Fines, Compensation and Material Litigation Report half year update
Royal Mail — Strictly Confidential
PRIVILEGED AND CONFIDENTIAL
Royal Mail Holdings plc Audit & Risk Committee
Purpose of Paper
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1. The purpose of this paper is to provide an update on accruals and provisions covering
potential fines, quality of service compensation and current material litigation and
environmental issues.
summarised in the table below:
The movements in the balances reported held at the 2010-11 year end are
Specific Claims provisions Total
regulatory
accrual
Quality of I REIMS TUPE Industrial I Amazon Risk *
Service diseases accrual
£m £m £m £m £m £m
Opening balance
at 28 March 2011 5 12 2 30 - 5 54
Released in P1-6 (5) - (2) - - - (7)
Utilisation in P1-6 - - - (1) - - (1)
Raised in P1-6 - 5 - - 7 17 29
Unwinding of . . . 4 . . 4
discount
Amendments in P7 - - - - (3) 3 -
Closing balance
at Sept 2011 - 7 - 30 4 25 76
Business unit UKLPI UKLPI POL Group UKLPI UKLPI
* - Central regulatory, litigation, [T and environmental accrual
Specific regulatory accruals
3. There was a regulatory accrual of £4.7m held at the end of 2010-11. The subsequent
movement is explained below.
Quality of Service Compensation — 2010-11
4. Quality of service in April 2010 was impacted by volcanic ash which resulted in flight
cancellations, impacting first class and premium products such as special delivery.
5. Quality of service for first class/special delivery fell below the target in September,
October and November 2010 for a number of reasons including the mail centre
rationalisations in the North West.
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6. Quality of service across all major products was impacted in December 2010 due to
the adverse weather conditions across the country and particularly the North and
Scotland, rendering it impossible to collect, trunk and deliver mail during the run up to
Christmas.
7. There was a knock on effect into January 2011 to recover from the Christmas backlog
such resulting in quality of service below targets for most products.
8. Although trends improved in February 2011, almost every major product other than
DSA was below target.
9. Compensation is paid to account customers if the actual results are >1% lower than
the target. Pre force majeure, first class account mail’s quality of service was 89.2%
versus a target of 91.0% and, at this level, £5m would be payable.
10. A robust force majeure case (relating to both ash and the impact of the severe
weather) was presented to Postcomm/Ofcom to seek dispensation for this service
failure.
11. Postcomm issued a decision letter on 26 July 2011 accepting in full three of Royal
Mail's force majeure submissions and accepting in part a fourth submission, thereby
granting dispensation for service failure sufficient to remove the requirement to pay
compensation to account customers.
12. Accordingly, the accrual of £4.7m has been released at 25 September 2011.
Claims provisions
REIMS exit provisions
13. REIMS provides a system for intercompany pricing (terminal dues) for postal operators
in Europe which are parties to it (Royal Mail is no longer a party to REIMS). REIMS
rates are higher than those of the UPU (Universal Postal Union).
14. REIMS exit provisions represent Royal Mail's estimate of how much we expect to
agree terminal dues rates with other European postal operators over and above UPU
rates.
15. No new claims in respect of REIMS settlements have been received although amounts
provided at the 2010-11 year end have been reassessed and adjusted as appropriate.
16. The balance of the REIMS exit provision at 25 September 2011 is £16.9m and
includes amounts relating to Germany (£5m), France (7m) and Greece (£3m).
CWU TUPE Regulations challenge
17. This matter relates to claims by the CWU in respect of WH Smith conversions that
TUPE information and consultation obligations have not been complied with by RMG
(as employer of record with the relevant employees seconded to POL).
18. The CWU succeeded in its claims before the employment tribunal. RMG appealed to
the Employment Appeal Tribunal (EAT). The EAT found in RMG's favour in December
2008. The CWU sought leave to appeal to the Court of Appeal and permission was
granted. The Court of Appeal heard the CWU's appeal which was on the narrow point
of whether there is a breach of TUPE where an employer informs employee
representatives of its mistaken but genuinely held belief that employees will not
transfer under TUPE.
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19. The Court of Appeal handed down its decision on 14 October 2009 dismissing the
CWU's appeal and found that the information and consultation obligations under TUPE
only oblige an employer to describe what it genuinely believes to be the legal, social
and economic implications of a proposed transfer.
