Oral evidence: Pension Protection Fund and Pensions Regulator HC 998-i Monday 9 May 2016

Oral evidence, 9 May 2016.

Witness

Alan Rubenstein, Chief Executive, Pension Protection Fund, gave evidence.

Chair

Before I ask you to identify yourself for the sake of the record, I will just put on our record that, while I am chairing this one, the next session, which will hear from Arcadia’s advisors, will be chaired by Iain. I will chair the one on the trustees and Iain will chair the one with Dominic Chappell et al.

Mr Wright

Alan, welcome. To what extent does the entry of large schemes such as the BHS pension scheme and others, such as the British Steel Pension Scheme, damage the PPF’s balance sheet?

Alan Rubenstein

I do not think it damages the balance sheet as such in the sense that, if we look at the impact of the BHS scheme, that scheme will be accounted for in our results for 2015-2016, and so is already taken into account. Clearly there is a cost. On the basis of the written evidence submitted to the Committee, we estimate at this stage that the shortfall between the value of the assets of the scheme and the value of PPF liabilities that will be taken on is approximately £275 million between the two schemes.

Craig Mackinlay

What might the entry of the BHS scheme into the fund do to the levy payable by other members into the future?

Alan Rubenstein

In the first instance there will be no impact because we anticipate each year that a number of schemes will fail, and we try to set levy on a long-term basis. The failure of any individual scheme does not impact the levy. Obviously, in the longer term, the greater the number of failures, the greater the amount of levy and vice-versa: if we see fewer failures or schemes that are better funded when they fail, then the levy needs to be less because the levy is the balancing item between the amount of assets that schemes bring in and the liabilities.

Craig Mackinlay

Are you saying that the BHS scheme is not enough to cause an upwards blip of the levy amount on its own?

Alan Rubenstein

That is correct.

Craig Mackinlay

You could probably factor it in with your thoughts for the year.

Alan Rubenstein

Indeed.

Chair

When you do these difficult calculations, do you have a list of risk companies that you think might well end up in the PPF?

Alan Rubenstein

We have a regular dialogue with the Pensions Regulator about companies that are in the lower realms of our insolvency numbers. Those companies change because insolvency probabilities vary.

Chair

Do you think your powers are adequate when you have those discussions, or do you have no powers?

Alan Rubenstein

We have no powers. The system is set up such that the Pensions Regulator has the job of supervising the funding of pension schemes and has the anti-avoidance powers to prevent people from taking advantage of the system; the Pension Protection Fund, which is us, is responsible for charging the levy on pension schemes and for paying compensation to the members of schemes whose employers have failed and where there are inadequate amounts in the scheme to meet the liabilities promised.

Chair

When did BHS cross your radar scheme as a worry?

Alan Rubenstein

The first time BHS crossed our radar would have been in 2012, and that was because at that stage we were conducting an exercise on the guarantees that employers had provided to their pension schemes. BHS was one of a number of schemes that would have seen their levies rise. They asked for a meeting to talk about the guarantee, which we attended, and they subsequently withdrew that guarantee. That was the first time.

Jeremy Quin

That is fascinating. Presumably that was prior to the 2012 recovery plan being submitted to the Pensions Regulator.

Alan Rubenstein

Yes, it would have been well ahead of that because the meeting would have been in March and the valuation would have been done probably six to 12 months after that.

Jeremy Quin

Prior to the submission to the regulator of the 2012 recovery plan, it was on the radar as a source of concern.

Alan Rubenstein

Yes, to the extent that there were a number of schemes who had offered guarantees that we felt were not justified, and so we had written to a number of schemes, of which BHS was one, and they requested a meeting to discuss it. As a result of that meeting, they subsequently withdrew the guarantee that they had put in place for the previous year.

Chair

How soon afterwards did you talk with the Pensions Regulator about their concern?

Alan Rubenstein

That was a specific guarantee-related issue, which we would have raised with the Pensions Regulator pretty much straightaway. We have regular meetings to share information and that is the kind of intelligence we would share with them. We also shared it with Ministers because at that time Sir Philip indicated that he was unhappy with the policy and wished to discuss that with the Pensions Minister, which I believe he subsequently did.

Chair

How many meetings do you have with the Pensions Minister registering concerns?

Alan Rubenstein

We have regular meetings with the Minister—typically quarterly—to discuss matters of interest—normally his or her interest, I should say. We would normally have a quarterly meeting with the Pensions Regulator to discuss the schemes that were of concern to them or to us in order to share intelligence.

Amanda Milling

You have got processes in place and you have got a dialogue in place and you have meetings with the regulator. Does the BHS episode suggest that the early-warning system that has been designed to prevent pensions being dumped into the Pension Protection Fund is actually inadequate?

Alan Rubenstein

I am not sure it necessarily does. Clearly there are lessons to be learned here but the exchange of information took place and the regulator then had to evaluate the 2012 recovery plan when it came in. They have two duties: one is to protect the PPF; the other is to balance that against their growth objective. That is really a question that they are better placed to answer than me in terms of what they did with that information.

Amanda Milling

You mentioned at the start that there are lessons to be learned. Could you outline what you feel those lessons are?

Alan Rubenstein

Certainly we have learned that 23-year recovery plans are rather ambitious, and so I think one of our concerns would be for the Committee to think about whether or not there ought to be some natural limit within the flexibility that is offered to schemes. There has to be some flexibility in the system for funding, clearly.

Richard Fuller

You just mentioned the 23-year recovery plan—that is the 23 years of British Home Stores’ recovery plan. How many other plans have you seen with a 23‑year recovery period or longer?

Alan Rubenstein

We would not normally see that; the regulator is responsible for supervising plans and agreeing the lengths of the plans with the trustees and the companies.

Richard Fuller

Do you have a 23-year period recovery? Is yours a 23-year period of recovery?

Alan Rubenstein

I am not quite sure what you mean.

Richard Fuller

When you put together a recovery plan for all the plans that you see and that come to you, in order to get them into balance, do you use 23 years or substantially less?

Alan Rubenstein

In our case it does not work in quite the same manner. The PPF is, as you know, funded by a levy on solvent schemes and the objective we have set ourselves is that by 2030 we should be in a position where the only levy we would charge is to cover any fresh claims; in other words, by 2030 we want to be in a position where we have sufficient funds to meet the long-term cost of all plans.

Richard Fuller

So the PPF takes the funds that are the most troubled and which cannot be met by the assets of the companies where the funds are in the first place and, for the recovery of those funds, you have a target of 14 years to get that back into balance.

Alan Rubenstein

No, that is not quite accurate. In fact, the only time schemes come to us is if the employer is insolvent, so there is no choice involved in it. The scheme transfers to a PPF simply if the employer becomes insolvent and the pension plan is under-funded. That is met by a combination of taking over the assets and liabilities, investment returns, recoveries and the levy; so, if you look at our current position for example, you will see that we are in fact about 115% funded, so we have a reserve of about 15% or around £3.5 billion at present.

Richard Fuller

The reason I am pressing you on that is because 23 years, which you deftly avoided, sounds exceptional as a recovery period. I am just querying why a company would look for a 23-year recovery period when most other companies have substantially less. There used to be a 10-year period. Why would a company want 23 years?

Alan Rubenstein

I think the question of any individual case is probably something for the regulator. What I can say is that, if you look at the average recovery period, that started off at about eight years back in 2006 and has in fact grown slightly to around nine years now. In those circumstances, certainly a 23-year recovery plan is more than twice the average.

Richard Fuller

If I was to call it exceptional, that would be a fair comment.

Alan Rubenstein

I believe so, yes.

Chair

When did the PPF learn it was a 23-year recovery plan?

Alan Rubenstein

Not until we got involved in discussions about re-structuring, which would have been much later on.

Chair

Would you have had a view if it came to you earlier?

Alan Rubenstein

We were always going to be of the view that the shorter the recovery plan the better, and the obvious reason for that is that the better funded a scheme is the less risk there is of a large call on the PPF, which ultimately, as we have said, has to be met by other schemes. We would always push the regulator to keep the recovery plans as short as possible, but that is easy for me to do because I have a single purpose whereas the regulator has to balance their objectives between competing forces.

