Scheme funding

25. DB pension schemes are subject to a statutory funding objective of having sufficient and appropriate assets to make provision for their liabilities.121 Actuarial valuations must be carried out at least once every three years to assess whether this statutory funding objective is met.122 If it is not, the Trustee and sponsor company are required to agree a recovery plan for how and when the scheme will be returned to full funding, including deficit recovery payments to be made by the sponsor.123 The agreed valuation and recovery plan, schedule of contributions and valuation must be submitted to The Pensions Regulator (TPR) within 15 months of the valuation.124

26. The main Carillion schemes had combined deficits of:

• £327 million on 31 December 2008;

• £617 million on 31 December 2011; and

• £439 million on 31 December 2013.125

27. Carillion and the Trustee therefore needed to agree three recovery plans over the past decade. The 31 December 2016 valuation was, Keith Cochrane told us, "somewhat overtaken by events"126 as the company unravelled, but the Trustee expected the total deficit to be around £990 million.127

28. The 2008 valuation was a warning of things to come. Carillion and the Trustee failed to agree a valuation within 15 months, mainly because of a disagreement over the assumptions used to calculate the deficit. Carillion pushed for more optimistic assumptions of future investment returns than the Trustee considered prudent.128 Additionally, while the Trustee believed that contributions of £35 million per annum were both necessary and affordable as a minimum, Carillion said they could not afford contributions above £23 million.129 Carillion also wanted the recovery plan to be 15 years, which the Trustee noted "exceeds the 10 year maximum which the Regulator suggests is appropriate".130 The valuation and recovery plans were eventually agreed in October 2010, seven months late, with payments averaging £26 million over a 16 year period.131 The company largely got its way.

29. The 2011 valuation reached an impasse on the same issues:

• The Trustee calculated the deficit at £770 million and requested annual deficit recovery payments of £65 million for 14 years to address it.132

• Carillion, using more optimistic assumptions, said the deficit was £620 million. They presented annual deficit recovery contributions of £33.4 million for 15 years as a take it or leave it offer.133

30. The Trustee's position was supported by independent covenant advice from their advisors, Gazelle Corporate Finance. Based on the financial reports available to it, Gazelle said Carillion could increase annual contributions to above £64 million without a significant impact on available cashflow.134 It also noted Carillion had "historically prioritised other demands on capital ahead of deficit reduction in order to grow earnings and support the share price".135 Despite the continued increases in dividends every year, the company had refused requests from the Trustee to establish a formal link between the level of dividends and pension contributions.136

31. Richard Adam, as Finance Director, argued the company could not afford such high contributions. Gazelle was sceptical of this: his pessimistic corporate projections presented to the Trustee were certainly at odds with the upbeat assessments offered to the City to attract investment.137 In retrospect, the gloomy outlook may have been more accurate. But if that was so, Carillion should not have been paying such generous dividends. Gazelle concluded that Richard Adam had an "aversion to pension scheme deficit repair funding".138 The scheme actuary, Edwin Topper from Mercer, said Carillion's "primary objective was to minimise the cash payments to the schemes".139 Robin Ellison, Chair of the Trustee, observed at the time that Richard Adam viewed funding pension schemes as a "waste of money".140

32. Despite TPR writing to both sides in June 2013 to indicate contributions in the range of £33 million - £39 million would not be "acceptable based on the evidence we have seen" - Carillion refused to increase its offer.141 In early 2014, however, a compromise was reached based on a new valuation date of 31 January 2013. Improved market conditions between those two dates had reduced the deficit to £605 million. The Trustee reluctantly accepted initial annual contributions of £33 million, in line with Carillion's original offer and £30 million less than the Trustee originally requested. While recovery contributions were scheduled to rise to £42 million from 2022, there would be new negotiations in the meantime.142 The Carillion group would also only guarantee payments due up to end of 2017.143 Beyond then, schemes would only have recourse to individual sponsor companies within the group. It was also agreed that the next valuation, based on the position at 31 December 2013, would be based on the same assumptions and would not consider the total level of contributions.144 It is difficult to interpret this result as anything other than a victory for Carillion in its objective of minimising its contributions to the scheme. We consider the role of TPR in this outcome later in this report.

