Carillion - Who sank the boat, and what does it mean for DB pension schemes?

Carillion is the latest high profile corporate failure to leave DB schemes and members (28 thousand of them) reliant on the PPF, not to mention the much wider collateral damage on employees, suppliers, subcontractors and government.

Whilst recent discussion has started to focus on improving pension scheme recoveries from insolvencies (but at which creditors’ expense?), prevention is always better than the cure.

There will no doubt be a full enquiry as to what went wrong, and there is significant complexity, but while its all fresh I thought a quick step through the key players and some key learning points for pension schemes might be valuable…

Who sank the boat?

Was it the 13 pension schemes? I start here because I’m an independent trustee and this is a pensions article, but whilst the ramifications for the schemes and members are very material I think the answer is no.  The schemes were receiving contributions of c.£50m pa which appeared manageable enough to keep the ship afloat, and left headroom for dividends of £80m pa which were paid to shareholders, so no, the pension schemes didn’t cause the failure in this case. Should the schemes have pushed for more?  There is always a difficult balance to strike between maximising contributions in to the scheme in the short term whilst allowing the business to invest for the longer term. Each case has to be looked on its own merits but does emphasise the importance to pension scheme trustees of regular covenant input and monitoring.

Was it the banks? The pensions debt is significant, but it’s the bank debt of c.£900m that was the lifeblood of the business.  RBS and Santander have come under pressure in the press as the members of the banking group who were least supportive in Carillion’s time of need. Ultimately, we don’t know whether they were the first to conclude that the new money need in the group’s turnaround plan was not sustainable or commercially supportable. But could the banks together be expected or compelled to sail on, lending more money and support irrespective of the potential for further losses to their businesses?  I don’t mean to be overly sympathetic, but what if their assessment was right? And we shouldn’t overlook the fact that in the aftermath HSBC, RBS and Lloyds banks have together committed a support fund of a further £225m to help smaller businesses affected by the Carillion fall out.

Was it government?  Successive governments have outsourced more and more public sector activity to companies like Carillion, and clearly place a great deal of reliance on them for day to day operations and delivering major infrastructure projects. Whilst this outsourcing has been to reduce cost, I’m not sure a model in which state owned contractors deliver projects like HS2 and build our hospitals would be efficient or realistic. Arguably those letting contracts could be better equipped to assess the balance of low prices vs risk of failure, and questions have to be asked (and indeed will be) about the level of diligence performed on Carillion before letting more major contracts in the wake of severe profit warnings.

Was it management?  Well, it was management who pitched for and won what were ultimately loss making contracts and controlled the (admittedly very complex) business’s cash flows and funding.  Management also made the decisions about dividends and would have negotiated the recovery plans with the pension schemes.  So management teams are always at the centre, steering the ship through both calm and choppy waters.  Theresa May and Frank Field are talking about a clamp down on directors’ remuneration where pension schemes are being potentially short changed – but will this just make it harder to find good management for struggling, pension laden businesses?

Was it the auditor?  Continuing with Frank Field’s comments, Carillion’s auditors are under scrutiny, but technically the only requirement of them around 10 months ago was to get comfortable enough that the business would continue for another 12 months – so they weren’t too far from the mark.

Or was it Brexit and the wider economy that sank the boat?  The UK construction sector is underwater, technically in recession with two consecutive quarters of negative growth.  Some significant private sector projects were put on pause immediately post referendum and the level of uncertainty in the economy has slowed commissioning of new projects.  Government has filled the void to some extent with infrastructure projects, but this has not been enough to stem the contraction.  In this context the sector has become increasingly competitive with contractors willing to low-ball pricing to win revenue and keep busy.  Coming back to management teams – they’ve had to make the difficult judgements about how long loss making contracts can be sustained, or whether to heavily reduce their cost bases in short order (ie deep redundancies).

And what does all this mean for pension schemes and trustees?

Of most interest to the readers of this blog is probably what if anything is going to change for pension scheme’s and their members to protect them from Carillion-like disasters?  A number of suggestions have been raised by politicians, but like the delayed white paper, it’s not likely that anything is going to happen fast…

By way of context we should recognise that the existence of the PPF is a great benefit to members.  Whilst the haircut in pension income will be meaningful and problematic for some (eg those hit by the cap and with the larger increases that they’ll sacrifice), the fact that most of the pension value is intact is clearly a major step forward from the pre Maxwell era.

Esther McVey has committed to explore whether the priority of DB pensions debt can be raised when the value of an insolvent employer’s assets are shared out.  Unless trustees have negotiated otherwise, pensions debt is usually unsecured and typically ranks behind banks who will often have first dibs.  If the DB promise is promoted above or alongside secured banks this will have an impact on banks’ appetites to lend (and the associated rates they charge), and any ranking ahead of other unsecured creditors, will mean suppliers may be more cautious in extending credit, and credit insurers will bear more of the brunt. Whilst we are all sympathetic to the position of impacted members and the PPF, is it right to elevate the scheme’s claim above an individual say who may have lost their deposit in a retail situation? Both are potential unsecured creditors. Elevating pension schemes in the hierarchy may mean a higher likelihood of members getting full benefits, perhaps something more than the PPF limits or potentially just reduce the call on the PPF.  But I would argue that for many corporate failures there’s a major shortfall in the value of assets and the scheme will still end up in the PPF – the PPF would just get an improved (potentially only slightly so) return from the insolvency.  So I’m not sure this is the right answer as it potentially just shifts a chunk of PPF funding away from levy payers and onto banks, suppliers and credit insurers who may not even have their own DB arrangements.

So what does this mean for pension schemes?

Prevention is always better than cure.  Corporate failures will always happen as part of the natural lifecycle of businesses and markets.  So whilst some of the contributing factors discussed above could be managed better or differently, it is inevitable that there will be further failures and some pension scheme members will rely on the PPF’s support.  We can’t stop it, what we have to do is find a way to limit the number of failures and protect more businesses that could be saved and with them, the interests of members and the PPF.

There is plenty that responsible trustees can do and support that TPR can provide at an individual scheme level.  Trustees can work constructively with employers to manage and reduce scheme risks, and look to get cash funding into their schemes that is affordable – balancing the short term interests of the scheme with those of the business and longer term covenant. Only by doing this can we improve the chances of members receiving their promised benefits. My suggestions would be that all trustee boards:

• Set a journey plan for the scheme in collaboration with the employer and based on the Integrated Risk Management (IRM) framework.
• Properly understand and regularly monitor their employer’s business as the scheme’s key underpin (thinking about performance, affordability and wider stakeholders as discussed above) – take professional advice here where there’s concern, lack of independence or complexity.
• Agree triggers for action with the employer, based around employer KPIs, investment performance and funding level.
• When triggers are hit, either pre agree or work constructively with employers to find proportionate remedies – these could include reducing risk in the scheme in ways that are in the trustees’ direct control if the employer is unable to provide more cash or enhanced security.

Taking these steps, and actively managing against an agreed strategy, may not stop employers keeling over, but it will give members the best chance of getting their full benefits whilst minimising the call on the PPF.