash management operations or increasing them in some cases in order to be laying off the position in the market. I would also say that obviously in a few weeks' time there will be the Pre-Budget Report and if something were to be known then, in terms of your scenario that this £37 million were not needed, I would imagine that would be reflected in the PBR.
Q8 Chairman: Did you advise ministers of the implications of raising money of this order which might not in fact be needed?
Mr Stheeman: We were not directly asked to do that. We were asked to raise £37 billion specifically and that was a figure which was given to us in the remit yesterday, but was indicated to us only over the weekend. As you are probably aware, following a statement by the Chancellor on Monday, we called consultation meetings with the market participants immediately to discuss how we would raise this amount.
Q9 Mr Brady: When Bradford and Bingley was nationalised the Treasury committed to pay Abbey £4 billion. Where did you find the £4 billion?
Mr Stheeman: That came also from the cash operations to which I was referring. We have large cash positions, both positive and negative, which we turn over every day in the market and we are able to absorb those positions, but of course they will need to be refinanced.
Q10 Mr Brady: How big are those cash positions typically?
Mr Stheeman: We try to manage them down. Were we not able to manage them down in our cash management operations in advance, they would be potentially huge on certain days. We receive forecasts from the Treasury about cash profiles for the exchequer and these forecasts show that there are also very seasonal flows to government cash management. We know for instance for certain when there is going to be a gilt redemption, when we have to pay money back. We have a pretty good idea, as a result of the forecasting, when we are taking money in. Were we not to address those, you are talking about some very, very big sums which for commercial reasons I would rather not go into too much detail on; I am happy to put some of this in writing to you if you like. What we try to do is smooth those cash flows in advance. Effectively I operate in the money markets to offset them and to make them manageable and less risky.
Q11 Mr Brady: Without wishing you to give figures you do not want to give, I suppose what I am driving at is whether you are suggesting that the £4 billion is a relatively insignificant part of that operation.
Mr Stheeman: It is probably fair to say that it would fall within the average daily turnover that we would be transacting in the market. One figure which we have made available to the public is that in the last financial year the sum total of all our transactions - I avoid the word "turnover" - the actual transactions on the debt management account in total reached £1.7 trillion. These are big numbers.
Q12 Mr Brady: Has the loan from the Bank of England associated with these transactions been transferred to the Treasury now?
Mr Stheeman: It has not yet.
Q13 Mr Brady: When do you expect that to happen?
Mr Stheeman: We are waiting to hear from the Treasury on that and that is clearly a key element, because that is something which we will eventually have to finance as well. That will also have to be taken into account, but we do not know at this stage when that will be.
Q14 Mr Brady: You indicated that you were reasonably confident that your auctions will be fully subscribed. Are you concerned though, given that in July 2008 your auction of 30-year index-linked gilts was only covered 1.1 times? Does that not give some grounds for concern?
Mr Stheeman: It is a very reasonable question. We have had, most recently just two weeks ago, an inflation-linked bond which was also only 1.1 times covered. It is possible that we will see an uncovered auction and I made it clear to colleagues in the Treasury and to ministers that that is a distinct possibility. Personally an uncovered auction is not something I regard as anything more than a market event. An auction tells you how much demand there is for a specific piece of debt being offered at 10.30 in the morning on a very specific day. If there is an uncovered auction we have processes in place to deal with that. What effectively happens - and the DMO last had an uncovered auction in 2002 - is that the government debt is created on the National Loans Fund and it is acquired by the DMO on the debt management account and any shortfall is funded immediately on the day by the cash operations which I just described. That is how we deal with that. I would not generally regard an uncovered auction as a very major issue. If there were a series of uncovered auctions, I would feel less comfortable, but I think it is fair to say that if you look around Europe and see what other European governments are experiencing at the moment, there has been quite a fair bit of, it is probably fair to say, friction in the process of distributing government debt sometimes in other markets. The way we sell our bonds is that we actually say in advance that this is a fixed amount that we are going to sell. Some other countries have a different method and they actually vary that amount according to the amount on the day.
Q15 Mr Brady: Would not an uncovered auction give rise to concern in the market at the time that you are having to fund so much?
Mr Stheeman: To a certain extent it might but I think it is a brief thing. It would be relatively swiftly absorbed; to be honest the market in its current state moves on very quickly from one event to another. Where I am not quite so sanguine is in the scenario which I just described where we would have a series of uncovered auctions. That is one I feel much less comfortable with.
Q16 Mr Brady: What are you doing or can you do to mitigate the risks of such under-subscription?
Mr Stheeman: That is why, for instance, when we heard about the £37 billion, the first thing we did was to call these consultation meetings. It is extremely important that in making the sort of decisions we are and providing advice to Treasury and ministers that we do we read market demand correctly, that we consult with our stakeholders, representatives of end investors, the primary dealers, whom we refer to as the gilt-edged market makers, the GEMMs, that we consult with them very carefully and we get their views on how we should be accessing the market to make the best possible choice.
Q17 Mr Brady: May I finally turn to the experience you had at the time of the Northern Rock nationalisation when the market was surprised by the level of gilts forecast? Could anything have been done to communicate that better to the market? Have you learned lessons from it?
Mr Stheeman: I am not trying to duck the question but from the DMO's perspective we finance the number that we are given. In fairness the market knows that there are normally - and yesterday was clearly an exception - two fixed dates a year where the financing plans are communicated and we publish a gilt programme, which are the Budget and the PBR. That certainty is absolutely critical to the market. It is easy for me to say this in my position but I think that once Northern Rock was nationalised some commentators could potentially have put two and two together and worked out that there was going to be a not insignificant addition to the government cash-raising requirement. I am fully aware that not many did; it is easy for me to say that but we were scouring some of the comments put out by City analysts and others to see whether they would actually factor that in. We did not see it at the time and you are right, the market was surprised.
Q18 Chairman: You said you had warned ministers that the next series of auctions might be uncovered. When was that warning? Was that on Monday or previously?
Mr Stheeman: No. We have obviously been seeing not just a rise in financing requirement but a deteriorating market environment effectively for the best part of a year. I have had conversations with the permanent secretary and he has told me he has certainly passed on to ministers the possibility that there will be an uncovered auction. I honestly do not believe that an isolated uncovered auction is a big issue.
Q19 Chairman: I understand that. I just wanted to be clear when you warned Treasury ministers that we might have a series of uncovered auctions. When was that warning?
Mr Stheeman: I had a conversation with the permanent secretary in the summer and I made quite clear that was a possibility and I asked him to inform ministers and he has done so.
Q20 Chairman: So that would be July.
Mr Stheeman: I believe it was possibly earlier. I know I had a conversation with him in late July on precisely this topic, but he told me then that he had already spoken to ministers so I am not quite sure when he actually made that point.
Q21 Mr Love: Apropos the discussion we have just been having, you are intending to auction a significant increase in the current financial year up to £80 billion. What are the key operational problems that you face as a result of that significant - I would not call it massive but significant - increase?
Mr Stheeman: That is a very reasonable question. The total amount forecast for gilts alone for this year will now be £110.
Q22 Mr Love: It goes up daily.
