Case Manager, the Regulator Philip Wilson, Business Analyst, the Regulator (together the "Regulator")

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1 Attfln ance Sacker & Partners LLP 20 Gresham Street London EC2V 7JE T +44 (0) F +44 (0) E enquiries@sackers.com DX Cheapside Date: 29 April 2013, 9am CIC E3r Subject: Carillion Single Trustee - meeting between Trustee representatives and the Pensions Regulator regarding failure to agree the 2011 valuations Attending : Case Manager, the Regulator Philip Wilson, Business Analyst, the Regulator (together the "Regulator") Robin Ellison ("RE"), Trustee Director Robin Herzberg ("RH"), Trustee Director Edwin Topper ("ET"), Mercer, Scheme Actuary Mandy Turner ("MT"), Mercer (by telephone) Deborah Gudgeon ("DG"), Gazelle Nick Gibson, Gazelle (by telephone) (together the "Trustee Representatives") Apologies: Attended by: Sarah Tune, Actuary, the Regulator Anna Copestake, Sackers 1. Purpose of meeting The Regulator met with the Trustee Representatives to understand the position of Carillion (DB) Pension Trustee Limited (the "Trustee") regarding its failure to agree the terms of the outstanding 2011 actuarial valuations for the Schemes 1 with the Company. This meeting would precede a tripartite meeting with Carillion pie (the "Company"), in which the Regulator would try to gain an understanding of where the differences lay between the Trustee and the Company's approach. The Regulator invited the Trustee Representatives to explain the Trustee's view of the current position and the events leading up to it. 2. Trustee position ET talked the Regulator through the Trustee's current position. The Trustee's initial position was that the global deficit (on a technical provisions basis) was 770 million. ET gave a brief summary on how this figure was reached. Although the Trustee acknowledged that if suitable contributions, based on the Company's maximum affordability, were agreed it may be possible to agree a lower deficit figure. The 1 The Alfred McAlpine Pension Plan, the Carillion B Pension Scheme, the Carillion Staff Pension Scheme, the Mowlem Staff and Life Assurance Scheme and the Planned Maintenance Engineering Ltd Staff Pension and Life Assurance Scheme _1

2 Page 2 S(JC~kc~:r s Trustee is also flexible on the structure of contributions during the period of the recovery plan and would be open to back-end loading contributions. This had been recognised by a revised Trustee proposal (sent on 26 March 2013) based on a revised deficit of 605 million but which was subject to increased Company contributions from 2016 onward. The Trustee Representatives said that the Trustee does not believe it is being offered contributions reflecting the Company's maximum affordability and is of the opinion that the Schemes are falling further behind the Company's other stakeholders as time goes on. The Regulator was informed that the primary disagreement is around what constitutes affordable deficit repayment contributions. ET explained that he had undertaken discussions with the Company actuary regarding the level of prudence in the calculation of the deficit. The correspondence sent to the Regulator contained details of the various points that had been 'traded' between the two sides. However, whether agreement could be reached will depend on the Company's ability and willingness to increases its cash contributions. The global buy out liability for the Schemes is estimated to be 1.1 billion. Although the Trustee was not expecting to base negotiations on that funding basis it is conscious that all Schemes are closed to future accrual and maturing. The Trustee would like to get the Schemes funded on a self-sufficiency basis as soon as possible. Approach taken in 2008 valuations ET explained that the Trustee proposed deficit of 770 million was within the parameters of reasonable and incorporated an acceptable margin of prudence. However, it was calculated on the basis of trying to address some key things that had been deferred during the 2008 valuations in the expectation that they would be addressed as part of the 2011 valuations. These included: De-risking to reflect maturing liabilities; The use of a net discount rate and a reserve to reflect investment expenses and ongoing expenses respectively; and The use of stronger mortality underpins. In particular, the Trustee had understood that the Company would meet administration and investment expenses from 2013 going forward. These matters had been deferred irrespective of the Company's ability to pay higher contributions. In the opinion of the Trustee it had placed less pressure on the Company in regarding the 2008 valuation because the construction and services sector was unstable at that time and the Trustee thought this would have improved by the next valuation. In addition, this was a time when the Company had concerns regarding refinancing and the Trustee did not want to prevent the employer group obtaining necessary funds. The Trustee was aware that the Regulator was not happy with the 2008 valuations. 2

