Stagecoach confirmed in a statement on April 10 that it had been excluded from the East Midlands, South Eastern, and West Coast Partnership franchises “for submitting non-compliant bids, principally in respect of pensions risk.”

“In our bids, we refused to accept the potential pension risks that the DfT requires operators to bear in relation to the three new franchises,” Stagecoach explained in a regulatory statement on May 2. “The full extent of these risks is unknown, but we estimate them to be well in excess of £1bn for the three franchises.”

The Railways Pension Scheme (RPS) is a defined benefit scheme split into a number of sections, including sections covering the franchised train operating companies. Each section operates on a “shared cost” basis with the employer responsible for 60% of contributions and the employees responsible for 40%.

Following privatisation in the mid-1990s, a franchised operator’s obligation to RPS have been limited to paying the employer contributions due for the period of its franchise. Operators have not been held responsible for any scheme deficit remaining at the end of its franchise and have also not been able to benefit from any surplus. Since privatisation, the DfT has had (and continues to have) a veto over operators’ decisions on RPS funding, benefit and contractual arrangements.

“The sections of RPS relating to franchised operators have been funded on a long-term basis,” Stagecoach says. “That funding approach was determined by the RPS Trustee Board, supported by its understanding that the DfT would cover any RPS liabilities as each franchise ends. More recently, the Pensions Regulator has questioned that extent to which RPS does in fact benefit from that underpinning support from the DfT. We understand that the Pensions Regulator considers there to be a deficit of up to £7.5bn across the franchised train operators and is seeking significant additional contributions to the scheme which are as yet unquantified.

“As a result, in the absence of any contractual protection, an operator of any new rail franchises could have an exposure to substantial additional pension contributions. As yet, there has been no final determination by the Trustees or the Pensions Regulator of the extent of the liability that would be borne by franchisees. While ultimately the DfT provided limited protection against the risk in the specification for the three current franchise competitions, our assessment was it still left the successful operators with substantial risk which could not be assessed.”

Stagecoach says DfT’s protection was limited to:

  • the 2019 scheme valuation only (so the operator took the full risk of contribution increases arising from the 2022 and all subsequent valuations)
  • deficit contributions only (so the operator took the full risk of contributions in respect of contribution increases relating to ongoing employee service costs), and
  • employer contributions only (so the operator took the risk that employees were unwilling to accept increased employee contributions leading to either industrial action or a need for the operator to fund the increases).

“In previous British rail franchises, we accepted that each of our train operating companies bore the risk of increases in the pension contributions payable to RPS during the period of the applicable franchise,” Stagecoach says. “However, that was prior to the requests from the Pensions Regulator for substantial and not yet fully quantified increases in contributions to RPS. Therefore, in our more recent franchise bids, we took specialist actuarial advice. Following careful consideration of the protection offered by the DfT, plus a review of potential downside scenarios, the outcomes showed that the potential additional cost and risk were substantial. We therefore, as a responsible business, included increases in pension costs in our bid forecasts and sought additional contractual protection beyond that offered.0

“The additional contractual protection sought was to ensure that in the event a bid was successful, the relevant train operating company's exposure to increases in pension contributions to RPS would be limited to a manageable level which it would be reasonable for a train operator to bear should those circumstances arise.”

Stagecoach says that despite the disqualification, it stands by its decision not to accept the DfT’s position on the pensions. The company’s position was also supported by its partners Virgin, French National Railways (SNCF) and Alstom, and Stagecoach noted that Arriva was also disqualified from bidding for the East Midlands passenger franchise for similar reasons.

“Little confidence in the franchising system”

Stagecoach’s view was echoed by Virgin Trains founder Sir Richard Branson, who called for DfT to put the three franchise contracts currently being awarded on hold pending the release of the Williams Review.

Stagecoach is a 49% shareholder in Virgin Trains, which operates the Inter-City West Coast (ICWC) franchise.

“Virgin has always been happy to accept appropriate risk and compete for customers, but the DfT has disqualified our West Coast Partnership bid because we refused to take responsibility for risks we cannot control - including the risk of funding unquantifiable additional pension liabilities,” Branson says in a blog post published on May 1.

A week after the East Midlands contract was awarded to Abellio, the BBC and The Times reported that details of Stagecoach’s bid had been sent by the DfT to Abellio two weeks before the bids closed.

“An expert third-party investigation established conclusively that Abellio did not access any information relating to any other bidders that affected their bid,” the DfT said in a statement. “There was no effect whatsoever on the outcome of the bid process. Stagecoach disqualified themselves from the process by lodging non-compliant bids.”

However, Stagecoach has since called for an independent inquiry into the breach, and Branson says the incident is another example that the current process needs to be reviewed.

“Clearly there are still serious lessons to be learnt at the DfT,” Branson said in a blog post on the Virgin Group website on May 1. “Instead of encouraging operators who are focussed on customer service and innovation, its priority seems to be outsourcing as much risk as possible. Rather than advocates of customer experience winning franchises, we could end up with an industry run by actuaries. Many bidders could disappear, with the UK effectively outsourcing areas such as pensions risk to foreign governments. It is notable that the East Midlands franchise has been won by an arm of the Dutch government.”

Branson says the developments have left him with little confidence in the franchising system.

“When the Williams Rail Review was announced, the government rightly cancelled the Cross Country competition,” he says. “With two of the three outstanding competitions under a cloud, it is far from clear that any franchise can be let robustly as things stand. The DfT should take a pragmatic view and cancel all franchising competitions whilst Keith Williams does his vital work.”