Mr Stheeman: It went up yesterday. That amount compares to £58.5 last year and the highest before that we ever had was £62.5. I am fully aware of that. The first effect is clearly one on the number of operations we have to conduct. For instance, whilst with just the £80 billion forecast we were expected to do 41 auctions, we have scheduled seven more, so there are now 48. We have to start looking for dates on which to hold auctions, we have to plan them in such a way that, if possible, they do not occur at a time when market data are being released, which could be market moving, on Monetary Policy Committee days, on days which could cause disruption. Clearly what we have been doing is looking very carefully to find dates on which we can conduct these auctions in as smooth and seamless a way as possible. That is the market side. On the operational side, one big thing we have introduced since we came here last has been to introduce a form of electronic bidding at auctions.
Q23 Mr Love: I shall come back to that.
Mr Stheeman: It is a key point for us. Frankly we would have been able to do this sort of remit under the old system but, in my opinion, only at a much higher level of demand on our resources and potentially also some operational risks. Automatic bid capture, as we call it, electronic bidding mitigates those risks to a large extent; it does not eliminate them but mitigates them.
Q24 Mr Love: Do you have sufficient resources to do what you have been asked to do this year and if you have not, have you spoken to the permanent secretary in relation to that?
Mr Stheeman: Yes, I have indeed.
Q25 Mr Love: You have spoken to him.
Mr Stheeman: I have spoken to him just a few weeks ago precisely on that point.
Q26 Mr Love: May I turn to the electronic bidding system? Can you indicate to us the cost of introducing that and the savings that you have indicated you think you are going to make as a result of its introduction?
Mr Stheeman: The actual cost of the system itself was zero. There was obviously a lot of internal cost in terms of time and personnel allocated. We used a system which is part of the Bloomberg system. They have an electronic bid system themselves which they use, they have tailored it to our needs. We spent the best part of a year actually designing and developing a system which suits the gilt market in particular and as a result we have introduced this. What cost savings have there been? Effectively they have mitigated risk so that we do not make mistakes and freed up resources across the Office for some of the other things we need. My colleagues inform me that we estimate the internal costs to which I referred - there were no external costs - to be in the region of up to £50,000.
Q27 Mr Love: For its introduction. How much do you think you are going to save as a result of its introduction?
Mr Stheeman: We will save not just purely in terms of administrative costs for the DMO, we are also saving, in my opinion, an enormous amount in terms of minimising operational risk and probably more importantly the turnaround time in which we get the results out to the market. It used to take us on average a little over 20 minutes to get the results of the gilt auction out to the market; now I believe that average is a little bit below ten minutes.
Q28 Mr Love: In America it is two minutes. We always compare ourselves to the United States. You are introducing a system from Bloomberg which presumably originates in the United States, so why can we not match the United States with the two minutes?
Mr Stheeman: Because the type of auction system and policies around the auctions
are fundamentally different to the
Q29 Mr Love: So it only cost you £40,000 internally to introduce this system and you are making some unspecified savings. Can you say any more about your discussions with the permanent secretary about the additional resource you are requesting?
Mr Stheeman: They are ongoing. We are a small office; we are approximately 80 people, just less in terms of permanent staff. It is not my desire or my intention to suddenly increase staff numbers incredibly. What we want to do, if necessary - and we are going through that process right now - is to see where we need additional resources to manage operational risk, to make sure we can continue to deliver what we can. I do not think personally that these are going to be very significant numbers but I am literally in the middle of discussions with the Treasury on that and it is fair to say that on both sides there is a recognition that there is a primary need not just for us to deliver the remit that we have been given but to make sure that there are no mess-ups in that process.
Q30 Mr Love: Let us talk about some of the difficulties. Currently £166 billion of gilts are held internationally. Do you see any problems with the appetite of international investors to take up the auctions you are currently projecting for this year?
Mr Stheeman: In general international investors like focusing on the short end of the market and that is particularly true for overseas central banks, which is also, frankly, one of the reasons why we have targeted the additional £37 billion at the short end. I do not have a crystal ball, I do not know how sterling is going to develop, I do not know how international investors are necessarily going to make their investment decisions over the next 12 months, but I think it is fair to say that sterling offers international investors an element of diversification away from the euro zone, away from the dollar bloc. I do not think that is going to go away for them, I do not think it is going to stop being a consideration in the choices that they make. Whether or not that will decline from £160 billion? I would think that unlikely; I think it will probably increase. What might potentially decline - though I am not saying it will, it is conceivable - is the percentage amount. We have seen consistently since 2002 an increase in percentage terms of gilts held offshore. Personally I have always wondered whether that will flatten off. It has not so far, so I am avoiding making any predictions. What is clearly true is that as our issuance has increased the market has become more liquid. As it has become more liquid it becomes more attractive to the international investor base and those things go hand in hand.
Q31 Mr Love: Let us just talk about yields briefly. Yields have been going up in the current international climate and that is probably likely to continue. Are you sure we are getting the best value for money out of the system?
Mr Stheeman: Yes, I think we are. The
reason why we are is that the market ultimately decides the price at which we
sell our debt. If we are committed, as
we are, to auctioning government debt, that process means that it is the market
which decides and by auctioning we are effectively allowing the market to set
its clearing level for our debt. The way
the yield curve has behaved is that we have had for a number of years, as you
are probably very well aware, in many cases an inverted yield curve in the
Q32 Nick Ainger: May I ask some questions on the Public Works Loan Board? In the report on page five it identifies that the current limit of the outstanding loans is £55 billion and that the Treasury are now consulting with a view to raising that cap. Has the figure now been agreed and when will the new cap become law?
Mr Stheeman: I understand that the idea is to lay down a statutory instrument literally any day now to allow that cap to be raised to £70 billion.
Q33 Nick Ainger: It will go right up to £70 billion which is the statutory limit in the Act.
Mr Stheeman: That is my understanding.
Q34 Nick Ainger: Given that substantial increase does the Public Works Loan Board actually have the capacity to deal with such a substantial change from what I understand is currently just over £50 billion outstanding loan book to the £70 billion?
Mr Stheeman: I believe so. There is a link, if I may say so, between your question and the previous question about the operational capacity for us to be able to issue so many gilts. Effectively it means doing more of the same sort of operations but the staffing levels are something we are looking at closely. I believe that the capacity is there. The other thing I would say is that the disbursements for the Public Works Loan Board tend to be, because they are for capital financing purposes primarily, on a much steadier basis. While we do see sudden spikes sometimes, in particular when yields move and local authorities look to take advantage of those moves in yields, for instance when they suddenly decline or when they are suddenly rising, in order to lock into what they think are advantageous longer-term borrowings, it has taken quite some time to get to this level. My guess is that it will continue to take some time to get to the higher level. One of the reasons why we have gone for the higher amount is to make sure that we do not have to come back soon and say we need to have a higher cap within too short a period of time.
Q35 Nick Ainger: You say the SI is going to be laid very shortly. Are you aware of what date it will actually be effective from?
Mr Stheeman: Not exactly. I was aware that it was supposed to be laid at the beginning of October; I understand we do not have a date. I am not sure when it will be effective.
Q36 Nick Ainger: In answer to a previous question you raised this issue of whether you have the capacity to deal with this. At what stage do you go back again to the permanent secretary and say that there has been such a significant change - which there clearly has been in recent weeks - that you really do need to address this capacity issue within your organisation?
Mr Stheeman: Clearly what I do not want to do and none of us wants to do is to wait for a situation where the Office is so stretched and colleagues are so under pressure that something goes wrong before we have that conversation; that is clearly not what we want to do. We are also cautious inasmuch as I do not want unnecessarily to add to overheads either. The view that I am taking in discussions with the Treasury at the moment has to be one for what we think are the sort of operational activities that we will see over the next three years. That seems to me a reasonable assumption and a reasonable base for us to be working along, not least because our administrative budget comes out of the Treasury's own parliamentary vote, so we need to discuss the context of that within the CSR context which binds the Treasury and the DMO as well. Clearly we will be talking to the Treasury about resources.