3 . Page 3 However since the previous valuation negotiations the industry sector has not recovered the extent thought and the Company has shrunk by 20% as a result of financial pressures and strategic decisions. Comments on Company proposal The Trustee felt able to agree to contributions of 31.3 million in 2013 and 33.4 million in 2014 and 2015 provided that contributions rose to around 39 million for 14 years thereafter. This was based on a 605 million deficit (a Trustee revised figure from the Company's proposal of 530 million to reflect a weaker covenant). The Trustee thinks that this offer may be below what the Regulator would accept and for that reason does not feel able to ) negotiate further. The Trustee was conscious of being too lenient in its negotiations with the Company and wanted to reach an agreement acceptable to the Regulator. However, the Company has refused to increase contributions from 2016 onwards and is only willing to continue contributions of 33.4 mfllion p.a. for the remainder of the recovery plan. The Company considers discussions surrounding increased contributions more appropriately raised when discussing the next valuation (which will be as at 31 December 2014) as the new schedule contributions from that valuation would most likely take effect around January In addition the Company does not accept the increase to the 530 million deficit figure to 630 million, to reflect a weakened covenant. ET considered it likely that Company may suggest that any ratchet up in contributions may adversely affect its share price and ability to refinance. The Trustee did, however, agree with the Company that post-valuation date experience, in this case movements in equity markets, should be taken into account. The 2008 valuations did so (albeit in a slightly different manner) and so for consistency this seemed appropriate. The Company wanted to reduce the Trustee's original deficil figure of 770 mllllon by approximately 200 million, based on 'more realistic' assumptions relying on relatively aggressive investment returns and including no element of de-risking (and to some extent including a degree of re-risking). The Trustee would not be able to agree to this far lower deficit without sufficiently increased cash contributions. It was explained to the Regulator that the Trustee would like to share in any increase in profitability and cash flow of the Company post 2014 e.g. a contribution linked to earnings or dividends. The Trustee would agree to such prof it sharing to fall away should it become apparent that a minimum level of profitability was not met. It would also consider the use of escrow arrangements. However, the Company is unwilling to consider such methods. The Company had said it would be willing to extend the current Company guarantee to December 2020 (i.e. for two valuation cycles). The Regulator and the Trustee Representatives noted that as most participating employers of the Schemes were service companies, and as such the ultimate liability is likely to be met by the Company in any event. 3. De-risking 3

4 Page 4 RE confirmed that the Trustee has been willingly engaging with the Company regarding investment risk management. Exercises such as longevity swaps, inflation hedges and cash equivalent transfers had been discussed. ET noted that such measures would affect the deficit and in some cases, for example longevity swaps, there would be an initial increase in deficit. In addition, any obligation on the Trustee to meet the on-going costs of such measures would also impact on the sufficiency of any proposed deficit reduction contributions. The Regulator asked what extent investment profiles differed between the Schemes and whether that caused concerns. It was confirmed that the profiles varied. For example, MT confirmed that some schemes had de-risked and had relatively low equity exposure where as others, such as the Mowlem Staff Scheme and the AMPP had not de-risked. ET expanded explained that the Carillion Staff Scheme was the largest of the Schemes but was relatively well de-risked, whereas the AMPP had more risk relative to its maturity. RE explained that the Trustee thought it sensible to agree a global deficit figure and contribution structure before turning to the issue of how those contributions would be allocated between the Schemes. The Regulator agreed. 4. Issues around expenses RE pointed out to the Regulator the current negotiations, as with the 2008 valuation negotiations, involved a significant amount of adviser impact and so were both time consuming and costly. In the opinion of the Trustee, the process has been protracted because the Company is not willing to negotiate. The Company had not moved from its opening negotiating position whereas the Trustee had moved from what it considered a reasonable position (its original proposal) to what it considered marginally acceptable (the proposal sent on 26 Marcy 2013). The Trustee believes that the current schedule of contributions requires the Company to pay 31.3 million in 2013 and 33.4 million p.a. thereafter (being 26.7 million plus estimated administration expenses of 3.2 million p.a. to cover administration expenses and investment expense of 3.5 million). Therefore the Company's offer of 33.4 million p.a. would at best honour the current schedule of contributions. In addition, this offer did not deal with all of the matters deferred at the 2008 valuations (see 1 above) (e.g. de-risking) and the Trustee considered the Company covenant to have weakened since the last valuation. The Regulator said that the lack of recognition of future de-risking was a major concern. The Regulator was told that the Company believes its offer of 33.4 million p.a. sees a 45% increase in contributions to the Schemes. The Trustee disagrees, as in its opinion, 33.4 million p.a. is simply honouring the current schedule of contributions. The Regulator queried whether the Company would agree with the Trustee's understanding of the effect of the current schedule of contributions and the approach taken to the 2008 valuation (i.e. the issues that were deferred). ET responded that, although he could not speak for the Company, he suspected that correspondence from the time would indicate the Company shared the Trustee's understanding. He thought that the Company may consider 4

