Administration and expenditure of the Chancellor's departments, 2008-09 - Treasury Contents

Written evidence submitted by the Government Actuary's Department (GAD)

  Thank you for your letter of 12 November 2009 asking us a set of questions on which you would like answers in order to prepare your annual report.

  I am delighted to respond to your questions. As background, understanding the answers to a lot of what you are asking will, I believe, be helped by an understanding of the overall strategy and business plans of the Department and how things have changed since I started. So I shall start by setting the scene in this regard.


  When I took on the role of Government Actuary on 1 May 2008, I instigated a strategic review which forced us to address the questions:

    —  what does success for GAD look like?; and

    —  what is failure of GAD?

  Without addressing these questions it is impossible to know what risks to control (of which more later) or how to motivate the department to a common objective.

  For GAD we decided that failure would be a sale of the Department caused by our own action/errors (as opposed to a Government inspired sale which would be subject to other considerations).

  Success, in the absence of a single metric such as profits as one gets in private sector, was set as a balanced scorecard of various metrics (see the key objectives described in the summary business plan attached; the objectives include delivery of the plan, improving sustainability and brand, complete HR initiatives etc).

  In addition, I have set myself three personal success measures:

    —  to ensure GAD is a success;

    —  to be truly the Government Actuary (ie providing all types of actuarial support to Government and not just pensions support as has generally been the case for some years); and

    —  to improve the "brand" of GAD, and actuaries generally, in Government.

  In order to deliver on this, we had a structured set of initial objectives as follows:

    —  determine a descriptor of GAD; which we have set as "Government Actuary's Department—the actuarial consultancy—in the public sector—for the public sector";

    —  determine, through client and employee surveys and an interactive SWOT analysis, the values to which we need to aspire (not just what we think we are);

    —  a total overhaul of the HR approach (new job descriptions, career maps, competencies, appraisal system, pay and reward etc);

    —  quality management information on a monthly basis;

    —  establishment of half-yearly employee attitude surveys (we have now finished three) and annual client surveys (the second is now just finished);

    —  segmenting our business into three strands and setting goals for each (ie to be principal provider of services on policy work, to be best in class for our regular work for public service pension schemes and to provide a valued service to other work suppliers). The key is that clients judge us on a scale of 1-10 and we achieve our goals if we secure target marks on client perception;

    —  to shift to a client-centric organisation which means (a) that clients decide whether they receive a quality service rather than as previously, we form our own view on quality and (b) we need to significantly change our culture with regard to client service, sales and marketing;

    —  restructure the management of the Department into functions with clear allocated responsibilities;

    —  to overhaul our training programme in line with the new culture, the new competencies etc; and

    —  determine the big risks which can lead to "failure" (seven in all). Interestingly of the 70 items on the GAD risk register when I started only three of the big risks were present—a proportion which we understand is not untypical. The big risks are getting sued, loss of any of our key clients, valuation software, personal data loss and three client specific risks.

  In summary, these objectives recognise that the two big things that matter for GAD are our people and our clients.

  As you have noticed we got off to a very successful start in 2008-09. After two years' previous decline, income was up 19%, staff numbers up some 30% at 30 June 2009, morale up significantly and indeed all the metrics turned very positive.

  As well as the summary business plan which is attached to this letter, I also attach our "user-friendly" annual report for 2008-09 which lists all of the things we do, our values etc which I believe will fill in many gaps. It also summarises on page two our achievements for last year and plans for this year.

  A key part of our plan is investment in developing two new areas for us:

    —  investment and risk consulting (this started in February this year); and

    —  opening a second office, in Scotland, to serve Scottish Government and Local Authorities (early next year).

  To finish this introduction, I will share with you my own approach to my own bonus which, sensibly, is different to that elsewhere in civil service given that GAD receives income broadly comparable to our expenditure so we can easily look at private sector analogies. The principles are:

    —  there should be no reward for failure;

    —  there should be the potential for a sizeable reduction if the risk of failure is higher at the end of the bonus period than the beginning (this I see as critical since it has more effect on behaviour than the previous principle);

    —  the maximum bonus should be set in advance with a realistic chance of achievement;

    —  if I am to advise others on risk and reward mechanisms (as I do), I should put my money where my mouth is and try out mechanisms on myself first to see what works; and

    —  there should be a real range of possible outcomes from zero to 100% rather than the more common narrow range which in practice could well be in the 66%-80% band.