Q37 Nick Ainger: On page eight of the report you detail the major changes to the structure of the Board's interest rates which were effective from 1 November 2007. Part of those changes was a separate set of rates for early repayments by local authorities. Could I ask you whether fewer local authorities are seeking to restructure their debt as a result of the apparent increase in the cost of early completion of loan? Has there been any change since November last year?
Mr Stheeman: There has been a slight change as I understand and that also is partly the reason why we introduced the change in the first place. Early repayments of loans were potentially putting the exchequer at a disadvantage and all PWLB lendings are made from the National Loans Fund. It is not supposed to be a function to provide a capital market refinancing opportunity: we are supposed to be lending specifically for the purpose of long-term capital investment. There was a danger that under the old interest rate setting regime which we had that the National Loans Fund would potentially have been put at a disadvantage and we are not permitted to lend at a loss from the National Loans Fund.
Q38 Nick Ainger: Given the current circumstances, with a large number of local authorities now having such serious problems with the Icelandic banks, for example, that they may wish to seek to restructure their debt, but they are actively discouraged by these changes, is there any way that the Public Works Loan Board can actually assist local authorities who are facing, in many cases in some of the smaller authorities, very serious problems? Is there any way that you can assist them?
Mr Stheeman: Under current legislation it is quite hard for the PWLB to be the body to do that and that is the key issue for us. Because we are not permitted to lend from the National Loans Fund at a loss, it makes it quite hard for us to see how the PWLB could be the statutory body that would step in to facilitate that.
Q39 Nick Ainger: Was the situation so bad that when local authorities sought to pay off the loan early you were actually losing money or that you were not making as much money as you were if the loan had carried on for its full term?
Mr Stheeman: That was effectively the thinking behind the change. We do not aim to make money out of this. There is an administration fee and we receive the income for this, but it is not a banking facility in the sense that we are looking to make a margin of profit versus another margin. There was, however, a serious concern that effectively local authorities could be putting the National Loans Fund at a financial disadvantage and it was to avoid that situation that those changes were made.
Q40 Nick Ainger: Since the changes have come in and local authorities have actually seen their effect are you aware, for example, that the LGA have made representations about the changes and the effect they are having on local authorities in England and Wales?
Mr Stheeman: Yes, we are. We have had
conversations and Jo has actually been to
Q41 Nick Ainger: The problem is, given the particular circumstances, it is actually maybe going to cost a local authority which is facing serious difficulties even more to try to restructure their debt.
Mr Stheeman: That is a possibility.
Q42 Mr Todd: There is a reference on page 15 in your discussion of Objective 4 to a technical breach which occurred during 2007-08 in the prospectus for the 3.5% conversion loan. Can you expand on that?
Mr Stheeman: Yes. That was to do with the timing of operating part of the sinking fund for a relatively small amount of money in order to purchase bonds for the sinking fund of this particular issue. An error was made in the actual timing of that purchase according to what was in the prospectus.
Q43 Mr Todd: It says here that you took legal advice and did not consider it likely to result in any financial repercussions. What repercussions might feasibly occur?
Ms Whelan: The error was in relation to which six-month period something should have been purchased in. The financial repercussions would be if the error was sufficient to cause people who were holders of the stock some sort of damage then they might potentially want to recover that. Our legal advice was that there was a very minimal chance of damage occurring to somebody from this technical breach.
Q44 Mr Todd: Presumably the experience has led you to go through some additional proof-checking processes for your prospectuses.
Ms Whelan: Yes. We have obviously referred very carefully to the prospectus, but we have also updated the procedures for the people who are operating this on the desk and the follow-through checks in the control area.
Q45 Mr Todd: Last time I questioned you about the role of the anachronistic and actually nowadays inappropriate description of the Commissioners for the Reduction of the National Debt. Would that those people existed.
Mr Stheeman: They do exist.
Q46 Mr Todd: It is clear that is not their intent. I was looking at the reference in the accounts to the recharging to clients between 2007-08 where the one thing they are doing is reducing their charges to clients. How is that coming about?
Ms Whelan: Typically we are just trying to find more efficient ways of administering the funds, choosing transactions which cost less to process and that kind of thing, so there is a simplification really.
Q47 Mr Todd: Do those have any bottom-line delivery to the clients? I am just thinking how that would actually work. One of the beneficiaries is the Public Works Loans Board customers, presumably largely local government. What meaning would the reduction of the charge have?
Ms Whelan: The charges of the Commissioners for the Reduction of the National Debt are levied on government departments and the investment funds and are not related to the local government community. They would, for example, be the National Lottery Fund and so on. That is where those charges are going. The PWLB is separately levying charges on transactions they are processing.
Q48 Mr Todd: Indeed. Maybe I have misunderstood the table we have which is on page 46; I probably have. It says administration income fees and charges to PWLB customers go down from £4.3 million to £3.5 million.
Ms Whelan: Those fees are really a function of the number of transactions that the customers want to do and also the maturity and structure of the transactions they want to do.
Q49 Chairman: You have a target of making no factual errors in the material you publish on the website or in your printed documents. In fact there were 12 factual errors last year. Did any of those have any significant impact?
Mr Stheeman: No, they did not, is the honest answer. There were some errors. The one which arguably could have had most of a result was in particular where we released the fourth quarter gilt auction calendar on 30 November six minutes early, but as far as we could see there was no discernible impact on the market. That was the one we felt also we should list here as being potentially one which could have moved the market.
Q50 Chairman: How many have there been so far this year?
Mr Stheeman: Factual errors on the website? I am not sure. If there have been some, I can supply you with those figure.
Q51 Chairman: We are half way through the year now.
Mr Stheeman: I think very few factual errors.
Q52 Chairman: Fewer than 12?
Mr Stheeman: I hope so.
Chairman: So do I. Thank you very much to you and your colleagues for attending this afternoon. We move into the next evidence now with the Valuation Office Agency.
Witnesses: Mr Andrew Hudson, Chief Executive, Mr David Park, Deputy Chief Executive and Director of Local Taxation and Mr David Tretton, Director of Rating, Valuation Office Agency, gave evidence.
Q53 Chairman: Mr Hudson, welcome back to the Sub-Committee. Could you introduce your team please?
Mr Hudson: Good afternoon Chairman. I am Andrew Hudson, Chief Executive of the Valuation Office Agency. On my left is David Park, who is the Deputy Chief Executive and Director of Local Taxation. On my right is David Tretton, who is the Director of Rating.
Q54 Chairman: We will come to your annual report in a moment. I want to ask you first about the issue of ports ratings. Could you just bring us up to date factually first? How many ports have you now reviewed?
Mr Hudson: We are very close to concluding the review of all 55 ports. Mr Tretton can confirm whether we have actually completed all 55.
Mr Tretton: There are four ports where at the moment we are in discussion with the port operators about the question of rateability of some ferry terminals. We are very close to concluding that and would hope that the notices on those will be served on the appropriate occupiers within the next week.
Q55 Chairman: We have to deal with facts here. So it is 51 completed and four outstanding. Is that the position?
Mr Tretton: Yes.
Q56 Chairman: How much additional revenue will be gained by altering these ratings?