Craig Mackinlay

Just to pursue that a little further, once the insolvent company schemes have landed in your lap, and you have reviewed what sort of recovery periods were there, have you noticed a pattern of very long recovery time periods, such as 23 years or 15 years? Have they all been fairly long? I am trying to get to why they are so long so they would be in some distress for some time.

Alan Rubenstein

We would not normally focus on the recovery period for a plan that has failed. Our focus would be on the members and making sure that we can assess the liabilities and the assets of the scheme as quickly as possible and to make sure that we can provide certainty for the scheme members as quickly as we can.

Jeremy Quin

You just mentioned your remit, which is very clear and which puts you in an easier position than some. In the case of the regulator, as you have already alluded to yourself, they do have split objectives as part of the 2004 Act and the 2014 Act in terms of what they are required to do. 23 years is an extraordinary length of time but are there other options that you would regularly see in the circumstances of a loss-making company with a limited asset base?

Alan Rubenstein

The question of agreeing recovery plans is really one for the regulator because they have the full picture. The picture we get is of some measure of the financial strength of the company, which feeds into our calculation of the levies since the levy is overwhelmingly risk-based. As I mentioned before, companies that come down the bottom of that list will naturally be topics of conversation with the regulator at our regular risk meetings.

Jeremy Quin

Would you say it is a difficult remit for the regulator to meet?

Alan Rubenstein

It is a challenging remit but, broadly speaking, they do a reasonable job at it. Nearly a quarter of a million people are better off today in terms of the pensions that they can now receive than they would have been had the legislation not been there. The regulator has used their anti-avoidance powers in the past so, broadly speaking, we are on the right track; but, as I said before, that does not mean we cannot make things better.

Michelle Thomson

Hello. Thank you for coming along today. In terms of the communication between the Pensions Regulator and yourself, do you have sufficient oversight of what potentially might be coming down the track from the regulator, given that you have to extrapolate and to forecast in order to meet the levels that you need to pay out in regards to 2030 and how you need to change the levy and so on? Do you have sufficient oversight of what is coming down the track from the Pensions Regulator or are you continually on the back foot?

Alan Rubenstein

I am not sure I would call it “oversight”. We have our own model that predicts the likely level of insolvencies going forward to 2030. It is a stochastic model that looks at a number of scenarios.

Michelle Thomson

How much specific input do you get from the regulator for that model? Is it sufficient for you to forecast accurately in order to meet your compensation levels?

Alan Rubenstein

We do not get any specific input from the regulator for that model other than data they provide us about the scheme funding. In terms of specific cases where we have a concern or they have a concern, the regulator will let us know when they are concerned about a company or, typically, when they have been approached by a company that wishes to carry out a regulated apportionment arrangement—in other words to effectively make part of the company insolvent and for the pension scheme to pass to the PPF. In those cases, we do have a very lively—

Michelle Thomson

Do you get it early enough? Are you always on the back foot in terms of the forecasting that you need to do?

Alan Rubenstein

From our point of view, we have enough information because we will always be involved if there is a regulated apportionment arrangement since the requirement is, first, that the company must be insolvent otherwise; we test that out. Secondly, we make sure that the recovery that is offered from the company to put the scheme through the RAA is a better outcome than we would have otherwise achieved through the insolvency. Thirdly, it is a requirement that the PPF as a creditor is treated fairly in that process, which does not necessarily mean equally but certainly means that everybody should share some pain. Finally, one of our other conditions is that the regulator must not feel that the use of their anti-avoidance powers would generate a better outcome for the fund than taking a deal. Those are the tests that we put through.

Chair

The first time you had worries about BHS, was it you raising it with the regulator or the regulator raising it with you?

Alan Rubenstein

If you go back to 2012, it was simply us passing on the piece of intelligence, which was that the company had been looking at using one of the Arcadia Group companies to guarantee a pension fund and had, in the end, withdrawn that guarantee. Later on, the regulator brought us into discussions when they received proposals from the company about restructuring.

Chair

So Arcadia withdrew a guarantee. Was that before large dividend payments were disbursed?

Alan Rubenstein

That I could not tell you. In March 2012 they decided not to recertify the guarantee.

Steve McCabe

Good afternoon. You were quoted in the Financial Times last year as calling on the regulator to be as robust as possible. What did you mean by that and what were you calling on the regulator to do?

Alan Rubenstein

That is an extract from a minute of the regulator’s board meeting at which they had asked me to present. As part of our arrangements to make sure that we act in a joined-up manner, I attend meetings of the regulator’s board and Lesley Titcomb, their chief executive, attends our board. At that meeting I had been asked to give an update on the PPF, and one of the points I was making was that scheme funding was still not very strong. The PPF 7800 index at the end of March suggested that the combined deficit of UK pensions on a PPF basis—that is not a fall-back basis; it is simply the amount required to meet PPF liabilities—was around £300 billion, and that five out of six pension schemes were in deficit; there are roughly 6,000 defined benefit schemes still around in the UK today. Against that background, you would probably expect the chief executive of the PPF to encourage the TPR board to do as much as it can to deal with that problem.

Steve McCabe

To be a bit tougher. Is that a fair assumption?

Alan Rubenstein

I recognise that they have competing priorities and so I am fortunate that I have a single role to fill, which is to protect members of pension schemes against losing all their pensions. I acknowledge that it would be tough for them.

Steve McCabe

Would it be reasonable to conclude from the answers you have given earlier that the 23-year recovery period is not exactly an example of the robustness that you were seeking?

Alan Rubenstein

I do not know the circumstances that led the trustees and the company to discuss and propose that. I also do not know what the reaction of the regulator necessarily was. That is a question that you need to put to Lesley.

Steve McCabe

I understand that and I understand that you cannot speak for them, but, if you are saying that you were worried about resources and you were worried about the number of schemes and you were trying to be frank and as robust as possible, were you at all surprised to discover that a 23-year recovery scheme had been proposed? Is that consistent with the message that you were trying to give the regulator at the joint meeting?

Alan Rubenstein

It is clear that I would like recovery periods to be as short as practically possible, and I will continue to press the regulator to do that, but I do recognise that they have issues that they need to address in terms of company profitability and solvency, and do not want to push companies over the edge.

Chair

Did you say “as robust as possible”? Were they your actual words that were supposedly recorded in the minutes?

Alan Rubenstein

I honestly cannot remember.

Chair

Presumably you checked the minutes, did you not? You had a copy of them.

Alan Rubenstein

Yes, I would have seen the minutes but I took them to be a paraphrase of quite a long presentation.

Chair

We obviously could ask the Pensions Regulator for a copy of those minutes, could we not?

Alan Rubenstein

I think those minutes use those words, because their minutes are actually published on their website.

Chair

Was there a discussion on whether your comments were fair or not?

Alan Rubenstein

No, I think the regulator understood my view on recovery plans. I certainly regard the minutes as a fair reflection of the discussions.

Richard Graham

You have very succinctly described the focus of the PPF as compensation, whereas the focus of the Pensions Regulator is on supervision, so, in a sense, we are discussing the other way around, which is, if the schemes end up as part of the PPF liabilities, how you would handle it and what the implications of that would be. One of your three ways of effectively generating assets and returns from the PPF is by claims on insolvent scheme employers. At this stage, what do you think the likelihood of the PPF trying a claim on the insolvent BHS is likely to be?

Alan Rubenstein

The current position, as you know, is that the section 75 deficit on both schemes is £571 million; and, in the circumstances of an insolvency, we take over the trustees’ right as claimants so we have a claim on BHS for £571 million as an unsecured creditor. I am not yet in a position to say what the outcome of that would be, because we need the administrators to do rather more work. As you also know, the regulator currently has an inquiry into the circumstances surrounding that; until that concludes, we will not know the actual recovery for the PPF, and hence the scheme will stay in assessment until we know that outcome.