20. Having clarified the law, the Court of Appeal remitted the matter to a fresh tribunal to
hear the facts and apply the law as clarified to those facts. The Employment Tribunal
found in favour of Royal Mail in that it had not breached the requirements to inform and
consult in accordance with the requirements of TUPE in relation to Post Offices which
had been franchised to WH Smiths.
21.A provision of £2.4m was held at the 2010-11 year end but reassessment at half year
has resulted in this no longer being deemed necessary and the provision has therefore
been released.
Industrial diseases pro’ n
22. The background to the industrial diseases provision can be found in Appendix A.
23. The report from Towers Watson in March 2011 gave their best estimate of the
potential for industrial diseases claims against Royal Mail as circa £75m gross (ie
unadjusted for the time value of money). Using a discount rate of 5% as a proxy for
the risk free rate (based on government bond rates for the term of the provision), a
total provision of £30m was raised at the year end.
24. The provision will be reassessed formally at the 2011-12 year end and the movement
during the first half year relates to utilisation and the unwinding of the discount.
Amazon claim accrual
25. Amazon claimed mid way through September 2011 that Royal Mail overcharged it
between 1 April 2010 and 31 July 2011, in respect of Packet Post Services. On 1 April
2010, due to regulatory concerns, Royal Mail stopped applying a reconciliation process
to Amazon Packet Post (which would give a debit or credit at the end of a month
depending on the actual weights of posted items). Amazon claims it was overcharged
as a result of the reconciliation process ending. Royal Mail refutes that Amazon was
overcharged. Amazon has not yet issued a legal claim, but has escalated its claim to
the top levels of Royal Mail. While further investigation was being undertaken into this
claim at the half year, an accrual of £6.8m was raised.
26. Subsequent to the half year, a confidential agreement settling the dispute was signed
on 12 October 2011.
Horizon claims
27. Post Office Limited has received four letters before action from a firm acting for former
subpostmasters who were dismissed when discrepancies between their branch
accounts and cash positions were discovered. Two of the claimants previously
pleaded guilty to false accounting in criminal prosecutions brought by POL.
28. Each claimant alleges wrongful termination of contract (based on alleged failings in
POL’s processes and computer system) and seeks circa £150k in damages. We may
receive a large number of similar claims - possibly between 55 and 150 according to
press reports.
29. The key legal issues arising are common to all the claims but the factual allegations
are different. Our strategy is to defend each claim robustly to deter future claims and
we will be responding to each in full. At present we consider the legal claims to be
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weak and the damages claims to be inflated. We do not know what the ultimate value
of these claims will be. We do not know what the ultimate value of these claims will be.
30. In summary, the considered legal view is that the claimants are unlikely to succeed.
Nevertheless, given the potentially high volume of claims that may be issued in the
county courts, we were advised by our QC, Richard Morgan of Maitland Chambers,
that “the quality of the judges would be unpredictable making it more likely that one or
two cases might be lost”. In light of this litigation risk, and the fact that a large volume
of claims may be received (that collectively may pose a material financial risk), it is
prudent to flag these cases at this stage. However, these claims are at an early stage
and we do not know how many claims we will receive or what their ultimate value will
be. We understand that it has therefore been proposed that no provision will be made
and there is no disclosure requirement at the half year.
Jeff Triggs
November 2011
Central Regulatory, Litigation, IT and Environmental accrual
31. A central accrual of £25m exists at the half year to address various regulatory,
litigation and environmental risks including three that have only emerged in the last two
months:
a. Overall Quality of Service failure: currently 7 of the 11 licence quality of service targets
are not being met and 6 of our commercial targets are not being met. Details of P6
QofS results are shown at Appendix B. Although the majority of these in themselves
would not trigger compensation payments at this point in time — because they are
within the tolerable error of 1% absolute lower than target — we would normally expect
to be in a far better place given Q1 and Q2 are the periods where the weather is most
favourable and the volumes are lighter. Indeed in prior periods we have generally
been in favourable positions and “banked” this over performance recognising that Q3
and Q4 can be difficult months even without adverse weather. Subsequent to the half
year, P7 QofS results were worse than prior year by 0.3% but early indications for P8
are encouraging.