Mr Hudson: Overall we expect, looking at the port operators and the occupiers together, that the overall increase will go up from about £181 million to about £200 million. Perhaps I could explain.
Q57 Chairman: Just before you explain it, could we be clear about the figures? That is an increase of £19 million.
Mr Hudson: That is correct.
Q58 Chairman: That is for one year annually or for the previous year.
Mr Hudson: No, that is an increase in the rateable value so the liability ---
Q59 Chairman: The revenue. I asked you what the additional revenue would be.
Mr Hudson: I beg your pardon.
Q60 Chairman: That was the question.
Mr Hudson: The revenue will depend on a number of factors such as the existence of transitional relief and other factors which the billing authorities have to apply. Our responsibility is to set the rateable values and that is what will go up from £181 million to about £200 million.
Q61 Chairman: But you must have made some estimate of the additional revenue.
Mr Hudson: No, it is not our responsibility to make estimates of the revenue in the sense that having put the assessments in the rating list it is then a matter for local authorities to assess the liability and then to send out the bills.
Q62 Chairman: Have you not seen any estimate of the additional revenue.
Mr Hudson: No; again, we would not seek to pull that together, it would not be for us to pull that together on a national scale.
Q63 Chairman: Have you seen any estimate?
Mr Hudson: No. We have obviously seen where some individual port occupiers have written in with what is happening to their own bills, but not in terms of any aggregate estimate of what this means for revenues.
Q64 Chairman: What kind of assessment would you do normally of the impact on an industry where you introduce a change of this nature?
Mr Hudson: We obviously appreciate the impact this has had on some businesses within the ports sector but what we have been working hard to do here is to get the correct apportionment of rateable value between the statutory designated port operators on the one hand and the port occupiers on the other hand. That is a matter of fact. Our job is to establish those facts and, in line with the legislation, get the rateable values right. As a result of the fresh information which has come to light and the work that we have done where we have taken great care to establish the facts in discussion with the port operators, some assessments have gone up, some have gone down, others have stayed the same within the overall net increase in rateable value which we have just talked about.
Q65 Chairman: You said that you appreciate the impact but have you actually assessed the impact.
Mr Hudson: The impact will vary. It is very hard for us to judge across the sector as a whole. As far as individual firms within that sector are concerned it will vary considerably. Some assessments have gone up, some have gone down, some have stayed the same. Looking at the position for whole ports, where again we do know the position in terms of rateable value, though it is not for us then to move on to actual bills, for some whole ports the position has remained much the same, even though obviously we are well aware that for others there have been big changes.
Q66 Chairman: But you have not carried out an overall assessment of the impact on the ports industry.
Mr Hudson: No. Our job is to get the rateable values right. We certainly appreciate that for some businesses within this sector there have been considerable increases and we understand the impact that has had.
Q67 Chairman: You appreciate it, you understand it but you cannot tell us what it is.
Mr Hudson: What we cannot do is to provide an aggregate assessment across the sector because of the pluses and minuses, the interaction between the port operators and the occupiers. One of the issues in this review has been the sheer complexity of these arrangements and hence trying to produce an aggregate across-the-board impact of what has taken place on the sector as a whole would be difficult. What I would say is that as a result of this work we have carried out, in discussion with the parties, trying to be as open as possible about it, we now have the rateable values onto a sound footing. If people have difficulty with that, if they feel we have the rateable values wrong, they are welcome to come to discuss it with us. If those discussions still do not lead to agreement, they have a statutory right of appeal. Our job is to get the rateable values right, to provide a fair and consistent basis for the bills.
Q68 Chairman: In establishing a new rateable value you are also backdating it to April 2005, as I understand it. How fair is that on smaller businesses which may have already in fact paid their rates through port charges?
Mr Hudson: Some assessments are backdated, some are not. It is not something over which we have any discretion; it is a matter of how the legislation applies. Where it is backdated we have looked into that very carefully to be sure of our ground. If the businesses disagree, they can discuss it, they have the right of appeal and we have worked hard to be sure of our ground on that where we think backdating is what is required by the legislation. We appreciate that some are arguing that they have effectively paid the equivalent of rates through the arrangements they have had with the operators. That is a matter between them and the operator.
Mr Tretton: We looked very carefully at the regulations which established the rules for backdating, realising that this would have a significant impact and we actually sought legal advice. This has been tested in the Lands Tribunal before just to establish that we were correct; in fact a consortium of the port operators approached us back in April contesting this issue and provided us with their opinion. We really felt, even though we have legal precedent, the need to double check this with our advising solicitor who also went to counsel and concluded that we had no option under the regulation, in the circumstances which were appertaining, but to backdate.
Q69 John McFall: I have received an awful lot of emails and letters on this issue. Whilst I accept the procedural arrangements which you have undertaken, it seems as though this is a huge problem. I have even been contacted by a number of MPs this morning: John Prescott came up to me this morning; Chris Mole spoke to me just before I came in here; Louise Ellman has spoken to me on it. There is real concern here and I think this is where economics and politics collide. We really need to try to assess this situation again. May I ask you about the change? Is it that rather than charging the port operators as a whole now the individual parts have been rated?
Mr Hudson: That is the direction of travel. It is a peculiarly complicated sector.
Mr Tretton: Might I expand? In most of the ports there is a statutory designated operator who controls all of the activities within the port, is responsible for all of the land. They have their assessment, or did until the new rating list came in in 2005, based on a formula which was quite straightforward and there was no degree of debate around what went into the formula. From 2005 they were assessed on a conventional basis to reflect rental value. That made it more pertinent for us to identify in rating terms, bearing in mind that rating is based on an estimation of an annual rental income, to find out who was actually in rateable occupation. For rating the two main ingredients are an occupier and a rateable unit. Following a review at the port of Southampton it was apparent there that for the statutory port operator they were actually including in their assessment far more land and occupations than were correct in rating case law and precedent. That alerted us in fairness to other ports to look at those as well.
Q70 John McFall: Let me just give you a flavour of some of the letters I have received. For example, Leafe and Hawkes Limited in Hull are saying "Please be in no doubt that small companies such as ours will be forced out of business, if they are faced with enforcement for these huge back-dated rating demands" to 2005. They say "We are not aware of any consultation having been held in England with our industry prior to the introduction of this significantly revised government policy and wonder why this was not carried out". Freshney Cargo Services Limited of Grimsby say "I am writing to you because of a significant and potentially 'catastrophic' new threat to our business. The new Port rating system which has landed completely 'unannounced' threatens our very livelihood particularly in times of recession". They point out "This is not just about Grimsby and Immingham but being rolled out to 55 ports in the UK". Hutchison Ports in Harwich say "... the VOA contrived financial figures for the port to arrive at a valuation without proper analysis and foundation, and in the clear expectation that the entire valuation will be reconsidered" and also say "The VOA has failed to communicate with occupiers on significant new rate assessments, proceeded over the past three years in an unacceptable manner". P&O talk about the repercussions for the local authority because Hull City Council is currently stalling the collection of business rates but it "... cannot decline to collect rates indefinitely and the difficulty facing P&O Ferries at Hull is a rates demand for the current financial year of £2.4 million, plus a backdated demand of £5 million". They ask us whether "... you will support our call for the implementation of the new system to be put on hold whilst a practicable way forward is pursued which could be brought in from 2010 in a fair and timely manner". I do not think all these people from all over the country have a coordinated message to us but there is a common theme here that consultation did not take place, that a huge account has landed on their doorstep and it has implications across the whole country. In a situation like that I think there is a need for reflection and consultation here so that we get this issue right.