5 Page 5 ~.)()_C'. ke:,f~j the 33.4 million contributions to incorporate administration and investment expenses and that may have been a deliberate negotiating strategy when the Company put forward its proposal. ET explained that the Company agreed it was obliged to meet administration costs from 2013 onwards. However, the Company did not consider itself under any obligation to pay investment expenses from 2013 onwards. RE explained that this dispute had not been pursued to date, as the proposed 33.4 million appeared to incorporate both types of expenses meaning there is at present no breach of the existing schedule of contributions. If this was to change, and contributions offered were insufficient to include investment expenses, the Trustee would consider taking action. 5. Affordability DG said that there was a disconnect between what the Company was telling the Trustee and what it was telling the City. Since 2008 the Company has shrunk by 20% but cash generation has significantly increased. However, a large amount (and nearly all) of this cash was spent on increasing dividends and the Eaga acquisition. She noted 2012 was a tight year in terms of cash flow for the Company, due in the main to a large working capital requirement. The Company is likely to emphasise that 2012 saw approximately 100% in cash conversion, which is one of its key metrics, yet the Trustee believes the Scheme have received a disproportionate share of ge.r1erated cash. The Regulator queried why the Company was reluctant to accept what, on the face of it, appeared to the Regulator to look like a reasonable proposal from the Trustees (referring to the Trustee's proposal of 26 March 2013). RE's understanding was that the Finance Director, Richard Adams ("RA"), considered funding pension schemes to be a "waste of money", particularly in respect of deferred members who did not actively contribute towards the business. RE thought that RA may consider one of his key roles to be the preservation of cash. DG supported RE's understanding and explained that RA would consider an escrow arrangement or back-end loaded contributions on the basis they would unfairly burden his successors. ET suspected that the Company would emphasise that the Schemes were seeing Company investment in the form of funding for the implementation of a longevity swap, totalling around 2 million. However, the Trustee is wary of taking on the on-going costs of that exercise. If these costs were to be met by the Schemes then the Trustee would want greater cash contributions under the recovery plan to incorporate these additional scheme costs. The Company's accounts indicated modest borrowing. However, it was noted by the Trustee Representatives that this may be 'window dressing' with RH explaining that the Company would hold back significant payments at half and quarter year ends for this purpose. RE understood that borrowing had increased around 150 million after the Eaga acquisition and confirmed that the Trustee would not want to unduly jeopardise the Company's refinancing facilities. 5