33. Following the July 2017 profit warning, Carillion was desperate to cut costs. The pension schemes were one of their main targets. The Trustee agreed to defer pension contributions worth £25.3 million due between September 2017 and April 2018, on the basis that the sponsor would otherwise have been insolvent.145 Carillion also sought to offload its pension schemes into the PPF in a bespoke deal, though it had far from sufficient funding to produce a proposal that would have been attractive to the Trustee, TPR or the PPF.146

34. Though most of them were shareholders, Carillion's former directors were not members of the DB pension schemes. Instead, they received generous employer contributions to a defined contribution scheme. For example, Richard Howson and Richard Adam received employer contributions of £231,000 and £163,000 respectively for their work in 2016.147 The performance indicators used to determine bonus payments did not include managing the risk of pension deficits. The directors rejected accusations, however, that they did not care about funding the pension schemes. They repeatedly referred to meeting their pension obligations, meaning fulfilling the deficit recovery plan, without any regard to the lopsided negotiation that led to its agreement.148 The company ultimately reneged on that agreement, asking the Trustee to forgo payments due in a desperate effort to save the company. Fundamentally, those directors did not meet their obligations. TPR makes clear that "pensions are deferred pay and pension deficits are responsibilities of the employer".149 Carillion failed in its obligations to honour its pension promises and to take adequate steps to address its pension deficits.

35. Honouring pension obligations over decades to come was of little interest to a myopic board who thought of little beyond their next market statement. Their cash-chasing acquisitions policy meant they acquired pension scheme deficits alongside companies. Their proposals for funding those deficits were consistently and resolutely derisory as they blamed financial constraints unrecognisable from their optimistic market announcements. Meeting the pension promises they had made to their rank and file staff was far down their list of priorities. This outlook was epitomised by Richard Adam who, as Finance Director, considered funding the pension schemes a "waste of money".

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121 Pensions Act 2004, section 222

122 Pensions Act 2004, section 224

123 Pensions Act 2004, section 226

124 The Pensions Regulator, Code of practice no.3 Funding defined benefits, July 2014, p44

125 Analysis of scheme valuation reports. The Bower pension scheme operated on a different valuation cycle and is therefore not included here.

126 Q362 [Keith Cochrane]

127 Letter from Carillion (DB) Trustee Limited to the Chair, 26 January 2018

128 Letter from Robin Herzberg to the Pensions Regulator, 25 March 2010

129 As above.

130 As above.

131 The recovery plans across the five different schemes were all 16 years in length, with the exception of Alfred McAlpine, which was 14 years in length. The Alfred McAlpine Pension Plan Annual report for the year ended 31 December 2010, p 28

132 Letter from the Trustee to the Pensions Regulator, 9 April 2013

133 As above.

134 Letter from Gazelle Director to Carillion Trustees, 23 February 2012

135 As above.

136 Carillion single Trustee - meeting between Trustee representatives and the Pensions Regulator regarding failure to agree the 2011 valuation, 29 April 2013

137 Letter from the Trustee to the Pensions Regulator, 9 April 2013

138 Letter from Simon Willes, Gazelle Executive Chairman, to the Chair, 29 March 2018

139 Mercer, Meeting note with Carillion single trustee schemes and TPR, 19 December 2012

140 Sacker and Partners LLP, Carillion single Trustee - meeting between Trustee representatives and the Pensions Regulator regarding failure to agree the 2011 valuation, 29 April 2013

141 Letter from TPR to Robin Ellison and Janet Dawson, 27 June 2013

142 Mercer, Carillion (DB) pension trustee limited scheme funding report actuarial valuations as at 31 December 2013, p 5

143 Gazelle, Carillion plc Paper for the trustee board, 7 February 2012, p 3