Mr Hudson: May I just comment on a couple of things there. As far as consultation in the past is concerned, as soon as it was clear, once the issues in Southampton had been clarified, that a major piece of work was going to be needed, we wrote to all the statutory port operators in May of 2006 and asked them not only to cooperate with us and let us have the necessary information for the work that needs to be done but also asked them to contact their occupiers because they know who they are dealing with.
Q71 John McFall: Could you accept from me that the port authorities perhaps did not contact their occupiers?
Mr Hudson: I have certainly had some of the same correspondence though not all.
Q72 John McFall: So this is a big problem.
Mr Hudson: I understand entirely that has happened. I just want to make clear what we have done.
Q73 John McFall: I understand. We have a problem and we have to sort this problem out but you have this account landing on people's doorsteps, businesses have been threatened and the proper procedures, whilst you requested that they be followed, perhaps were not followed and this is a surprise to these people. We cannot really allow a situation like this to go on because your formal approach to it was correct in your eyes. We really need to assess this situation individually, do we not?
Mr Hudson: I appreciate clearly that this did come as a surprise to the occupiers who are writing to both you and me. As far as our job is concerned, we are statutorily obliged to produce an accurate rating list, which means once something like his has come to light and the facts are clarified ---
Q74 John McFall: This is what gets the hair on the back of the necks of these small businesses standing up. What I am really asking you to do here is to reflect on the situation, keep in contact with us as a committee and see your way through this and if there is a need for this to be delayed to 2010 come out with a proposal which is acceptable. It is completely unacceptable for people to find a huge demand on their mat.
Mr Hudson: I understand the point Mr McFall. I am not sure it is within my gift as Valuation Office Agency.
Q75 John McFall: Why is that? Tell me.
Mr Hudson: Because our responsibility is to produce an accurate list and the billing issues and wider issues ---
Q76 John McFall: I would say to you as a select committee that if you are going to put demands on individual entities then you really have the responsibility to be aware that these entities know about that and that is the weakness in your case.
Mr Hudson: We took the steps which we felt at the time were appropriate in order to spread the word on this. We were not seeking to be secretive about this and we are open to discussions with any parties who want to come to discuss it with us. I accept that in practice some of the people who have written in were not aware that this work was going on.
Q77 Chairman: You report to ministers. Who is the current minister you report to?
Mr Hudson: Our departmental minister is the Financial Secretary to the Treasury; on these sorts of local taxation issues it is Communities and Local Government and also Welsh Assembly where relevant.
Q78 Chairman: When you said to Mr McFall that it is not within your gift, you are able to advise ministers, given where we are, of the situation presumably and give ministers advice, if you saw fit to do so, that this may all need to be looked at again. You are able to do that are you not?
Mr Hudson: Yes. We are in very close touch with colleagues in Communities and Local Government and ministers are well aware of the situation.
Q79 John McFall: Did you brief ministers before you came here to tell them exactly what type of questions we would be asking because of all this flurry of information? If you did, I am surprised that ministers have not contacted us to say there is an issue here, a big political issue here and an economic issue.
Mr Hudson: Ministers are well aware of the issue and I saw a response to a question from Louise Ellman.
Q80 John McFall: We will write to the minister today on that and maybe invite the minister along here to this Committee, if that is okay. We need this sorted out. I understand from an official's point of view, from a bureaucratic point of view, that your answer is fine but it is not watertight in terms of us getting to the core of this problem.
Mr Hudson: There was an exchange on the floor of the House yesterday in oral questions.
Q81 John McFall: I am not worried about the floor of the House, I am worried about here. Mr Tretton nodded his head.
Mr Tretton: I was nodding really to say that it is really an element of what you were saying about clarity. The whole issue here is that in the ports you have a statutory port operator who controls what goes on in that port. They will grant licences, leases, all sorts of agreements with operators which are often for more than just to occupy the land. Perhaps with hindsight we should have done more investigative work although, that said, if you visit a port and look what is there physically on the ground you are often no wiser in terms of who occupies what part of that without an instructed and informed view by the port authority.
Q82 John McFall: There is a weakness in your case.
Mr Tretton: It is very good looking back with hindsight. We believed, because it would have been in their interests ---
John McFall: You have already said to me that you could have done more investigative work.
Chairman: You said you failed to investigate it properly.
Q83 John McFall: Exactly. What you said to me is on the public record.
Mr Tretton: I would not say that it was a point of physical investigation. We have made the inquiries with the port operators.
Q84 John McFall: Was it a mental investigation then?
Mr Tretton: No. If I may just get the reply out.
Q85 John McFall: Try to be coherent and concise in your answers because that helps.
Mr Tretton: The difficulty here is the relationship between the port operator and the individual occupants and that is what we sought to delineate. We did that until we realised it was wrong.
Mr Hudson: With the benefit of hindsight we have learned a lesson and please God this does not come up again. If it were to, we would seek to improve our communications with the occupiers as well as the operators. That is certainly a lesson.
Q86 Nick Ainger: When were you as an agency instructed to carry out this revaluation?
Mr Hudson: It was not a matter of being instructed: it is part of our job to make sure that the
list is up to date. The sequence was
that in 2004 there was an issue within the
Q87 Nick Ainger: Let us just be clear. I am quoting here from a letter dated 10 March 2008 from Andrew Gausden the Group Valuation Officer, Sheffield Group to P&O On Board Services, so I presume it is P&O at the Zeebrugge Terminal Building. He says "Until 31 March 2005, the valuation of large ports was prescribed by statutory formula under the Docks and Harbours (Rateable Values) Order (2000)".
Mr Hudson: That is correct.
Q88 Nick Ainger: "From 1 April 2005 the law changed and the formula rating of ports was discontinued". When were you informed that the law had changed and that you would have to start a revaluation with effect from 1 April 2005?
Mr Tretton: It was part of the Local Government Act 2003.
Q89 Nick Ainger: So from 2003.
Mr Tretton: Before that.
Q90 Nick Ainger: So you were aware that this revaluation needed to take place with effect from 1 April 2005 and you have just told us ten minutes ago that you are still four short of the 55 ports that you were supposed to have revalued by 1 April 2005. Is that correct?
Mr Hudson: No.
Q91 Nick Ainger: It is not correct.
Mr Hudson: May I try to explain? The position is that we put the values in the 2005 list accurately on the basis of the information that we had at the time. Of course we knew about the change in legislation in good time. What then transpired was that following this particular investigation in Southampton we realised in this complicated area that questions of fact needed to be established in more detail than we had done before and in the discussions prior to the 2005 list being established we got information from the statutory port authorities and both our understanding and theirs at the time was that those values were correct.
Q92 Nick Ainger: So you published your preliminary rateable values around April 2005, but it has still taken you three and a half years before you have completed - and you still have not completed - adjusting the original valuation that you placed on the ports back in 2005. Is that correct?
Mr Hudson: That is correct.
Q93 Nick Ainger: Exactly. So it has taken you three and a half years. Let us move on. You said that we need to have clarity here. You told us that overall the rateable value for all these 55 ports had gone from £181 million to around £200 million.
Mr Hudson: Yes.
Q94 Nick Ainger: A rateable value of around 10%.
Mr Hudson: Yes.