Richard Graham

If you assume the worst from the PPF’s point of view, and that there will be nothing that comes out of any claim that you might make, and given the size of the PPF deficit, which I assume is based on a 90% pay-out to scheme members, what is the necessary investment return required, bearing in mind the duration of the liabilities and so on, that you would need to generate to be able to effectively pay it off using simply the assets of the scheme that you take in?

Alan Rubenstein

First, can I just clarify that, for members who have passed the scheme retirement age, the pay-out is 100% of their current benefit, not 90%.

Richard Graham

For the 6,000 existing pensioners.

Alan Rubenstein

For the existing pensioners, correct. For the deferred pensioners, the structure of the compensation is that they will receive 90% of their accrued benefit up to a cap, which, based on our calculations, will not affect any members of the main scheme but will affect approximately 10 members out of the senior staff scheme.

Richard Graham

Focusing on the main scheme then, and the existing pensioners and the remainder of their lives and then the 13,500 deferred members, what calculation have you made?

Alan Rubenstein

The calculations we would make are, first, about the size of the deficit. Obviously, we have yet to make detailed calculations and the £275 million number that was in our written evidence is still an estimate based on the 2012 valuation for both schemes with the assets and liabilities rolled forward. I would say it is reasonable to think that it is somewhere between £250 million and £300 million with £275 million as our point estimate, which we have included in our balance sheet as at 31 March.

Richard Graham

Just to be clear for the Committee, that includes an assumption about investment return.

Alan Rubenstein

Yes.

Richard Graham

Which is what, roughly?

Alan Rubenstein

That includes a discount rate that is similar to the value an insurance company would use on buy-out, and that is mandated in the Pensions Act 2004; we have to use that kind of approach.

Richard Graham

So, in simple terms, effectively the liabilities of the scheme for both existing and deferred members again would have to be subsidised by assets from elsewhere.

Alan Rubenstein

Yes. The funding of the PPF is composed of the transfer of assets, the recovery from insolvent employers and the levy and the returns on the asset pool.

Richard Graham

Yes. But clearly if your own fund performance exceeds the assumptions made in your calculation, that is going to be a benefit in reducing the liabilities that have to be subsidised from somewhere else. However, if the reverse happens, then of course that figure increases.

Alan Rubenstein

Correct, although ultimately that would flow through in levy.

Richard Graham

Right. Earlier you said in answer to a question from the Chairman that you were not anticipating any increase in the levy from taking on BHS pension scheme liabilities. Does that hold true under any circumstance or should the investment performance be very different?

Alan Rubenstein

The way I tend to think about it is that any individual claim should not trigger a change in levy, because levy payers have been very clear to us that they want a levy approach that is stable and predictable, and therefore allowing ourselves to move the levy up or down according to claims in an individual year would not be welcome. Ultimately, of course, you are right that if our investment returns exceed the assumptions that are in a buy‑out, then the levy would come down because the levy is the balancing item. If, on the other hand, we failed to achieve those returns then the levy would have to go up. Our investment philosophy is one that is relatively conservative given where we are, and so we would aim to not see levies go up because of that.

Richard Graham

Effectively, in many ways, when you take on a scheme’s liabilities the immediate impact on the balance sheet is to flatter it, because you take on the assets as well; surely the longer-term impact of taking on large schemes like this one, with significant deficits, is actually to weaken it and therefore makes the PPF’s task harder. That presumably is what lies behind the natural enthusiasm for the PPF to ensure that TPR is on the case as early as possible with schemes that might be running into trouble.

Alan Rubenstein

I do not think that is quite correct. The immediate impact of the BHS scheme is a hit to our balance sheet as of March of approximately £275 million. That is what we will be recognising and that is the difference between the assets that we have taken on and the value, as we assess, of the liabilities. If, in time, we manage to invest those assets that we have taken on, along with the rest of our assets, and do better than our objective then clearly the levy will come down. However, we already make some assumption about those returns in the levy calculation. I know there is some thought that whenever we take on a scheme we make immediate profit but that is absolutely not the case. Whenever we take on a scheme we make an immediate loss and our funding position is weakened; it is only if we achieve our investment targets over the long term that we flatten that out.

Michelle Thomson

Following on a similar theme, can you ever envisage a set of circumstances where the PPF itself could become insolvent and, if so, what would that set of circumstances or that scenario be?

Alan Rubenstein

It is clearly possible that, with a total deficit out there of around £300 billion, the PPF could be overwhelmed, but I would argue that, in such circumstances, we would probably be worrying about other things as well as the PPF. In normal circumstances, we model the distribution of likely claims and, based on that, we could absorb well into the tails of the expected claims distribution without having to immediately change levies, although, clearly, over time, as we have discussed, the higher the draw on the PPF the higher the levies would be, and the better funded the schemes are the lower the levies on those schemes that are having to fund it.

Chair

Do you think, Alan, that, taking this long-term view of your responsibilities, the PPF scheme may well need some major reforms?

Alan Rubenstein

I honestly do not think so. One of the advantages of the way Parliament set the PPF up was so that it could have the functions of an insurance company but without the constraints in terms of capital cost insolvency, and so there will be periods, as now, where the PPF is in surplus. There may be periods in the future when the PPF is actually in deficit. We were in deficit, for example, to the tune of about £1 billion in 2009, but the long-term nature of this structure enables us to, in most cases, ride out the fluctuations in claims that I guess are inevitable and meet people’s compensation requirements in the long term. Clearly, there are cases where that will not be possible but, at the moment, the probability that we would put on being able to meet that 2030 target I spoke of before is just over 90%.

Chair

Is that based on more optimistic returns on capital or what might be a new long-term low trend returns on capital, which may be the world that we are in up to 2030?

Alan Rubenstein

No, it is based on a very conservative approach that seeks to hedge out most of our risk of inflation and duration risk and, at the same time, achieve a return over Libor on our assets of 1.8%, so, if you look at the risk that we take as an investor compared to the typical risk of a pension plan, we are probably taking about a third of the amount of risk, which I think is appropriate for funding our position.

Mr Wright

In terms of the long-term viability of the PPF, what discussions have you had regarding the British Steel Pension Scheme at the moment?

Alan Rubenstein

We are obviously aware of the discussions that are taking place and, as you know, the Government are trying to work with partners to find a solution to that. We are clearly waiting to see what the outcome of that is but it would be my view that, should the PPF be forced to step in and pick up the British Steel Pension Scheme, then we would be able to do that, albeit obviously, by definition, our immediate funding level would drop, because clearly it would not come to us unless there was a shortfall on PPF benefits.

Mr Wright

But it is not a material risk that would undermine the long‑term viability of the PPF.

Alan Rubenstein

I would not expect it to undermine our long-term viability based on what we currently know about the scheme and what the trustees have disclosed about their funding.

Mr Wright

Short-term viability?

Alan Rubenstein

No, certainly not.

Chair

Have you not considered from what you have said—which could be interpreted as very happy news for pensioners whose companies go belly up: that they would be getting their pensions—when we look at the risks coming down the tracks, it seems to me that there is a moral hazard here? While the levy is divided into two parts, we are asking the righteous, who actually look after their pension schemes and pay money in when they have got large dividends to distribute, to bail out those that have failed. Have you thought that maybe an alternative to that pressure on the good employers and the risk to jobs if they are dragged under is to actually have the levy on individual members, for it is the members who have most interest in taking their pensions?

Alan Rubenstein

The basis of the levy is of course set out by Parliament and we have sought over the years to make most of the levy risk-based so that those who pose a greater risk to the PPF pay the highest premiums, and the model that we launched with Experian for the 2015–16 year moves that further towards that risk-based approach and was widely welcomed in fact by the industry. Nobody likes paying their insurance premiums but, if they feel the basis is broadly fair, that is what we would aim to achieve.

Chair

Do you think it is fair though?

Alan Rubenstein

What we find is that there are certainly companies out there that feel unfairly treated, but they are actually quite a minority. It is not the nature of the beast that the companies that are satisfied with their levy take to the airwaves. We consulted widely, before we brought in the new model, with industry, with small businesses through the BCC, and with trade associations like the PLSA, and the general consensus and the feedback that we got to our consultation document was that the new method, which is an improvement in terms of reflecting the curve of claims that one sees, was a positive step forwards.