  A proforma to the approach I adopt is attached. Note that this approach is only applicable to me at present. It may get extended to the Executive on the Board but it is not appropriate beyond that level. Note also that the proforma approach is designed to avoid "shutting the stable door after the horse is bolted" as is the intention of bonus deferral elsewhere. Quite which of the two approaches turns out best is too early to say but the approach I am adopting is not tried and tested elsewhere but is a novel and worthwhile alternative to understand as the years go by.

  Turning now to the questions:

Q1.  How has GAD's business changed in response to the economic crisis

A1.  To date very little. Our income for 2009-10 should again be some 20% higher than last year. 80% of our work is UK public sector which has been and will be secure until 1 April 2010. Beyond that we expect:

    —  more pressure on fees;

    —  extra work for any new government, whoever is in power, at the start of an administration;

    —  growing our two "investment areas"; and

    —  some risks to some overseas insurance contract renewals (although we are investing much time in protecting our position and have very good relationships).

  On balance we expect the second and third to be more significant than the first but this is by no means certain. So we are now into a theme of consolidation for 2010/11 and have contingencies prepared.

Q2.  To what extent is the new Investment and Risk team a response to the changing economic environment over the last year?

A2.  In principle the answer is none but there was an indirect influence.

  When I started, the Department had very limited expertise on investment or risk. Elsewhere, in the private sector, investment is now mainstream actuarial work. Risk is upcoming. I looked round Government and quickly came to the view that there is a big need for quality mathematical and actuarial support in both these areas so we launched the initiative of setting up this team with a view to "marketing" our services. There is no doubt that the credit crunch supported us in the analysis but it wasn't a direct driver.

  To date, the core team has grown from one person to four in under a year. As well as investment risk, we are also chairing a cross-Government group on project risk, we are aiming to link with NAO/Internal Audit to establish a joint audit/actuarial approach to managing and controlling risk and, are working with APA, UKFI and Treasury.

Q3.  How much of the (Investment and Risk) team's work has been on the modeling of the Asset Protection Scheme for HM Treasury?

A3.  The short answer is not much. The work of designing the APS was already under way when the team was formed. That said, GAD were able to review the proposed terms of the APS and comment on some risk-related aspects of the design. We also reviewed an illustrative cashflow model that was used to help with the scheme design, commented on its suitability for analysing risk on an ongoing basis and proposed an alternative approach to the modeling which would enable more of the potential risks to be captured. In addition, members of our insurance team worked with the investment and risk team given that the infrastructure of the APS bears some resemblance to an insurance company. Now that the APA has appointed its new head and new head of risk, we are actively liaising with them regarding monitoring and evaluating risks going forwards where we believe a combination of actuaries with the APA's credit experts can deliver better than either expertise in isolation.

Q4.  What skills and expertise does the (Investment and Risk) team possess to be able successfully to advise on investment risk management strategies and approaches to hedging risk?

A4.  Members of the team have extensive experience of working with pension funds, insurance companies, asset managers and investment banks in designing and implementing risk management and hedging strategies. Specific expertise includes:

    —  financial and demographic risk assessment;

    —  stochastic asset liability modeling;

    —  investment strategy implementation and asset allocation optimisation;

    —  critique of any investment strategy and hedging;

    —  risk mitigation strategies eg interest and inflation swaps, longevity hedging, insurance to effect a risk transfer etc; and

    —  strong communication skills.

  It is also worth recording that we are actively exploring with other parts of Government (including NAO, Internal Audit, Treasury, Cabinet Office and departmental risk Managers) ways in which we can bring our skills on quantifying/managing risk from a mathematical/financial perspective into a coordinated framework with other relevant risk skills for the better control of risk across Government. This proper professional mathematical modeling expertise has been conspicuous by its absence to date.

Q5.  (In relation to Solvency II) what additional work will GAD be required to undertake?

A5.  The work that our insurance team will do on Solvency II needs to be considered under three headings:

    (i) who is our client base;

    (ii) the ongoing work for existing clients; and

    (iii) other work (training and development, new project for new and existing clients).