Q95 Nick Ainger: Can you explain therefore why in Pembrokeshire, with the ports of Fishguard and Milford Haven, the actual RV has gone up 221%, why in Felixstowe it has gone up 212%, why in Harwich, according to the information that we have been given, it has gone up 275% and there have been claims that some of the RV increases have been as high as 500%? How, given that information, can you claim that the RVs on all these 55 ports have only gone up on average by 10%?
Mr Hudson: Some RVs have gone up, some have come down, some have stayed the same.
Q96 Nick Ainger: Could you tell us which ports have gone down?
Mr Hudson: I am very happy to look at specific examples to check the information. I am not sure whether we can actually do that now this minute in terms of the impact on those ports.
Mr Tretton: The figure Mr Hudson was referring to is a cumulative effect on the ports overall. When you look at individuals, some have gone up significantly because they did not have an assessment in the new rating list. In fact part of their occupation was reflected in the statutory port occupier's assessment. What we have done here is redistribute that. In Hull, if you look at the statutory port occupiers and in some of the other larger ports, their assessments have reduced significantly because they were being assessed on information that was provided openly for property which in rating terms, following rating case law, they should not have been assessed for; there should have been separate assessments.
Q97 Nick Ainger: If that is correct, why are we getting, for example, the former Deputy Prime Minister John Prescott complaining rightly about huge increases for operators within ports yet you are telling us in Hull there has been a significant reduction in rateable value?
Mr Tretton: The scenario to picture is that you have a statutory port
operator. If nobody else operated on
that port at all - and we have some ports which are similar to that, certainly
in East Anglia Felixstowe and Harwich are ones where the port operators have a
wider control - all of the rating liability would be down to the statutory port
operator. Many of these ports now,
through licences, have granted other occupations and the circumstance you are
referring to in
Q98 Nick Ainger: I think you need to give us a lot more detail on this issue. I just cannot see how very major port operators are telling us that they are seeing huge increases and they are large operators and yet you are telling us that overall there is only a 10% increase in rateable value.
Mr Tretton: The overall impact, which is a global figure, is one which does not reflect, as you rightly say, what is happening to individual ports. In some of these cases these port operators, the large operators as such, although they may have believed they were paying rates through their agreement with the port operator - and that is a personal agreement between the two, we do not see that - they have not, from a rating point of view, had an entry in the valuation list which a billing authority has physically charged. Saying that they had huge rate increases ---
Q99 Nick Ainger: I understand that point but you told us that overall the RV for statutory port operators pre-2005 was around £181 million. You are now telling us that from the beginning of April 2005 that it will be around £200 million. Am I right on that?
Mr Tretton: The point you made earlier about the process of a preliminary evaluation, the figures that were entered into rating lists at 1 April 2005 were the actual rating assessments for that list based on the facts that we had. They were compiled and placed before the billing authorities and it has been subsequent to that that following an alert from our investigations at Southampton that we then went to look at all of the ports to see whether or not a similar effect that we identified in Southampton was actually apparent. In some of the ports, over 55, there has been very little change in the actual assessments within the port. When we inspected, we did find some occupations there had not had an assessment that they ought to have had. I suspect these are the ones ---
Nick Ainger: I am not disputing that. What I find difficult to appreciate is your claim that the rateable values have only gone up 10% and what the experience of large operators seems to indicate. You need to give us far more detail on that.
Q100 John McFall: Nick was making the point about John Prescott being concerned. If we look at the P&O letter which was sent to me, Hull City Council are deferring collecting rates. That is not doing them any good in the longer term but P&O say that the extra burden they face under the new assessment calls into question the commercial viability of future investment in Hull where they provide employment for 400 people ashore and 818 people afloat. They bring to my attention a letter which they received from VOA as late as March 2008 advising that there could be an impact on the business rates paid by the tenants. In that letter, paragraph five, they say "The port operator may have already alerted you to this" but it is not sure. Here we have a company receiving a demand in March of this year. I notice in paragraph two of the letter they have given me that the VOA say "... the recent visit to your property by a member of my staff", so you were conducting some visits. There has to be consistency here. If you are demanding of people, you should have your staff talking to people. There is a loophole here. We will not get anywhere today with this. What I want you to do Mr Hudson is to go back to your relevant ministers and talk to them about it and see that we, as a committee, get a letter from the ministers on this issue so that we can plot the way forward. I would suggest that we keep this as a pending item on our agenda so that we get a satisfactory outcome to this problem.
Mr Hudson: I shall obviously report to the minister on the discussion we have had.
Q101 John McFall: What I am asking is that you report to the minister, you tell the minister to contact the Committee because we shall be writing to him as well on that. What I am saying is that this is an issue which is going to be taken at ministerial level now.
Mr Hudson: As I think is clear, ministers are well aware of the issue and the strength of feeling about it and the impact that it is having in certain quarters. I will of course pass on the Committee's wishes.
Q102 Mr Todd: From an issue which sounds as though it may have been self-inflicted to some extent to one which is inflicted upon you, which is the change in the position on business rates on empty property, what sort of feedback have you found in that? Have you found a lot of applications from businesses where empty property is now being rated for some sort of relief?
Mr Hudson: We have had something like 3,500 proposals - strictly speaking appeals in colloquial language - since April, which we think are related to the changes in the regime. It is a bit hard to judge to be absolutely strict what is and what is not associated with that. So that is the number.
Q103 Mr Todd: Is that backed with any evidence of people deliberately damaging their property in such a way as to remove it from a liability for business rates if it remains empty?
Q104 Mr Todd: What sort of percentage of these applications has been successful to date? As you say, there are several technical arguments which could be presented and which lead to relief.
Q105 Mr Todd: When you say "resolved" have you resolved them in the failure of the applicant?
Q106 Mr Todd: Just to wind up, you will be aware that at a point where we appear to be entering into a recession there may be lots of people who will say this is an unfair levy on a property which cannot be let, for which there is no market. How are you going to address that argument that a property, while vacant, may simply not be letable in the local context of a market for that sort of premise?
Q107 Mr Todd: Have you communicated the sort of volume of activity on this to HMRC and to the minister?
Q108 Chairman: How many of your council tax valuations have actually moved homes to lower bands? I have seen a figure of around 70,000 over the last ten years have been moved into higher bands. How many have moved into lower bands approximately?
Q109 Chairman: Since 1997.
Q110 Chairman: Can you let us have note on that? Have complaints about banding increased or decreased?
Q111 Chairman: You have to answer the questions Mr Park. Have they increased or decreased?
Q112 Chairman: Mr Hudson, your staff survey revealed low staff satisfaction and in fact I think you have had a period of industrial action. Can you explain to us how that happened?
Mr Hudson: One of the main reasons was last year's pay settlement which staff found difficult. The staff survey also came shortly after we had announced some restructuring proposals and a number of offices were the subject of consultation about closure. I am glad to say that in the staff survey we took in June staff satisfaction picked up from 53% to 58%, so we are on the up. Going back to your previous point about complaints, I am glad to say that customer satisfaction is at an all time high.
Q113 Chairman: On staff morale are there more redundancies to come?
Mr Hudson: We, in common with a lot of departments, have reductions in our budget so the number of staff will continue to reduce. We are doing all we can to achieve that by natural wastage.
Q114 Chairman: So there will not be any compulsory redundancies.
Mr Hudson: We have said we will do all we can to achieve it by natural wastage.
Q115 Chairman: So there could be some compulsory redundancies.
Mr Hudson: We are doing all we can to achieve it by natural wastage which we have managed to do in previous restructurings without the need for compulsory redundancies.