Chair

Would you say there is a moral hazard for you in that the more the charge goes on those who are risky, the more chance the company will go under?

Alan Rubenstein

There is clearly a challenge for the regulator in that position in terms of their agreement on funding but, when you look purely at the PPF, the overall cost of the PPF is around £600 million a year; the levy for 2016-17, the year we have just started, is estimated at £650 million. That is covering liabilities of around £1.6 trillion and a current estimate as at 31 March, on a PPF basis, of around £300 billion. So, on the basis of how much it costs to insure against default with the PPF, I actually think that it is pretty good value for money.

Jeremy Quin

Earlier in your evidence, you referred to some 5,000 schemes being in deficit currently, and others have suggested as many as 600 or 1,000 are in serious difficulty. You also referred to the length of time for the average recovery plan stretching out to nine years. To what extent do you think these plans are adequate? I know it is the regulator that builds them and not yourself but you must have a gut instinct. Are we looking at a situation where the industry is assuming that yields are going to change and that, if they do not and we continue in the current apparently abnormal market conditions, we are going to have a very serious problem on our hands in the next two to four years?

Alan Rubenstein

It is certainly my sense that there is a fair degree of hope out there about the future course of interest rates. Clearly we can only deal with what we see today but I do recognise the issues the regulator has in terms of balancing their various objectives. As I say, if I had a free choice and if it came cost-free, obviously I would want to see recovery plans as short as possible; but I recognise that life is not that simple.

Richard Graham

You and I have communicated over the frustrations of a few DB schemes in my constituency, which are family-owned companies that have been going for more than 100 years who have found the new basis on which the levy is charged to have increased their subscription considerably; for a small company that is very frustrating because it prevents them from expanding, taking on more employees and so on. If I were one of them, I would be looking at a situation like this and saying how frustrating it is, when you have a long-term commitment to a business and a workforce, to then find that there are companies whose owners apparently have a much shorter-term approach, which includes significant pay-outs of dividends to the owners and then leave a company with an enormous deficit on its pension scheme, which then has to be funded effectively by people like them through the PPF. What would you say to them and what do you think can be done to reduce that feeling of frustration by people who have seen the risk levy that is applied to property collateral, in particular on their type of long‑term businesses, become much more expensive while others appear to be able to exit, leaving these problems?

Alan Rubenstein

I would say, first, that I can understand their frustration, but I would point out to them that the levy they are charged on a risk-based approach is a function of the insolvency probability, recognising first of all that companies that had defined benefit pension plans in general are less risky companies overall because typically they will be longer established, like the ones you talk about, and they will also have more employees. If you look at the insolvency figures you see most failures among young companies and companies with small numbers. We are talking about relative rather than absolute numbers here, but I would say, first, that it is due to the insolvency probability and, secondly, it is due to the funding situation of their particular pension plan. The levy is designed that no matter what your insolvency risk, if you have a pension plan that is fully funded on a PPF basis then you will pay no risk-based levy. It is deliberately set up that way to try to encourage people to fund their pension plans. We have tried in our latest development of the levy to make sure that the algorithms we use are reliable. The measure that one tends to use for these kind of things is something called the Gini coefficient. Whereas if we had a coefficient of 100% we would have a perfect fit and we would be very suspicious of it, a typical model might have a Gini coefficient of somewhere between 40% and 55%, and 55% would be deemed good. The Gini coefficient for our latest Experian model is approximately 70%, which suggests that overall it is getting the picture about right, although I can understand that in individual cases it feels uncomfortable.

Richard Graham

Chairman, can I just log that although I think the Gini coefficient is probably a useful tool, nonetheless it does not take away from the frustration of small, family-owned, over-100-year-old companies. There are many in the north of England that really struggle with the implications of the levy while watching some of the bigger companies going into administration and leaving these vast deficits. It is something we ought to just log.

Chair

There is not just one moral hazard here, is there, Richard?

Craig Mackinlay

We are living in an era—and quite a long era, which I do not think any of us expected—of quantitative easing, low interest rates and low gilt yields, which has expanded the problem that the DB schemes have. I can see that old DB schemes are becoming a bit of a blockage in M and As and restructuring of big corporates. Do you think that we are likely to see, unless we have some legislative change to prevent it, more exotic and imaginative routes to get away from these old liabilities, just to make the market keep moving?

Alan Rubenstein

My experience is that the market will always keep looking for ways and we need to be on our guard; the regulator in particular needs to be on their guard. One of the things that I would like to suggest to the Committee is that we think about making it easier for the regulator to intervene proactively. At the same time we have to be very careful that we do not get ourselves into a position where we suggest that every time there is an M and A deal to be done, the regulator has to provide clearance. That part of the system works quite well, in the sense that you have a choice: you can apply for a clearance from the regulator. It probably takes a bit of time. It probably has some cost in terms of increased security, depending on the actual deal involved. Alternatively, you can decide that you do not wish for clearance, in which case the regulator is free to use their anti-avoidance powers if they suspect that there has been an abuse. Overall that works reasonably well. From my point of view, what I would like to see, on the basis that prevention is better than cure, is perhaps some way of the regulator being more active before we reach that situation.

Richard Fuller

Can I just take you back to when you said that the British Home Stores pension fund first came across your radar, which was in March 2012? You said you were conducting an exercise with a variety of employers and were providing guarantees. You said that as a consequence of that, the guarantee in the British Home Stores pension fund case was withdrawn, and I think you said that Sir Philip Green said he was going to discuss it with the Pensions Minister. You also said that the guarantee in this case was not justified. Why do you feel it was not justified?

Alan Rubenstein

At that time the deficit in the British Home Stores scheme was around £200 million or perhaps a bit more than that. We looked at the company providing the guarantee. I should restate what I said: it was not so much withdrawn as not recertified, because it had been certified for one year and then the following year, when we raised an objection, it was not recertified.

Richard Fuller

Who was it recertified by?

Alan Rubenstein

A guarantee has to be accepted by us, and the second year after the discussions the company did not put it forward to be recertified.

Richard Fuller

Up until now, I assumed that you sat behind the regulator in any dealings with funds that were going into trouble. What you have just said is that there was an instance where a fund had a deficit, there was a guarantee and you could leap over the regulator and not certify that.

Alan Rubenstein

No, if that is the impression that I have given you then I have not conveyed it clearly. Normally we would absolutely stand behind the regulator. We pay the compensation and the regulator does the supervisions as Mr Graham said. However, in the case of a levy bill we will allow companies to provide guarantees that will reduce the cost of their levy if there is value in the guarantee. That to me makes sense. If, for example, you were pledging a property worth £200 million against your pension fund in the event that the company became insolvent and your deficit was £200 million, then that reduces the risk to the PPF and ought to rightfully be recognised. In this particular case, the company that was offered up to provide the guarantee when we looked at it seemed to us incapable of providing a guarantee of £200 million.

Richard Fuller

What was that company?

Alan Rubenstein

It was called Davenbush I seem to recall. It is a member of the Arcadia Group.

Richard Fuller

But it was not Arcadia Group itself that was behind the guarantee.

Alan Rubenstein

Correct.

Richard Fuller

So it was withdrawn because you felt that it did not have sufficient assets to justify the guarantee.

Alan Rubenstein

We said that the guarantee from that company could not meet, in our view, the value of the shortfall that it was being pledged against, and because of that the company chose not to recertify it for a second year.

Richard Fuller

When that happened, did you then notify the pension regulator.

Alan Rubenstein

Yes.

Richard Fuller

So they knew that this guarantee that had been in place was now going. What replaced the guarantee?

Alan Rubenstein

Nothing. They simply paid a higher levy.

Richard Fuller

Was the guarantee on the pension fund deficit?

Alan Rubenstein

Yes.

Richard Fuller

You took away their guarantee, their levy went up but now there is nothing to look after the debts on the pension fund?

Alan Rubenstein

I am obviously misunderstanding slightly.

Chair

Are you saying that the company was worthless, generally speaking, and therefore could never cough up the guarantee had you required it?

