Carillion: Lessons for trustees

12 Jun 2018

The collapse of the construction giant raises questions on how the trustee’s role could be strengthened to make sure that it doesn’t happen to other schemes.

In January, Robin Ellison faced every trustee’s worst nightmare. The former chair of construction giant Carillion’s defined benefit (DB) pension scheme appeared in front of a parliamentary inquiry having to defend his role in the scheme’s collapse to a group of angry MPs. Words such as “recklessness”, “hubris” and “greed” were thrown at him when discussing the attitudes of the sponsor towards the scheme.

In the wake of the Carillion scandal, answers are being sought. How could the construction giant have liabilities stretching to £7bn while assets totalled a mere £29m? How could the scheme almost double its deficit from £508m in 2013 to £990m in three years? An inquiry by the Work and Pensions Select Committee published in May predict that the vast majority of this bill, £800m, will be footed by the Pension Protection Fund – the biggest bill in its 14-year history – while Carillion employees are likely to lose a significant chunk of their pensions.

This raises challenging questions for trustees as the stewards of those schemes. To what extent should they have to weigh-up the short-term financial interests of the sponsor versus the longer-term funding requirements of their scheme? And, given the limited power trustees have to enforce their views, should they be held accountable for systematic under-funding of pension schemes? Could expanding the powers of trustees help to prevent similar crises going forward?


The inquiry on the Carillion scandal outlines how the scheme’s deficit spiralled within just a few years, partly as a result of a series of misguided acquisitions by Carillion and partly due to the effect of the low interest environment on the scheme’s discount rates.

By 2013, the difference between Carillion’s original DB scheme assets and liabilities was £86m, a level which the inquiry described as “undesirable” but “manageable”. However, through its corporate acquisitions, the construction firm took responsibility for an additional 11 DB pension schemes, some of whom had significantly higher levels of deficits.

In 2006 and 2008,Carillion incorporated the Mowlem and Alfred McAlpine pension schemes, which had deficits of £33m and £123m, respectively. Their combined deficits grew to £424m by 2011.

Ellison stresses that the scheme’s investment management strategy, which was overseen by Mercer, was not the reason for the growing deficits, although the low interest environment remained a challenge. About 45% of the scheme was invested in fixed income and equities, respectively, with the remainder allocated to cash and alternatives. This was by no means an unconventional portfolio.

Trustees considered hedging the effects of interest risks, but Ellison remains sceptical whether this could have redressed the balance. “Hedging was looked at from time to time but it was expensive and doesn’t actually produce money for pensions; it (mostly) simply dresses the balance sheet, i.e. is often more cosmetic than practical,” he argues.

Yet it was the pressure of the scheme’s mounting liabilities, which started to become unsustainable. Gazelle Corporate Finance, which acted as covenant adviser to the trustee, also backs this view. “As interest rates reduced over this period, the value of the scheme’s liabilities increased relative to the scheme’s assets. Given the large size of the schemes combined liabilities, the financial impact was substantial,” executive chair Simon Willes said in his testimony to the parliamentary inquiry.


Unable to address the spiralling deficit crisis by adjusting their investment strategy, the only option the trustee saw was to demand an increase in deficit payment contributions. The parliamentary inquiry acknowledges that trustees attempted to prevent the crisis: “The trustee pushed Carillion hard to secure additional contributions to fund the pension deficits.”

The inquiry highlights consistent disagreement between the trustee and Carillion’s finance director Richard Adam, with the latter systematically attempting to prevent any increase in deficit contributions. In 2011, the trustee estimated that the deficit was £770m and recommended annual recovery payments of £65m, while Carillion said the deficit was at £620m and offered deficit repayments of £33.4m.

Unable to enforce its views on the board, the trustee eventually turned to The Pensions Regulator (TPR). Yet while the watchdog has the power under section 231 of the Pensions Act 2004 to impose schedules for contributions, and threatened to do so in 2011, the parliamentary inquiry concluded that: “Carillion correctly interpreted these as empty threats”, and ultimately accepted a significantly lower recovery plan for deficit contributions from Carillion.

Gazelle chair Willes commented: “We were not sure at the time how Richard Adam managed to persuade TPR not to press for a better recovery plan. We believe the result was that Carillion did not expect any regulatory action would ensue from taking an aggressive with the trustee in funding negotiations. On the trustee side, Robin Ellison consequently saw little or nothing resulting from further regulatory interventions on the trustee’s behalf.”


The inquiry’s conclusion was even more damning. “The pension trustees were outgunned in negotiations with directors intent on paying as little as possible into the pension schemes. Largely powerless, they took a conciliatory approach with a sponsor who was their only hope of additional money and, for some of them, their own employer”. With regard to the TPR, the inquiry states that it “failed in all of its objectives.”