Chairman: I accept that.
Q116 Nick Ainger: You told this Committee last year that you intended to reduce your staff numbers by 230 in 2007-08. Did you do that?
Mr Hudson: Yes, and we probably did a little bit more because we finished 2008 round about 4,000 or a bit short; we are now at 3,800. We continue our downward trajectory.
Q117 Nick Ainger: You also told us that you intended to reduce in this financial year by a further 190. Are you going to do that as well?
Mr Hudson: We are on track to do that.
Q118 Nick Ainger: Given the pressure, not least from the port industry, on your level of work, how are you able to meet the demands of your customers? You say you are having very high levels of satisfaction but given quite significant reductions in staff numbers how are you actually maintaining the standard of your service?
Mr Hudson: I am glad to say - and I pay tribute to our staff here - that we are improving value for money, we are sharpening up our processes, better investment in technology helps and we are able to do this. On the ports front, clearly that is a matter of pretty specialist staff rather than numbers where we are able to reduce.
Q119 Nick Ainger: That was an aside.
Mr Hudson: I wondered whether it was.
Q120 Nick Ainger: Have you taken on any more consultants in replacing? Have you costs for consultancy increase during this time of staff reduction?
Mr Hudson: Not systematically. Where we use consultants it is only where we need a particular skill or a particular job to be done that we do not feel we have the skills to do in house. No, we do not have a systematic policy of losing permanent staff and replacing them with consultants.
Q121 Nick Ainger: The figures in the report show that up to 31 March 2007 you spent £140,000 on staff consultancy and it is increased at the end of March 2008 to £246,000, an extra £100,000 on consultancy.
Mr Hudson: Yes; I am aware of that. However, these were for specific projects. Quite a lot of it is IT consultancy where, rather than make recruitments if there is something specific which needs to be done short term, it is better to bring in a consultant rather than hire somebody permanently. Yes, in 2007-08 we spent a certain amount more on that than in 2006-07.
Q122 Nick Ainger: So it could go down in this financial year?
Mr Hudson: It could go down. Whether it will or not, I do not know, but the principles are the same.
Q123 Chairman: Your merger with The Rent Service took effect from April. What are the recurrent savings as a result of that merger?
Mr Hudson: Next year we expect the costs to the Department for Work and Pensions of that activity to be about £28.5 million compared with £37.5 million this year. That is an estimate so there are many things wrapped up in that. The biggest difference is actually that the volume of work on housing benefit activity is reducing. The savings that we make, particularly for instance as The Rent Service is closing down all its offices so all its staff are coming into existing VOA accommodation, mean there will be economies of scale of that sort.
Q124 Chairman: So it is about £9 million.
Mr Hudson: Nine million is the reduction in the cost of that activity; part of that is because the volume is coming down.
Q125 Chairman: Are any staff from either your Agency or The Rent Service losing their jobs?
Mr Hudson: There is a reduction in staff numbers inevitably to enable us to realise that sort of saving and The Rent Service have conducted a voluntary redundancy programme to deliver that.
Chairman: We are going to leave it there. May I thank you very much?
Witnesses: Mr Trevor Llanwarne, Government Actuary and Mr Kevin Down, Director of Finance, Government Actuary's Department, gave evidence.
Q126 Chairman: Mr Llanwarne could you formally introduce yourself and your colleague please?
Mr Llanwarne: I am Trevor Llanwarne. I am the new Government Actuary, appointed from 1 May this year, and on my right is my Director of Finance Kevin Down.
Q127 Chairman: Welcome to the Sub-Committee. I am sorry we have kept you waiting slightly. This is your first appearance so perhaps you could explain to us how your previous experience has equipped you to be Chris Daykin's successor?
Mr Llanwarne: Good question. I have joined here as the Government Actuary from 1 May. My background is pensions, although I have worked in life insurance as well for ten years. I was head of the pensions operation at PriceWaterhouseCoopers on the actuarial side and I was responsible for quality and risk for the final three years of that period. I think I have a very good overall rounding of matters actuarial and with particular reference to pensions.
Q128 Chairman: Why did they take seven months to find you?
Mr Llanwarne: I was on 12 months' notice with PWC.
Q129 Chairman: In what areas of the Government Actuary's Department do you think you are going to be able to make an immediate contribution?
Mr Llanwarne: I would hope in all areas, to be frank. Although insurance is something of which I have not had much experience for many, many years, we do do some insurance work, as you will have seen from the report, and I have managed within the first few weeks to make sure that we restructured the insurance operation so that it has started getting back on track in delivering service to clients. I appointed a new head of insurance in that period and I think it would be fair to say that it is running full steam ahead as opposed to where it was in the early stages.
Q130 Chairman: The annual report, which I know concludes just before you started, highlights some quite serious difficulties you have had with understaffing in the Department. How are you addressing those?
Mr Llanwarne: There is a number of areas which had to be addressed. However, I can give you some updated figures because as of 31 March our total was 96 and it was about 100 a year earlier. We are already at 105 as of now. The key issue, as I saw it, was to have a properly motivated personnel department and actually address that first. We have addressed that and I believe we have a very strongly motivated head of HR and a department that is all working onside. We are now having absolutely no problems getting recruits coming in.
Q131 Chairman: So you are not struggling to recruit the right calibre of staff now.
Mr Llanwarne: No; not now. I think it is for two reasons: one is what we have done in relation to the HR department itself, but also it is certainly true that the market for actuaries is different to what it was 12 months ago. It is easier to get people now.
Q132 Chairman: Bonus payments last year increased from £23,000 to £37,000. Can you explain that?
Mr Down: That was an increase in the non-consolidated bonus payments. Previously every member of staff in the Department received a bonus of the same amount so it was a very small bonus. We changed that to a performance-related bonus.
Q133 Chairman: Every single member of staff got the same bonus. Is that right?
Mr Down: In previous years, which was not performance related and made no sense at all.
Q134 Chairman: So it was not a bonus.
Mr Down: Exactly. What we did last year was to change the system to make the bonuses performance related so they actually relate to staff performance.
Q135 Chairman: On the issue of data protection, you report no personal data-related incidents in 2007-08. Is that still the position six months on?
Mr Llanwarne: Yes, it still is.
Q136 Nick Ainger: Could I quote you from an article by John Ralfe in the Financial Times of 14 July 2008? This is just an excerpt about the mineworkers' pension fund. "An analysis of the actuarial valuations since privatisation, obtained under the Freedom of Information Act, shows that the huge payments to government and members are being made from fictitious surpluses. This is because the method of actuarial valuation, set down by the government actuary, understates liabilities by discounting at the 'expected return on assets', including 70 per cent equities, not the index-linked gilt rate, which would better reflect the fact that pensions are inflation-linked and government guaranteed. On an index-linked gilt basis, there was a £0.9bn deficit at market values at the (latest) 2005/06 valuations, not the reported £1.9bn surplus. In 2002/03 the deficit was a whopping £5.3bn at market values, rather than the reported £0.7bn deficit." I do not know whether you accept those figures but Mr Ralfe does seem to indicate that rather than miners and the Government, who take 50% of these surpluses, benefiting from genuine surpluses we are actually paying out from the core of the pension fund rather than from surpluses. Do you have anything to say about that?