Alan Rubenstein

The company that was requiring the guarantee? Yes, pretty much.

Richard Fuller

I am very curious, Chairman, that the company can be sitting there as a guarantee of a pension fund liability and that in 2012 you can go in, identify, essentially as the Chair has just said, that there is nothing there and it is all smoke and mirrors, and the consequence of that is not some immediate investigation but just, “We will have to increase you levy next year”. Have I got that right?

Alan Rubenstein

Not quite, because this was something that was not, as I said, unique to BHS. There were a number of advisers out there from respected firms who were advising their clients on ways to reduce their PPF levy. One of the ways you could reduce you PPF levy was to provide a guarantee. When we became aware that this was being abused—and we felt it was abuse—

Chair

How was it being abused?

Alan Rubenstein

That was not the only case of companies providing a guarantee from an entity that could not have supported that guarantee when it was called.

Mr Wright

Which firms were advising clients on that?

Alan Rubenstein

Probably many of the major accountancy firms were involved.

Richard Fuller

On the guarantee that had been put up at British Home Stores at that stage, would I be right in saying that that essentially was a worthless guarantee in your assessment?

Alan Rubenstein

It was not worthless but it certainly could not have withstood a claim for £200 million.

Richard Fuller

Subsequent to that guarantee being lost, just to confirm, as far as you are aware nothing was put in place as a guarantee on the liability of the pension fund.

Alan Rubenstein

Yes, but remember the way that the levy works is that companies are assessed on their insolvency probability and their shortfall. If a company wishes to put a guarantee in place to improve their insolvency risk that is fine, and clearly, if that guarantee would have provided full protection that effectively reduces the liability. If there is no guarantee provided by a parent or an associated company that does not mean the system falls apart. It simply means you pay a levy based on the sponsoring company’s financial health and the scheme’s deficit. That was essentially all that happened, but clearly it is the kind of thing that we brought to the regulator’s attention. I should be clear that this was something that we had spotted and therefore we moved to change the rules so that trustees ultimately had to take advice and certify that, if they were provided with a guarantee from a sponsoring employer, they had taken advice on the value of that guarantee, and that they would be essentially liable for saying that that guarantee was worth what it was claimed for. In a sense we are engaged; going back to the point we had before, people generally do not like paying insurance premiums and they will do what they can to reduce them. We generally find that we have to close off avenues now and then, and that was one of the avenues that we closed off.

Chair

What is the role of Arcadia in this? Did this company have funds before to pay the guarantee or did nobody check?

Alan Rubenstein

The company providing the guarantee was a member of the Arcadia Group.

Chair

What responsibilities does the Arcadia Group have to a company that cannot fulfil its obligations?

Alan Rubenstein

That is not a question I can answer, I am afraid.

Jeremy Quin

From the point of view of the BHS pension fund, the trustees had to take a view on the covenant that was being used to guarantee them, so the trustees of that company, Davenbush, had to take a view on the covenant.

Alan Rubenstein

Historically they would not have been asked to certify. When we discovered that people were using companies that could not support the guarantees one of rule changes we made was to require trustees to certify them, so now they have to.

Jeremy Quin

To clarify, it is the company that is responsible for paying the levy and therefore it is the company that is taking a view as to whether or not that covenant is satisfactory.

Alan Rubenstein

Technically, the levy is payable by the pension fund, not the company, but most pension funds have an agreement with their sponsor that their bill can be passed straight on to the sponsor. In most cases companies will pay, but that is not the technical position.

Jeremy Quin

That is a shade of grey I was exploring. It was the pension trustees’ responsibility to ensure the levy was paid. They were released partly of that obligation because of the covenant and the guarantee being provided by the second company, but it is actually the company itself that was in communication with the regulator.

Alan Rubenstein

In most cases where the levy is passed on, which I think is the vast majority, any reduction in the levy obviously benefits the sponsoring company.

Jeremy Quin

You identified this as an historic abuse, and it is no longer an abuse because the trustees are required to certify that they have taken advice and there is adequate covenant to support the guarantee that is being provided.

Alan Rubenstein

Correct.

Craig Mackinlay

On the existence for I do not know how many years of the guarantee by Davenbush, do you think in discussions with the Pensions Regulator it would have given them some warmth and assurance to perhaps have accepted this long, 23-year restructuring? Would that give the Pensions Regulator some assurance that it looks like you have got some powerful guarantor in place?

Alan Rubenstein

To answer the first of your questions, the guarantee was in place for just one year and then withdrawn. In terms of the financial strength of the company and whether that guarantee, had it still been there, would have influenced the regulator, I do not know, because they will look at a whole range of indicators and they will talk to the trustees. They would have had to satisfy themselves about what value was being provided from that, but clearly having been alerted—

Craig Mackinlay

Was it about the same time that this 23 years was being negotiated?

Alan Rubenstein

No, that would have been afterwards, because the discussion was prior to the 2012 valuation.

Richard Graham

On this point of guarantees that did not prove as substantive as you might originally have assumed, was this quite a common practice, particularly for larger schemes, and were actuaries and consultants also recommending this as a route for pensions schemes to take?

Alan Rubenstein

I could not tell you offhand how common that was, in terms of the percentage of claims. I could look into that and write back to the Committee if you would like. Yes, actuaries and consultants were also involved in this. It is a common thing, as I said, that people seek ways to reduce their PPF levies, and if we see abuse of the system then we act to try to stamp that out.

Richard Graham

Technically that advice was being provided to the employer and the business, presumably, rather than the pension scheme, because the guarantee was coming typically from a subsidiary of the owners.

Alan Rubenstein

There I would be speculating because obviously we were not part of those discussions. What we saw was guarantees offered up, and we became suspicious of the backing for these, so we investigated a sample and when we investigated that sample we discovered the abuse was reasonably widespread and therefore we took steps to stop it.

Richard Graham

Were the offers coming from the pension scheme and the trustees or from the employer direct?

Alan Rubenstein

That I could not tell you, but clearly the guarantees have to be provided by the parent through means of either a parent company guarantee or through an asset to the trustees, and the trustees were then effectively signing off on that. In the early days, the trustees were not required to examine the value of the guarantee that they were offered. We changed the rules to make sure that they were.

Richard Graham

Did you change the rules or did the Pensions Regulator?

Alan Rubenstein

We did, because we set the rules as to what is admissible and what is a guarantee in calculating the levy.

Richard Graham

With the situation today, would it be true to say that some of those guarantees still exist but pension scheme trustees have signed off that they are comfortable with them, and the Pensions Regulator and yourself have both looked at them and you accept them, and that then enables a reduction in the levy?

Alan Rubenstein

The Pensions Regulator would not look at the guarantees from the point of view of levy because that is not part of their responsibilities. They may well look at them when looking at funding plans. In terms of how we look at them, yes, you are absolutely right that we require the trustees to certify that they have taken advice and the guarantees are worthwhile. We then spot-check a sample just to make sure that we agree with the trustees that the value of the guarantee covers the amount that it is being offered up for.

Richard Graham

You would review that, would you, because in theory presumably you could have a situation where an entity like Davenbush—let us not us that as the example—might appear to have significant capital behind it one year but might, through various transactions, be very different a year or two later?

Alan Rubenstein

It has to be recertified every year so it gets freshly looked at.

Chair

One last question, Alan, and thank you for your time with us. It follows Richard’s point. What happens from year one to year two, where a company in year one you think is good for a £200 million guarantee but in year two it is not? Have you experienced companies just leaving their assets around like this?

Alan Rubenstein

No, I think—and it is purely speculation, but based on what we saw elsewhere—advisers had indicated that if you have got a strongly financed entity, no matter whether it could afford to pay the guarantee or not, then by using that as a guarantor you could have its financial strength rather than the actual sponsoring employers’ financial strength recognised in the calculation of the levy.

Chair

When you say you saw this going on elsewhere, do you mean elsewhere in BHS or in companies generally?

Alan Rubenstein

No, in the pension scheme universe. In this regard BHS were not a particularly special case.

