Pension schemes.

Stagecoach pensions ruling at odds with original franchise terms

As a participant in franchise bidding competitions, starting from the first tranche of contracts in 1994 and (from then on) a number of renewals involving incumbent operators and new entrants to the market, the many complexities in the process are well understood.

There has been success and failure in securing contracts, and over time advisers to bidders have become adept at interpreting the contents of an Invitation to Tender and creating competitive advantage.

Pension arrangements were a given, where each bidder had to be compliant and the conditions were originally provided by the Office for Passenger Rail Franchising in its overview of contract content provided in September 1995.

The starting point is that the 1993 Railways Act protected the right of each member of staff to remain a member of the relevant shared cost section of the Pension Scheme (the sections were established for each of the privatised companies). This was defined by the Railway Pensions (Protection and Designation of Schemes) Order approved by Parliament in 1993, which applied to all members employed on November 5 1993 (the date of the Act).

For franchise bidders, the protection was described as “the indefeasible right” that was non-negotiable. In addition, members had the legal entitlement to build up future benefits that were “no less favourable” than those that existed under the British Rail scheme as at May 31 1994.

At the time, pension scheme surpluses were more likely than deficits. And in the early years after privatisation, both employers and employees enjoyed periods of ‘contribution holidays’ because surpluses were not allowed to exceed certain thresholds. Not really a very sensible policy, as these surpluses would have cushioned the harder times that were to follow.

The surpluses were expected to normalise by 2003, when a standard level of contribution would be 9.5% of salary for employees and 14.3% for employers. There were deficit funding provisions based on increasing employee and employer contributions, but importantly the level of any increase to be paid by the franchised operator was capped at a figure 130% above the standard level. It was not an open-ended liability.

The Railway Pension Scheme inherited from BR provided defined pension benefits, and 99% of the staff were members. This was the result of the creation in 1967 of the Wages Grades Pension Fund - later merged with the main fund to provide similar final salary-based benefits to all grades of staff.

The first threat to the balance between pension fund income and their obligation to beneficiaries came in 1997, when a newly elected Chancellor of the Exchequer removed the tax relief pension schemes claimed on their substantial dividend income (which was the source of funding for paying pensions and other benefits without cashing in investment). Financial analysts believe UK pension fund members have lost at least £ 250 billion to date as a result of the decision.

A new threat emerged after the financial crash of 2008. The crisis meant that banks no longer had confidence to lend to each other. To address that, the Government supported the banks in a process called quantitative easing, which provided lowinterest credit between 2009-12 to restart funding for businesses, house builders and personal lending. It was to total £ 375bn.

The damage to the pensions industry was that it reduced assumptions about the return on investments, at a time with changes in longevity. Since 1993, an individual retiring at 60 can now expect to live longer (79 to 83 for men and 82 to 85 for women). It is unsurprising that pension fund deficits emerged, as has been the case for the Railway Pension Scheme.

In the 25 years since the pension protection provided in the 1993 Railways Act, there has been a move away from offering defined benefits where for each year of service a higher pension is agreed (which has a cap of two-thirds of final salary). There are other benefits such as generous death-in-service payments and ill health retirement. In place, money purchase schemes have emerged where defined contributions are made that determine benefits based on the value of the fund.

The railway companies have, in the main, retained defined benefits because of recruitment issues if they were removed. In any case, there was the expectation that as interest rates returned to more normal past levels, deficits would be eliminated.

It is instructive that during the first period when the East Coast franchise was operated by the Department for Transport (2009-15), after National Express gave up the contract, the annual accounts revealed a rising pension fund deficit. The judgement that no action was necessary, as the issue would go away by itself, underlines views held elsewhere that deficits calculated on post-2008 rates of return are not really real.

What has changed is that the Pensions Regulator has identified that the potential shortfall in the Railway Pension Scheme has risen from £4.8bn to £ 7.3bn in the three years between 2013-16. And with interest rates remaining low, the potential for a ‘bounce back’ has reduced.

Although the number is large, so is the membership - it stands at 338,000, with £ 25.5bn assets held. The shortfall for most Sections is in the order of 10% of calculated liabilities, and many companies have agreed to make lump sum contributions to reduce the shortfall with increased employee and employer contributions. These are not unrestricted obligations, of the type it has been suggested was required from Stagecoach (which is a partner of Virgin West Coast).

There are two reasons that make this an unfair expectation. A cap was established of 130% on the forecast base level of contributions in 1993, and the benefits for the many staff in the Railway Pension Scheme at that time cannot be changed as their benefits are protected by Parliament.

The Williams Review is in the middle of a widespread consultation exercise aimed at putting the passenger interest first.

The Virgin-led West Coast franchise has consistently outperformed other main line operators in terms of passenger satisfaction and growth. To be disqualified from future operations because of a questionable funding interpretation to meet a pension deficit is at odds with what the DfT and everyone in the industry is trying to achieve. A review of the decision is essential.

“The potential shortfall in the Railway Pension Scheme has risen from £4.8bn to £7.3bn in the three years between 2013-16.”