Carillion’s reluctance to address liabilities in its DB scheme was certainly not matched by prudence to reward investors. In its  16-year history, the company has increased its dividend payments consistently every year, despite stark differences in corporate performance throughout this period.

The parliamentary inquiry suggested that this could have been challenged by the regulator. “There is also little evidence that TPR offered any serious challenge to Carillion over their dividend policy, despite their guidance acknowledging that dividend policy should be considered as part of a recovery plan.

“TPR argued Carillion’s ratio of dividend payments to pension contributions was better than other FTSE companies and that they “cannot and should not prevent companies paying dividends, if that is the right thing to do” the inquiry states. Carillion’s directors had little incentive to prioritise pensions over dividend payments. While all of them were shareholders in the firm, their pensions were not covered by the DB scheme. Instead they received lucrative payouts through a separate DB scheme.

For Andrew Wauchope, senior investment director at Psigma, this is part of a structural problem of underfunding pension schemes. “If you look at the large issuance of debt since the 2008 crash, you can see that executives are increasingly measured by indicators such as earnings per share, which can be easily boosted by share buybacks, nobody is actually looking at whether this is a good measurement for executive performance,” says Wauchope, who argues that reducing scheme deficits should be a target in measuring executive performance.

He also believes that a pension scheme’s deficit should be factored in when discussing mergers and acquisitions. “You might get fewer takeovers and mergers but at least gradually resolve some pension issues,” he states.

Indeed, a recent report by consultancy LCP stressed that this is part of a broader problem. In 2017, the 100 firms included in the FTSE 100 paid £80bn in dividends, compared to a mere £13bn in contributions to the pension scheme.


For Willes, the failure to push for higher deficit contributions and to challenge dividend payments raises questions on whether the trustee showed sufficient independence from Carillion. “Gazelle believes Carillion may have set out to manage its biggest pension creditor (being the schemes) so that the trustee did not represent an effective negotiating counter-party to Carillion.”

Among others, Willes highlights the dominant role of Carillion chief financial officer Lee Mills on the trustee board and the fact that Mercer acted as actuary and investment consultant for all pension scheme work for the trustee and Carillion. With regard to the role of Ellison in particular, Willes stated that: “Robin Ellison was appointed by Carillion and only Carillion could remove him.”

Ellison challenges this view, arguing that “anybody who ever sat on the board would know that sometimes it was too independent. Gazelle were retained to advise on the strength of the covenant, they only sat in on one or two meetings and don’t really understand the dynamics”.

Richard Butcher, managing director of PTL, agrees that being an employee for the sponsoring firm is not necessarily a bad thing. “Trustees have to identify and manage their conflicts of interest. This does not prohibit conflicted trustees from acting (the law only prohibits the scheme actuary and scheme auditor from being trustees). It would not be sensible to introduce such a prohibition. Employed trustees bring knowledge and information that external trustees could never have. This is useful – provided they do manage their conflicts.”

At the same time, Wauchope acknowledges: “In some corporate environments it is very difficult for the employee trustees to make their voice heard compared to employer trustees and there is a strong culture of not standing up to management,” he warns. “We need more independent trustees by which I don’t mean non-exec directors, I am referring to people from outside the company, and maybe we also need a tightening of trustee responsibilities.”


What then, are the lessons to be drawn from the crisis? Robin Ellison is sceptical whether strengthening TPR’s mandate, as proposed in the recent government white paper on pensions, would help. Instead, he  suggests that the powers of trustees should be reinforced allowing them to impose contributions levels on sponsoring schemes. He argues that the regulator is not equipped to determine what levels of contribution a sponsor can or can’t afford and that trustees are much better equipped to make these decisions.

David Weeks, co-chair for the Association of Member Nominated Trustees, also emphasises the key role trustees can play. “The best remedy to ensure the safeguarding of a scheme is to have an independent board of trustees.“At the end of the day, they are the best people to assess these corporate decisions relating to their employer.” With regard to the regulator, he suggests that it should do less policing and more prevention.

Joe Dabrowski, head of governance and investment at the Pensions and Lifetime Savings Association (PLSA), argues that the regulator does have a role to play. “We welcome the proposals for additional regulatory powers suggested in the government’s defined benefit white paper and support the changes TPR set out in its TPR Future Programme to be tougher and faster.

This, combined with stronger corporate governance and also better governed and more confident trustee boards, should enable earlier and more effective interventions.”

Others suggest that the onus should also fall on the employer. Butcher recommends: “We need a clearer legal duty on employers to proactively disclose information to trustees and a legal ability for trustees to renegotiate employer contributions, without first having a full actuarial review, where there is a material and urgent change in circumstances.”

Psigma’s Wauchombe argues that executives should be provided with clearer incentives to reduce their scheme’s deficits, while the role of the regulator should also be strengthened. “This sharp increase in pension deficits happened in a strong market environment, what will happen when we will face the next crash? Deficits will definitely widen again, regardless what the yield is,” he warns.

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