Chair

That is a concern, but, Alan, thank you very much for the evidence you have given us. Examination of Witnesses

Witnesses

Lesley Titcomb, Chief Executive, The Pensions Regulator, and Nicola Parish, Director of Case Management, The Pensions Regulator, gave evidence.

Chair

Lesley, I think you know the format. Might you introduce yourself and then your colleague, or your colleague can introduce herself?

Lesley Titcomb

I am Lesley Titcomb. I am the Chief Executive of the Pensions Regulator.

Nicola Parish

I am Nicola Parish. I am the Director of Case Management.

Jeremy Quin

Lesley and Nicola, thank you for joining us. Welcome to the Committee. When did you receive the 2012 recovery plan?

Lesley Titcomb

We received it 17 months after 31 March. It was due 15 months after and it was slightly late.

Jeremy Quin

That would have been August 2013.

Lesley Titcomb

Yes.

Jeremy Quin

Between August 2013 and March of this year—if I am out by a month I apologise—following your receipt of the plan and March of this year, may we ask what you did with it?

Lesley Titcomb

Sure. So in September 2013, on receipt of the plan, we opened what we called a recovery plan case. Typically in those situations that is because it is unusual in some way, in terms of perhaps the length of its recovery plan, the strength of the employer, maybe the investment strategy or any other assumptions in that recovery plan that we have an issue with. What we do there is we engage with the trustees, typically, and we did not issue a closure letter in respect of that recovery plan. We had not accepted it as it were. It was still an open matter. The employer then came to us at various points during the following months with propositions as to the way forward and how this could be dealt with, and then we reached the point where the sale to Retail Acquisitions happened. At that point we immediately opened an anti-avoidance case.

Jeremy Quin

But there was over a year in which not a great deal happened.

Lesley Titcomb

There was engagement with the employer and the trustees about the recovery plan and trying to understand why, for example, an atypical recovery period was in place. Do you want to add anything on that?

Nicola Parish

The other thing to add is that over that period of time there were, as you said, other issues going on in the background—things that we probably cannot touch on too much today because of the investigation that is ongoing, but there were other solutions being discussed. It was not that there was not much happening, as you said. There was quite considerable activity over that period of time.

Jeremy Quin

I am conscious you were here when Alan our previous witness said that concerns had been flagged as early as March 2012. I wondered whether this would not have been a situation in which you sprang into action immediately on receipt of their recovery plan in 2012 and got to grips with it immediately.

Lesley Titcomb

As I said, we did open a case immediately on the receipt of the recovery plan.

Jeremy Quin

In this length of time, when would you have taken a more formal step regarding this recovery plan if it had not been for the takeover?

Lesley Titcomb

It is a little difficult to say on that because all these situations tend to be scheme-specific. It will depend on what responses we are getting from the trustees and the employers. It will depend on other things that happen. As Nicola said, there were further developments during the period, so it is not easy to give a timescale on this. If we feel we are not getting any traction then we will start to move towards the consideration of whether more formal powers are engaged.

Jeremy Quin

How often have you used those more formal powers?

Lesley Titcomb

We have got to the point of nearly using them many times. Do you want to talk a little bit about this?

Nicola Parish

The point is that the industry is aware of our powers in relation to scheme funding and that we have been on the point of using our scheme funding powers on a number of occasions. Very often discussion with the trustees and the employers and explanation of the powers that are available to us is often a good way of bringing people around the table and coming to a realistic view of what an appropriate recovery plan would be. It is true to say that as of now we have not had to resort to going to our determinations panel to ask them to exercise powers. We have managed to influence and bring about a satisfactory solution before that stage.

Jeremy Quin

In every case you managed to secure an agreement with which you are comfortable.

Lesley Titcomb

Yes, we have reached the point where we have either got something changed or we have understood why things are as they are and been satisfied.

Jeremy Quin

This is my last question; I know that Mr Wright want to come in. You had a previous recovery plan, the 2009 recovery plan, which I think was a 12-year recovery period. This is a near doubling of the recovery period three years later, and the covenant would have deteriorated in that period. This must be one of the most dramatic reversals in fortune of a pension fund you have seen. I am coming back on to the timing again as to when exactly you would have been issuing formal notices.

Lesley Titcomb

I cannot comment specifically, not having been there at the time. What I would say is that recovery plans of 23 years or more are very atypical. The vast majority that we see are between, say, seven and 12 years. That would be far more usual.

Chair

Would all of the schemes, Lesley, that have ended up in the PPF be ones where you had this very British conversation around the table, and then they went belly‑up on you?

Lesley Titcomb

Typically the system is predicated on the funding principally being an issue for resolution and agreement between the trustee and the employer. The regulator is there and we can try to assist, for example, if that conversation is not going well, and we can step in if they fail to agree. We can then take issue if we feel that, for example, assumptions are not prudent and that type of thing, but the system is not set up in a way that means we are exercising active ongoing supervision. The engagement is very much built around a three‑year valuation process and then the submission of a deficit recovery plan if the scheme is in deficit.

Mr Wright

Chair, I want to follow up on the line of questioning that Jeremy pursued and go back to the 2009-10 recovery plan. That, as Jeremy said, was a 12-year period in which the scheme would move into balance by January 2022. The nature of that recovery plan had the employer paying £5.5 million in 2010-11, £7.5 million in 2011-12 and £10 million in 2012-13 and thereafter increasing contributions by 10% a year. Was the regulator happy with that arrangement?

Lesley Titcomb

We had some engagement with the trustees around that plan, so it did not get closed down straightaway. We opened a case and we looked at it but we then were satisfied at that point. It reflects the flexibility that is built into the system. We could, for example, have a system that required all liabilities to be fully funded at all times. It would be expensive to industry. We do not have that. We have something that has a statutory funding objective, which the employer and the trustee have to aim for, and we as the regulator have to consider whether we think their plans are realistic. If we feel they are not, we then have to have regard as well to the ongoing sustainability of the employer and hold all these things in balance: what is the best thing to do in the circumstances to try to ensure the security of the scheme and the protection of the members’ benefits, to try to protect the Pension Protection Fund, but also to give businesses the chance to progress, to invest and to grow? We believe that a strong sponsoring employer is the best way of supporting these schemes.

Mr Wright

I am still unclear as to whether you were happy with that 2010 recovery plan in broad terms.

Lesley Titcomb

We were content in the end with the 2009 one that was signed, yes.

Mr Wright

Then you fast-forward to 2013 and you have a 23-year recovery period with the employer paying less—£9.5 million per year—and you were not happy with that. How active can you be, in terms of the powers laid down by Parliament, to step in and say, “That is not good enough”?

Lesley Titcomb

Typically what we would do in such circumstances is to talk to both the trustees and the employers to understand why they felt it was necessary to move to that, and to then consider whether we think that is reasonable, taking into account the balance that I indicated. If not, we would then start to indicate where our areas of concern were and see if the employer was prepared to move on that. We would take the trustees along with us as well and try to explain to them why we were not happy with what we were seeing, because of course if they can bring pressure to on the employer as well—

Mr Wright

Can I just push you on that? In terms of the trustees’ scheme, when Retail Acquisitions bought BHS in March 2015, the trustees for members of the scheme provided an update. In that update it refers to the £9.5 million paid by the employer and it states, and I quote, “The trustees would have preferred to receive more than this, but they acknowledged that BHS could not afford to pay any extra”. Did the trustees come to you with these concerns? If so, what did you do with them?

Lesley Titcomb

I am not aware that they did come to us with those concerns. When we launched the anti-avoidance case in March 2015, that was off our own initiative on the basis of the reports of the sale.

Mr Wright

You did not have an investigation any earlier than that.

Lesley Titcomb

Not an anti-avoidance investigation, no. We had the open situation with the 2012 valuation.

Mr Wright

What checks and work do you do to ensure that in this case BHS could not have afforded to pay any more into the pension scheme?

Lesley Titcomb

Those would be exactly the type of questions, checks and assessments that we would be doing whilst looking at a recovery plan with an employer.

Mr Wright

What did you do in this specific case?

Lesley Titcomb

I cannot ask specifically on what we were doing.