Mr Llanwarne: The first thing to say is that, as you will understand, actuarial valuations in relation to the coal schemes were done by my predecessor rather than me. In getting my feet under the table the two coal schemes, the Mineworkers' Pension Scheme and what they call the BC triple S, the staff pension scheme, are two where valuations are up and coming fairly shortly. It is very important to understand a big difference between schemes like these and a lot of the public sector schemes. There is a big difference between those and the traditional private sector schemes. Although I do not know the detail of the figures you are quoting, so I would not wish to comment on that without looking at it more, I would say - and this is important - that the way private sector pension schemes are run is quite different to the way in which these schemes are run. These schemes basically have a government guarantee relative to benefits in them and therefore it is much more of an issue as to what is that balance between Government and the trustees as to where all parties want it to be. To apply traditional funded private sector approaches to schemes which are run in quite a different way and with this guarantee which you do not get in other schemes certainly is something where I would be flagging at this point that you should not be applying traditional approaches. I do not know but I do wonder whether traditional ways in relation to the private sector have been applied to these schemes which are quite different. It would be quite tough for me to go into more detail because I have not done the valuation yet and I do not know the numbers.
Q137 Nick Ainger: What Mr Ralfe seems to be arguing is that the actual surpluses are not there. Irrespective of how a particular scheme operates and whether there is a government guarantee behind it or not, his argument is that there were no surpluses and yet there was a significant distribution to members and to the Government who took 50% of those surpluses. Bearing in mind this was a direct criticism, admittedly not of you but of your predecessor and the Government Actuary's Department, was there any rebuttal? Did you issue any response to this? It is a direct criticism of your work or the Department's work.
Mr Llanwarne: I think you will understand that any rebuttals or whatever in relation to press articles - and there are quite a number of press articles; governments get into the same position more generally with press articles - would have to be done in conjunction with the trustees of the pension scheme and it would be totally inappropriate to do that independently in my view. No, there was not a rebuttal but I would say to you that if you go and look at any valuation report of any private sector pension scheme you will get three or four different numbers for surplus on three or four different bases. There is not one unique number as to what the surplus is or not. What is critical about this pension scheme is that the way in which the valuation is done is set out in specific legislation relating to it as to what you do, how you calculate the surplus and it is reasonable to do that because, unlike the private sector, where it is absolutely critical that you get things in balance between your assets and your liabilities, this one has the underlying government guarantee which makes it quite different. When someone asks whether the surplus is this or that, I will say to you that if you do your calculation on one basis you get that surplus, if you do your calculation on another basis you might get another surplus or a deficit and I would suggest that in relation to this, I do not think it is going to be too long before I have to sign up to a valuation on these schemes and then it may be better for you to raise those questions in relation to anything I produce at that time.
Q138 Nick Ainger: The concern is that, because there is that government guarantee, if Mr Ralfe's analysis is correct and we are paying out these surpluses not actually from surplus but from the basic underlying investment, ultimately the taxpayer, because there is that government guarantee, will have to start paying, which is something obviously we would not wish to do if errors have been made.
Mr Llanwarne: I do not think errors have been made. In a lot of these areas you have to be very careful. The taxpayer over the last ten years has actually won. Somebody else, whom I do not know, actually did a rebuttal saying the taxpayer has gained enormously over the years from the way this has been running and if it had been done in the way John Ralfe suggested, this person wrote, the taxpayer would have been far worse off. Because this runs over many years I would suggest you do have to look at things in a wider way.
Nick Ainger: It will be interesting to see once you come up with your valuation what your estimate of the surplus is.
Q139 Mr Todd: I am not sure what the rewards of your job are but the website of the government actuaries list your illustrious predecessors and all but your immediate predecessor ended up with knighthoods and every single one of them gained some additional decoration as well, including Mr Daykin who became a Commander of the Bath or something like that; I am not familiar with these but no-one has offered me one. I note that non-monetary reward which appears to be guaranteed to the post. May I ask about the new competitive environment of the Government Actuary which succeeded the Morris review? How is that working out?
Mr Llanwarne: I think it is going well, if I am honest. I come from a private sector background, I am used to competition and I am guessing that is one of the reasons why an outsider was appointed to this, because it is a new environment. I welcome it quite frankly because I do believe that once you are in a competitive environment you start looking much more carefully at what it is that matters to the clients. It is critical that I deliver that service to the clients as opposed to just saying - which tends to happen if there is not competition - we will be the determiner of the quality of the service. The post-Morris environment says the clients should be the big determiner of the quality and that significantly sends up the type of work we do and what we do as a result.
Q140 Mr Todd: Does the downturn in the Department's income suggest you are losing some market share?
Mr Llanwarne: We were.
Q141 Mr Todd: You were but now you are not?
Mr Llanwarne: No, the income for the first six months, which you will not have received yet, shows we have turned the corner and it is going up again because we are focusing on what the client is specifically asking without whatsoever reducing the quality of what we do.
Q142 Mr Todd: Mr Down mentioned your bonus scheme change which I must say sounded necessary. Are bonus schemes related directly to improving the market share of the Department? Are they based around that principle or income generated or what?
Mr Down: Based on the staff performance system. All members of staff receive an annual assessment and depending on the markings in that it is based on that.
Q143 Mr Todd: It is not related in any sense to the outcome of tenders you presumably make.
Mr Down: No, the current system is not.
Q144 Mr Todd: The Ombudsman produced some criticisms but again this relates to a period long before your time; criticisms of the Government Actuary's Department in the inquiry into Equitable Life. I am sure you will have read the Ombudsman's report because the Department was heavily criticised. Do you have any reaction to that outcome?
Mr Llanwarne: No, is the simple answer. The Government are going to give their response shortly.
Q145 Mr Todd: We know that.
Mr Llanwarne: It would be quite wrong for me to say anything in advance of that.
Q146 Mr Todd: Do you think this will have any effect on the reputation of the Government Actuary's Department or do you feel this was all so distant in the past that your customers will not have particular regard for that?
Mr Llanwarne: Firstly, I do not feel it will have any impact. Secondly, we have done surveys of our clients in the few months I have been here and it is not coming out whatsoever as an issue. One of the points which is perhaps worth tabling on this is that nobody in the Department as it is was involved in doing the insurance work that related to whenever it was done. That is not to imply any criticism whatever; it is simply a matter of fact. Purely as a matter of fact, that does significantly help in terms of our relations with our current clients. We are not hitting any problems whatsoever.
Q147 Chairman: I want to come back to Mr Down on the point about the income. In February 2008, right towards the end of the year, your spring supply estimate estimated your forecast income at £12,906,000 just a month before the year end, yet the actual outturn was £10,093,000. Why was there such underperformance?
Mr Down: This is because the figures in the supply estimate are a lot higher than the actual outturn.
Q148 Chairman: Why?
Mr Down: Historically GAD worked under what used to be called net running cost control whereby you had your gross expenditure target, you had your appropriations in aid which covered that and then you had the net outturn below that. It was the net control total which was the target we worked towards. Within the supply estimates we need to allow some headroom because Parliament only authorises certain amounts of receipts to be appropriated in aid against expenditure. We have to allow a certain headroom within the supply estimates in case a client comes to us and there is a sudden upsurge in work in February/March time. We would not be able to do that work for the clients if we did not have that headroom. At the time when we produced the supplementary estimate our forecasts were in line with the outturn.
Q149 Chairman: But the headroom you sought was £3 million.
Mr Down: That headroom is historic; over time that figure has been there. It is the net total figure which we work towards with our spending team.
Chairman: We will leave it there. Thank you both very much.