  It should also be remembered that Solvency II does not come into force until 2012.

  Taking each in turn:

    (i) Our insurance client base is primarily regulatory support work for non-UK regulators. In other words, we have the equivalent role for certain overseas regulators that actuaries at the FSA have for the FSA in respect of the UK but, naturally, the work we do is commensurate with the state of development of the relevant local market. We also perform a small (but growing) amount of consultancy work for Governmental Departments in the UK.

    (ii) In relation to ongoing regulatory support work, much of this arises from September, through March. There is no increase for October 2009-May 2010 on account of Solvency II regulation. The first year when this is expected to arise is 2010-11 when we are likely to offer an internal model review service (but whether clients defer until 2012 is unknown). We are planning that in 2010-11, our workload will be some 50% higher on existing EU clients. However, this estimate represents a very wide range between 10% and 100% and only in six months' time will this become clearer. Further, it should be realised that EU work represents just some 25% of our insurance team's business.

    (iii) We are already seeing new work arise in terms of training sessions for regulators and for certain UK Government Departments. We also expect our expertise will create real opportunities to win new overseas clients. We recently secured a new client with the Bahamas regulators.

Q6.  What is GAD's strategy for coping with this increased (Solvency II) workload

A6.  At present, we are keeping a watching brief and indulging in very low cost marketing exercises. This is because there is so much uncertainty of whether there will be much extra work and when it will arise, coupled with the constraints imposed under Parliament's spending rules. As a Government Department, we are constrained to not go below budget of a £588,000 net cost for 2009-10 (based on £13.5 million income) nor to make any profit. This makes it almost impossible to staff up in advance for work that will not arise for at least a year and potentially never. Further, the potential growth relates to non-UK work which is outside our core strategy. (The rationale for having a public sector GAD is to support UK central government; if we become a profit-centre for non-core work we would likely suffer in our ability to deliver to this core strategy). Against this background (and the earlier mentioned risks with some of our overseas contracts) "our wait and prepare" strategy is:

    —  monitor and report quarterly on Solvency II activity/developments;

    —  build relations with the actuaries in FSA for purposes of sharing knowledge, joint training etc with a view to determining if there are any future possibilities of secondments either way to create a more flexible pool of labour to respond quickly to demand;

    —  attend the key international insurance regulator conference each year; and

    —  develop a 2010-11 Solvency II strategy in May 2010.

Q7.  Does the estimation of numbers of staff needed next year include those required to complete the increasing Solvency II work?

A7.  Our estimation of 130 average staff for 2009-10 does not include any specific Solvency II extra staff but it does effectively make an allowance. We just applied an overall increase to 2008-09. Already the estimate looks like it might be too low independent of Solvency II. Regardless, any increased workload, if it comes, will not be big relative to the Department as a whole. We do not know if much will arise in 2010-11 and we have to manage relative to some very tight financial "caps and collars"!

Q8.  How many man hours do you envisage being spent on this area in 2009-10 and 2010-11?

A8.  For 2009-10, the client-training fee based work (some to UK departments, some overseas) will comprise some 50-150 man-hours. For internal awareness and training, we do not specifically itemise or budget our pure Solvency II elements but we started internal training in the summer of 2009 and envisage some 100-150 total man hours for our 15 insurance team members on awareness and training in 2009-10. We will not come to a view on 2010-11 until May 2010 (see A6 above) for all the reasons given. Things are too uncertain at present.

Q9.  To what do you attribute GAD's success?


    —  Absolute clarity on meaning of success/failure and the big risks to failure.

    —  Clear recognition that our strategy focuses on our people and our clients.

    —  Leadership and Drive. I will do everything I ask others to do and not afraid of taking personal risks.

    —  Combining private sector focus and techniques with the strong ethics and service culture of public sector.

    —  It would be wrong to totally ignore the recession! Although not a major contribution, the recession has, when combined with all the positive messages and our changed reputation, helped us recruit and retain quality staff. But I would not wish you to overplay this aspect.

Q10.  To what extent is the increased income the result of increased charges for your services rather than increased business?