Nicola Parish

I can talk typically about how we might deal with that. Within our case team we will have people who are very skilled and experienced at looking at companies and looking at their accounts and seeking to understand the strength of an employer—its trading record, for example, or if the employer has put out any forecasts around what the business might look like—to build a picture, from our perspective, of how strong we think that employer is and how able that employer is to stand behind a pension scheme.

Mr Wright

As part of that work, would you look at the dividends policy of the company and the level to which case had been taken out of the company in previous years?

Nicola Parish

Certainly whether dividends had been paid or not would be something that we would look at. We would also look at whether there was any plan to pay dividends in the future, and it is something that you will find in our guidance that we very strongly signpost trustees to take into account as well when they are having their discussions with employers around recovery plans.

Mr Wright

What happened in this case in terms of looking at dividends policy in previous years of BHS?

Lesley Titcomb

If I may, we would rather not go into that. It is germane to our open investigation at the moment, so I would rather not discuss in too much detail precisely what we are looking at in terms of past history.

Mr Wright

It makes our job very difficult. Do you have the powers, if you are looking at dividends policy, and cash has been extracted out of the business and yet there is a pension deficit with regards to this, to say, “You really need to put more money back into the pension scheme for the employer”?

Lesley Titcomb

This is exactly where we come to with, for example, the anti‑avoidance type case that we are running at the moment. We essentially can look at two ways forward. One is to secure a financial support direction for the scheme, which is usually a decision in principle from our determinations panel with a particular person or an organisation that has some connection with the scheme that needs to provide support to it. There is then a matter of discussion as to the level of that support and the period for which it is provided, and that type of thing. The alternative course that we can do is to seek to secure what is called a contribution notice, which is for a specific amount, and again it is principally usually against individuals.

Chair

Can you put a charge or take control of any of the property of the company?

Lesley Titcomb

We would not typically. We would be looking to the trustees to try to secure better and stronger scheme funding; for example, a charge over assets somewhere else would be something that they could take into account and try to secure in order to bolster that covenant.

Chair

Do you advise trustees ever to do that?

Lesley Titcomb

We encourage them to look for alternative sources of strength, but of course we then have to consider their value, if anything, and whether they are worth the paper they are written on, to be quite frank. That is where it is essential for the trustees to take the appropriate advice to ensure they are getting something worthwhile.

Chair

There was a stage where the shops of this organisation were very valuable and they were sold and then leased back. Would you have the powers to suggest to trustees that they make moves on that front?

Lesley Titcomb

We can suggest almost anything to the trustees, though whether they choose to take us up on it is a different matter. You are illustrating exactly the type of discussion that would happen in those situations: “What other sources of comfort are available to you as trustees in these circumstances?”

Jeremy Quin

I have two questions, but just following immediate on after that, you are beholden in that respect to the calibre of the trustees. Do you have any powers to recommend a change in trustees? Do you ever question how competent a trustee panel are in executing their duties?

Lesley Titcomb

Your point is absolutely right, Mr Quin. The whole system is very, very dependent of the calibre of trustees. We have no initial approval power over trustees. In a number of circumstances, not just DB schemes, we can seek to have a trustee replaced or we could appoint an independent trustee. I should say it is a power that we have only tended to use where there is a real record of several inappropriate actions and that type of thing. A typical example of where we have used it is in scam situations, but we tend to try to achieve more through educating, enabling and facilitating the discussion between the trustees and the employer.

Jeremy Quin

I get the impression that you are quite sparing in the use of all your powers. In terms of the 18 months after the receipt of the plan—I am sorry to come back to it—in an M and A and a takeover situation, people are reviewing pension funds in a matter of weeks and taking decisions and having those discussions. I appreciate there is stuff that you cannot tell us, but can you give us some flavour as to what process you go through in order to test the adequacy of that recovery plan and engage with the trustees? Is it a matter of you looking at it over a month and then speaking to the trustees, or is it a six‑week period? How do you undergo that process?

Nicola Parish

In terms of timescale, the first thing to bear in mind is we will be looking for the co‑operation of the trustees and the employers to help us. We opened a case very quickly after the 2009 valuation and then the subsequent 2012 valuation was received. In terms of timescales, six weeks would be too long. We would be looking to engage much more quickly with the trustees and the employers in the vast majority of cases. These discussions can be, as you would appreciate, pretty complex at times. There will be a lot of information that we will want from the trustees and the employers to understand why they would think that what they had put forward was an appropriate recovery plan. That can take some time to analyse. There is also a role here for us to educate trustees and employers. Where they might have thought something was reasonable, we would be explaining all of the different ways of looking at that as a situation and encouraging them towards a solution. We would look to do that as quickly and as efficiently and effectively as we possibly can. There will come a point at which we will realise, as Lesley said, that we now have to move to the use of our powers. That very much depends on the scheme, the risk it poses and the attitude and approach that we perceive from the trustees and the employer.

Lesley Titcomb

The other point to make is that there are a number of schemes where we engage proactively with the trustees and the employer before the valuation is due, to make quite clear what our expectations are and to try to iron out some of the potential difficulties. We find that a more effective way of tackling these situations than acting after the event, once the recovery plan and valuation are in. On some of the biggest and more risky schemes, we seek to engage proactively.

Jeremy Quin

There are some hundreds of schemes that might be at risk. Do you have the resources and the ability to go through each of these and do them in a timely fashion, or is there a whole string of similar circumstances out there?

Lesley Titcomb

We, like any regulator, do have to make choices. We receive about 1,400 to 1,500 recovery plans a year at the moment, from the volume of schemes that are in deficit. We put all those through a calibration process basically looking for certain risk indicators and we then follow up on those. We make these risk-based choices. We have a significant amount of regulatory resource within the organisation. We have to make choices about how we use it across the range of our responsibilities as well, so it is not just choices within DB regulation but also with the other regulatory areas.

Jeremy Quin

There are some hundreds of schemes that might be at risk. Do you have the resources and the ability to go through each of these, and do them in a timely fashion, or is there a whole string of similar circumstances out there?

Lesley Titcomb

As any regulator has to, we do have to make choices. We receive about 1,400 to 1,500 recovery plans a year at the moment from the volume of schemes that are in deficit. We put all those through a calibration process to basically look for certain risk indicators. We then follow up on those. We make those risk based choices. We have a significant amount of regulatory resource within the organisation. We have to make choices about how we use across the range of our responsibilities as well. So it is not just choices within DB regulation, but also with the other regulatory—

Mr Wright

In terms of that proactive stance, I take it that BHS was not part of that proactive position.

Lesley Titcomb

I believe that is correct, yes.

Mr Wright

Why not? Was it not considered a risk?

Nicola Parish

There are various factors that go into determining the highest‑risk schemes.

Mr Wright

Do you have a risk register? What are the criteria to be included on that proactive bit?

Lesley Titcomb

The most significant criterion on that is probably the strength of the employer. As I have said, that is absolutely key here.

Mr Wright

We have just heard from the PPF that, in terms of any guarantee, it was not worth anything.

Lesley Titcomb

If I may, that is an entirely separate issue here. There is the strength of the employer, the sort of investment assumptions and projections that are assumed in the recovery plan, investment strategy and that type of thing. There is past history as well: what do we know about how they have tackled this challenge of the valuations in the past?

Mr Wright

Is the 18-month period relatively unusual? You would prefer weeks. I can understand the complexity, but is 18 months a long time?

Lesley Titcomb

The time it takes to deal with the recovery plan does vary hugely. Some of them are very simple; some of them are quite small as well. This would have been one of the more complex.

Nicola Parish

It would have been one at the more complex end. As discussed, other solutions were being put forward as well, which are difficult to go into now. That does mean that there is added complexity and length of time needed in order to properly assess the situation. All of these other solutions are things that, as it says, are solutions and therefore are certainly worth considering, investigating and inquiring into.

Chair

Can I just ask you before I go to Richard, Lesley, did I hear rightly that you said that when the discussions were underway you did not view the BHS scheme to be at risk?