6 Page 6 C' ( "<' 17. (.:._\,. ( ~ J ' l -',\. '.,. l. ' DG took the group through a paper of new statistics produced by Gazelle. The Regulator queried whether the! net debt position of the Company would be picked by the City. RE and DG were unconvinced City analysts pick up on the true net debt position. This rang true with the Regulator' s experience. The Regulator also queried whether the City would be aware of the 1.1 billion buy-out figure. RE queried whether it would be relevant as the main concern would be the agreed figure on a technical provisions basis. DG said the Trustee was happy for the Company to window dress tor the City (particularly given 2013 changes to Company accounting and the upcoming need to renegotiate the Revolving Credit Facility ("RCF")). 6. Covenant DG explained that the default risk of the Company had increased slightly since the last valuation and it was thought that the Schemes would get little on insolvency. This resulted in the Trustee focussing on obtaining cash for the Schemes. The Regulator queried whether the Company had a market credit rating but it was told it does not because the Company issues bonds placed privately. ) It was noted by all that the Company's share price had seen ups and downs, predominantly due to some short selling, and were subject to some volatility. This did appear, however, to tie in with the sector. The Trustee Representatives confirmed that the Company had reviewed Gazelle's Report and did not dispute its factual content although did dispute some of its conclusions. The Trustee Representatives warned the Regulator that the Company had been critical of Gazelle's work, although had been in agreement to Gazelle's appointment. RH flagged that Balfour Beatty (a. major competitor of the Company) that morning issued a further profit warning. RH noted say that Carillion had a more balance of portfolio than Balrour Beatty, in particular following a recent strategic movp. towards a greater proportion of services work. The Regulator noted that Carillion had not issued a profits warning. The Regulator asked the Trustee Representatives how they would rate the Company's covenant on a scale of 1-5. DG said that back in 2008 they considered the covenant to be moderate to positive. This had continued during 2011 to 2012 but had declined since. There were concerns regarding the medium terms, which is why the Trustee wanted to strengthen certain assumptions. The Regulator asked whether the Company had other pension schemes to fund. DG explained that when looking at maximum affordability those other schemes were taken into account. The Trustee Representatives informed the Regulator that there were two other schemes, both of which were open to new joiners. They took in members following transfers from the public sector and were more 'business critical' than the Schemes. For this reason, the Trustee believed the Schemes were falling behind relative to those other schemes. The Regulator confirmed that, in general, it is not comfortable with recovery plans increasing whilst dividends are being increased. The Trustee Representatives agreed although they had some understanding of the need for the Company to pay a certain amount of dividends to be able to raise finance. 6

7 Page 7 S ('I.,1.C-~ 1(... ere,.) The Regulator asked if the Trustee was aware of any chink in the Company's armour that could be used. RE thought was no chink as such because the Company was unwilling to move from their original position. 7. Trustee Board with expertise RE explained that the Company had presented it offer to the Trustee Board, which contained a number of Directors financial and Company experience. The Trustee Board was unconvinced by the presentation. For the benefit of the Regulator, RH confirmed the Trustee Directors that sat on the Assets ) and Liabilities Sub-Committee of the Trustee as: Lee Mills, Head of Treasury; Simon Eastwood, Divisional Managing Director; RH, Divisional Managing Director; Paul Kitto, a Business Development Manager; and Brian Watkins, Former Finance Director of Mowlem. 8. Trustee 'line in the sand' The Trustee and its advisers had considered various lengths of recovery plan with differing levels of contributions, some of which assumed no de-risking and some of which assumed slow de-risking (e.g. in line with maturing deferred liabilities). ET confirmed that the 'line in the sand' was: The use of a gilts plus 2.5% discount rate; Slow de-risking to reflect maturing deferred liabilities; and An agreed deficit of 670m; The resulting contributions would be 46m p.a. but the Trustee would be willing to consider back-end loading. The Company has offered 33.4 p.a. which is just under 10 million short. The Trustee is willing to include post valuation date experience. The Trustee originally thought that the company could afford to pay 60 million p.a. to the Schemes. Following Gazelle's updated report the Trustee now believes the Company could contribute 46 million p.a. to the Schemes. 9. Next steps The Trustee Representatives asked the Regulator it would accept a deficit of 550 million if the Company offered an extra 20m per annum. The Regulator said much would depend on whether their actuarial colleague, who unfortunately could not make the meeting, would be satisfied and where the Schemes' lay when compared with other schemes in the early engagement process. 7

8 Page 8 ' '.. The Trustee Representatives understood but wanted it noted that they did not want to reach an agreement in which they would be deemed too lenient in their acceptance of the Company's position, which would ultimately be criticised by the Regulator. The Trustee asked the Regulator to point out to them if and when they were too accepting of the Company's position in order to agree the valuation. In line with its proactive early engagement process, the Regulator would like to be kept updated as to any further discussions and negotiations between the Trustee and the Company. The Regulator intends to compare the position of the Schemes' valuation proposals with those of other schemes (in similar circumstances) that are also part of its early engagement process. To the extent a scheme tends to sit on the outside of the majority, the Regulator is less likely to accept the valuation. ) 8