A.10  The increase in fee income for the year (allowing for the increase in work-in-progress which is shown as a credit against expenditure in the accounts rather than income) is about 21%. This comprises an increase in chargeable hours worked of 15% and an increase in average fee per hour of 6%. So, roughly, just under one-third is increased charges and two-thirds is increased business. It is worth considering, conceptually, where the increased business has come from which is:

    —  a catch-up of work (backlog), that had slipped behind expected timescales in the previous year, arising from the recruitment of extra staff;

    —  being given extra work from ongoing clients by being more on top of our workload; and

    —  new clients.

  Of these, the last only made a small contribution in 2008-09 but 2009-10 year to date is already showing significant wins in new clients; some against strong competition.

Q11.  What are your projections for income for 2009-10?

A11.  Although difficult to predict we anticipate income could be between £13.5 million and £14.5 million which would represent another year of close to 20% growth depending on the precise turn-out.

Q12.  Why did you waive this year's bonus when GAD has had "real and genuine success" (Annual Report and Resource Account, p 22) over the last year under your stewardship?

A12.  On a factual basis, I did not waive the bonus in full. I took £15,000 and waived the potential excess of up to £25,000. Although a final nominal figure was never agreed, it was accepted that it would have been in excess of £20,000 without the waiver. So how did we arrive at this position? It was a combination of two factors:

    (i) I want to make GAD a success. This means we need to build and preserve good relations with all parts of Government in order to get work and more work from them. I was advised that to push for more than £15,000 would create serious difficulties to the Civil Service given their desire to achieve more cost control over the pay bill.

    (ii) I felt that a full waiver would be quite wrong since it would create a message generally in the Department that the Department had been a failure meaning that success would be seen by all as being no better than failure—which would create the perverse behaviour of rewarding failure! To explain, the message to senior people of no bonus after a successful year would have been "it doesn't matter whether you do poor work; you're not going to lose out relative to doing good work, since you end up with the same pay—so why do more than the minimum"—hence the reward for failure consequence of a full bonus waiver.

  So it was pretty straightforward. My big objective of "GAD success" meant it would be stupid to push for more than £15,000. Note that in line with my drive for transparency/disclosure, we positively disclosed and accounted for my 2008-09 bonus in the 2008-09 accounts notwithstanding the cash not being paid until 2009-10. If you would like more details of my 2009-10 bonus arrangement over and above the proforma attached please let me know.

Q13.  How is GAD going to measure performance against these aims, and how will GAD report this to stakeholders?

A13.  Against each of the three aims we take measurements:

    — firstly on the client's perception of "preferred provider", "best in class", "highly valued";

    — secondly on income growth for each category.

  We have targets for the perception measures (85% for preferred provider, 60% for best in class, by summer 2010. These are stretch targets given a base of 76%,and 36% respectively in August 2008.

  Our growth targets for each category are 20%, 7% and 10% per annum. The last two are being beaten. We are behind on the first.

  In early 2009 we did a full report to stakeholders of the results (good and not good) of the summer 2008 exercise. We will do the same again in early 2010 in respect of this year's exercise. If you would like to see the report we issued earlier this year, please let me know.

Q14.  Will GAD be repeating the client survey conducted in 2008-09 on an annual basis in order to gain stakeholders' views on GAD's performance?

A14.  Absolutely yes. We conducted an equivalent survey in September/October 2009. The results are not fully analysed. Initial indications suggest not much change over the year. So we need to understand why this is the case and do better.

Q15.  GAD's Annual Report records great success in recruitment with staff numbers up accordingly. Does the fact that "Consultancy" costs and "Agency and other temporary staff" costs have increased dramatically suggest that GAD has nevertheless been working this year without the full time permanent staff it needs?

A15.  There is a sizeable increase in Consultancy and Agency costs as you rightly point out. The increase in agency costs reflects our great success in recruitment and represents the agency commissions for each new recruit we take on through agency introductions.

  The increase in commissions is caused by us taking on a handful of staff to cope with our workload where:

    (a) some did not actually wish to become permanent members of GAD;

    (b) given our rapid expansion, it suited us to have some flexibility to easily reduce numbers if for example the increased workload did prove to come just from catching up on the backlog.

  As of the present, we still have two such individuals on a staffing level now of 134 so we believe we are managing this well at present.