Lesley Titcomb

No. We have to be careful about our terms here. I said that it was not one of the schemes that we engaged in proactively, as I confirmed to Mr Wright. It did not, at that point, meet the threshold for us to engage proactively. I have not gone back and examined in detail why that was, as yet.

Chair

That might need revision, might it not?

Lesley Titcomb

We would of course consider all the processes, the triggers and the risk indicators and so on in these situations. We learn from the experience as we go along. It is not a perfect science.

Richard Graham

On this point, there is a clear contradiction between two of your key objectives, potentially. One of the objectives is to reduce the risk of situations that may lead to compensation being payable for the PPF. The other is, in relation to DB schemes, which this is, to minimise any adverse impact on the sustainable growth of an employer. Clearly, these two things come to a head at the moment where you might be looking at a contribution notice and effectively imposing that on an employer. In the case of BHS, at the moment when the owners were taking out significant amounts of dividends, and it looked as if the deficit of the pension scheme was increasing, what was your thinking then about whether a contribution notice was required?

Lesley Titcomb

If I may, there are a number of things we just need to pick up on there. First of all, our sustainable growth objective has only been in place since 2014. My understanding is that it only applies in situations where we are agreeing a recovery plan.

Nicola Parish

It is when we are looking at the funding of a scheme.

Lesley Titcomb

Yes, it is when we are looking at the funding of a scheme. The type of situation you are talking about there, Mr Graham, in terms of a contribution notice, would be when we were exercising our anti-avoidance powers. We just need to be careful about that. As I recall, in terms of the timings of the extraction of the dividends they were some distance away in the past. When we are thinking about funding, we would be looking at what is available now to put in: “What can the employer afford now? What other sources of funding are available?” It is when we feel that something has happened that has triggered our anti-avoidance powers that we start to go back into the past, looking at what happened, and who did something that could have been considered as them in some way walking away from their responsibilities.

Richard Graham

When you look generically at schemes and whether they might be at risk of having to come under the PPF, presumably you have always looked at whether there are guarantees there. At what stage did you communicate with the PPF about the value of this guarantee over the BHS scheme?

Lesley Titcomb

We were aware of the PPF’s particular exercise in terms of the guarantees that might be offered up in order to reduce the levy. What I cannot answer here off the top of my head is whether, in terms of the 2012 situation, there were any guarantees involved there in terms of dealing with the deficit in the scheme as distinct from trying to reduce the levy. You have two situations in which a guarantee can be used.

Nicola Parish

Can I just interrupt there to clarify? We were just checking; the guarantee that Alan was talking about was not relied upon for scheme funding purposes. That was a guarantee that he was looking at in the context of how much the levy should be, but it was not something that was taken into account for the purposes of scheme funding.

Richard Graham

If we may, Chair, because I think it would be helpful to this Select Committee’s inquiry, what was broadly the relationship between the trustees of this scheme and the corporate, the employer behind the scheme? That is a pretty crucial thing in any pension scheme’s strength of governance.

Lesley Titcomb

That is quite difficult for Nicola and me to comment on. Neither of us have direct experience of that relationship. I have no reason to suspect it was massively different to any other relationship at the time. I genuinely do not know. Nobody has brought anything to my attention in that regard.

Richard Graham

How strong would you assess the effective covenant behind the BHS scheme to be?

Lesley Titcomb

It would be fair to say that in 2009 we regarded it as reasonable. Certainly by the time we get to 2012 it could well have been one of the factors that triggered the situation with the 2012 recovery plan.

Richard Graham

Do you think that the key issue, in a sense, is the speed of the decline of the corporate performance, the level of money being taken out of the company and then eventually its sale, while at the same time the pension fund itself was seeing an increase in the deficit?

Lesley Titcomb

Those are typically the sort of things that we would see in a situation where there was, for example, an increase in the length of the recovery plan, change in the levels of contribution of deficit repair payments and that type of thing. You will understand that I am being careful not to comment on individual situations here.

Richard Graham

I do. At that stage, when the warning signals are there and you have your third priority—to promote employer compliance with their pension responsibilities—when do you sit down with the employer and say, “We have a problem”?

Lesley Titcomb

As I said, the main regulatory engagement here is through the three‑year valuation. Parliament has not given us the power to approve those. Funds do not have to submit them to us for approval. They have to submit them to us, and we will then use them as a tool, as a regulator, to try to see whether we are okay with them, or whether any of our other powers are engaged, but we do not have to specifically sign off. As I said, if we have a plan presented to us that meets any of the triggers, then we engage with both the employer and the trustee.

Richard Graham

There was a 2012 tri-annual review.

Lesley Titcomb

That is correct, which was received 17 months later.

Richard Fuller

For good reasons or bad reasons, you do not sound like much of a regulator. You took 17 months to receive a plan. That plan had a 23-year recovery period, which sounds like it is twice the average. Your response was to “open a recovery plan case”. The fund had a £200 million deficit, which was growing, but you did not think it “required proactive response”. When you go after someone who has a fund that does not have enough money in it, your first question is, “How much can you afford?” You are not much of regulator, are you?

Lesley Titcomb

I do not agree with that statement.

Richard Fuller

I am just quoting back what was said.

Lesley Titcomb

As a regulator, we have to operate within the framework provided to us. The framework provided to us provides for the three-year valuation cycle, the submission of a recovery plan if a scheme is in deficit, and then for the vast majority of schemes it is possible either that they come up with a perfectly reasonable recovery plan or that we can, through engaging with the trustees and with the employer, ensure that anything necessary is rectified. I have to stress that it would be inappropriate to put a greater burden on the vast majority of schemes and employers who behave responsibly, either through stronger types of regulation, more proactive, continuous supervision or meeting a minimum funding requirement, for example.

Richard Fuller

You could have tougher tools in your toolkit, which you could decide to use, than you currently have, could you not?

Lesley Titcomb

The Work and Pensions Committee is well aware that I am prepared to ask for more tools in my toolkit if I need them.

Richard Fuller

Can I take you specifically to the time of the sale of British Home Stores to Retail Acquisitions? When was the Pensions Regulator advised about the possibility of a sale?

Lesley Titcomb

We were not, that I am aware, advised in advance. We learned about the sale from the newspapers.

Richard Fuller

They just dropped it on you.

Lesley Titcomb

Yes. As I have indicated, we had been engaging with them over the period since the 2012 valuation. They had discussed a number of propositions with us, and then the next we heard that there was a specific development was the sale. At that point, we immediately triggered an anti-avoidance case, which is exactly what we should do in these circumstances. That is why the powers are there.

Richard Fuller

Just to be clear, in the time that British Home Stores, and the owners of British Home Stores, were involved in a detailed series of discussions with you about a massive deficit in the pension fund—their obligation to the employees—they did not have one conversation with you to say, “You know what? We are thinking of selling this company”?

Lesley Titcomb

I cannot say that. I am referring specifically to the sale for a pound to Retail Acquisitions.

Richard Fuller

That is what I am saying; they did not say—

Lesley Titcomb

Looking at what we would have known about the situation at BHS and so on generally, I cannot believe that those engaged would not have thought that a sale of some sort was possible. That was definitely a possibility. I cannot really say more. I was not directly involved with those discussions.

Richard Fuller

Just to clarify, the idea that a sale might be possible in the circumstances may have been something that was discussed. However, this particular company, Retail Acquisitions, the regulator found out via the newspapers.

Lesley Titcomb

That is correct.

Richard Fuller

You have certain powers, do you not, to act? Obviously, you acted after the sale. Were there any other powers that you could have invoked other than the anti-avoidance case?

Nicola Parish

We have talked already about the scheme funding powers. That is a set of powers that is available to us that enables us to impose a recovery plan, or enables us to impose deficit repair contributions. That is something that we would have had in our minds at the time. We were trying to bring the trustees and the employer towards a reasonable and appropriate recovery plan. That is a power that was available to us.

Richard Fuller

Could I just ask you specifically about third party notices? It is a power, if I have this right, to persons whose failure to do something is causing or has caused someone to contravene legislation. Can you just explain very briefly when you might invoke that power, particularly with relation to a transaction of the sale of one company to another company?