Q16.  Has GAD recruited the right staff?

A16.  There is no doubt that with the changed direction and the recession, GAD has been able to recruit some real quality actuarial staff at all levels. In a year's time, might we look back and say "we could have done better there" or "we missed an opportunity on that issue" or "we misjudged"? I expect so. But that's always the way of things and at present I have no omissions or regrets.

Q17.  Are GAD's pay levels sufficiently competitive to attract the senior staff and specialists that you need?

A17.  At present the answer is yes. But we need to monitor very closely since, once there is real growth in the economy, there is a significant risk of losses of good staff. Positive adherence to our key values and exposure to plenty of interesting work will be a great help.

Q18.  How many staff will you be recruiting in the next financial year?

A18.  We expect our staff numbers at 31 March 2010 to be broadly as they are today (ie 134) plus two or three new staff to set up our Glasgow office.

Q19.  Is GAD still on course to move into a new office in "early 2010"? Do you have a more precise date for the move?

A19.  No. GAD will be unable to more into a new office as planned.

  Although we had received OGC and Treasury approval in April 2009, and had a firm commitment of new better, cheaper premises and had a new tenant for the whole of Finlaison House, we hit problems due to our sub-tenants. One of our sub-tenants is the Baha Mousa Inquiry. They had originally expected to vacate in April 2010 but this is now likely to be extended to late 2010. So the new tenant for Finlaison House, quite reasonably, pulled out needing full immediate occupancy. It will be difficult to find new tenants in the current climate so we are focused on staying in Finlaison House for the foreseeable future and delivering quality service to our clients.

  We are being more efficient in our use of space—Finlaison House is 2,874 sq metres with GAD occupying 1,376 sq metres (a reduction from 1,515 sq metres on 1 May 2008 when I took on the role notwithstanding the higher staff numbers).

  The committee should be aware that, as a result of our failure to move, our finances are very vulnerable to sub-tenants leaving. We could in the next year or two face a hit to our net costs of over £1 million based on what may or may not happen. We are in discussions with Treasury and OGC about managing this potential exposure.

Q20.  What benefits do VIP events bring to GAD and its business?

A20.  Ultimately, our aim is to have greater penetration of Government so that Government makes best use of its in-house actuarial services wherever this is appropriate. There are lots of areas of Government where our expertise could be of real benefit and currently is not, due to lack of knowledge and lack of sponsorship. So our first aim is to spread the word amongst senior key participants and influencers that we're back in business.

  Our second aim is to act as a facilitator between key government/public sector individuals and the external financial world where there are often misunderstandings. If all parties can better understand each other then policy implementation will work better for all parties (in the non-party political sense) for the good of the country. And if we can do this, then this will also support our first objective.

  To date we have held four breakfasts—two in January on gilts issuance (with Treasury/DMO), one in June on Longevity (with ONS and Cass Business School) and one in October on the Walker review (with Sir David Walker speaking).

Q21.  What was the cost of holding these events?

A21.  The total cost of the four events to date was £1,572.

Q22.  What progress has been made on the valuation of the miners' pension scheme?

A22.  The September 2008 valuation for the Mineworkers Pension Scheme has been completed and signed in September 2009. Copies were circulated to the trustees, DECC, HM treasury shortly afterwards. A copy is enclosed. The statement on risk requested by the committee is included as Appendix B of the report. Members of the scheme were briefed on the outcome by a newsletter issued in late October. There is no formal publication of the report other than as described above.

  The valuation for the British Coal Staff Superannuation Scheme has nearly concluded its consultation phase and we hope to sign the report in the next month or two.


  My aim in the above has been to answer the questions fully and honestly with the hope that you can see the tremendous progress the whole Department has achieved and takes pride in, along with the challenges we face. We are on a journey to even greater things for the good of Government and the country. But as stated there are many challenges ahead and potential minefields to navigate. So if you would like any more information about the past or the future, whether in writing or face to face, please do not hesitate to get in touch and I would be delighted to assist further.


    —  Business plan.

    —  Short form Annual Review.

    —  Proforma bonus approach.

    —  MPS valuation.

Trevor Llanwarne

Government Actuary

5 January 2010

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