We are not currently meeting the USO collection and delivery targets and in fact we
have not met both these targets since 2006-07 without adjustment for force majeure
(for industrial action and/or bad weather) and this appears to be due to both industrial
action and Letters modernisation. This and the underperformance in first class retail
could be used by the media which could put pressure on the new regulator to take a
tough stance.
Bulk compensation accruals have been raised at the year end in the last two years
when relative underlying performance at the half year was better (2010-11 £5m; 2009-
10 £10m), but have been released in prior periods after dispensation was approved.
The risk is assessed to be in the £0m to £5m range.
b. Changes to customers entitlements to seek compensation: Postcomm announced in
September 2011 it was consulting on the removal of entitlement to claim compensation
from Royal Mail for loss or damage of untracked contract mail services and a reduction
in the claim period for loss of or damage to mailed items where the right to claim
compensation remains (such as contract tracked services) to 80 calendar days from 12
months.
We expect this consultation to complete in January 2012 and that Ofcom will agree
with our proposals. We believe that the publicity around this will increase the level of
claims for compensation for loss / damage in the short term and in the rest of this
financial year. We have never implemented such a change in recent times — and
32.
33.
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therefore there is no precedent - but have already received a claim from Amazon (of
£1.8m over and above the one explained above). We expect further claims from
Amazon and the rest of the bulk mail and packets market.
The risk is assessed to be in the £0m to £15m range.
iRed: A decision to close iRed down has been taken and a provision of £1m has been
booked to business disposals / closure within exceptional items. A forensic audit has
been performed by PwC and the interim CEO, Declan Salter. There is a risk that iRed
claimed too many savings than contractually entitled to and that these may have to be
de-recognised.
The risk is assessed to be in the £0m to £5m range.
IT risks: a £5m accrual was booked in 2010-11 to cover a risk that IT licences fees
have been under paid compared to the amount of use. Although no formal request
has been made by IT suppliers to review the usage in 2011-12, we did settle with
Oracle for £8m last year.
The new CIO has identified a number of risks in the IT estate that have potential cost
and reputation impact on RM, should they occur. These encompass
* an inadequate IT security framework
* agap in our current email archive process
* anaged server estate, a proportion of which is now out of support from the
vendors.
Although work has started in all 3 areas to address these and some of the exposure
will be reduced fairly quickly, for the 3rd area in particular, the exposure will remain for
12-18 months.
The risk is assessed to be in the £0m — 25m range.
The range for all of the above is £0m - £50m and driven by several abnormal events
and the size, scale and complexity of the Group. Accruing £25m (50% of the
maximum risk, or 0.5% of sales or costs) is considered to be reasonable at the half
year and until further information and facts are known. This would not be specifically
disclosed given the sensitive and commercial nature of the above risks.
Ernst & Young have been made aware of these risk areas and ranges and agree with
the approach taken.
Mike Prince
November 2011
Recommendation
34,
The Audit & Risk Committee is asked to:
a. Note the amounts recorded for fines, compensation and material litigation at 25
September 2011 and agree they are reasonable in light of the risks and factors that
have emerged since March 2011; and
b. Agree that the Horizon claims are a contingent liability which is considered remote
at this stage which means no accrual is booked and no disclosure is made.
Mike Prince
November 2011
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Appendix A
Background to the Industrial Diseases Provision
35. The need to identify a specific industrial diseases provision has arisen through BT
seeking clarification from the Court as to the liabilities transferred to BT following the
split of the old Post Office Corporation in 1981. A test case was issued on 22
December 2008, with a stated value of over £100,000. The test case brought was
based on one individual's claim for compensation as a result of his exposure to
asbestos dust during his employment at the Post Office Corporation between 1961
and 1970. The individual was employed on the telecommunications side of the
business.
36. Historically, BT had taken the approach of assuming liability for any pre-1981 claim
that was addressed to it. Since 2008, BT have stated that claims from employees who
left the old Post Office Corporation prior to 1981 should be met by Royal Mail
regardless of whether or not that person worked mainly in the telecommunications or
the postal areas of the business. In 2008, Royal Mail and BT agreed to split the liability
of these claims 50/50, pending the outcome of the test case.
37. In November 2009, the test case was heard by the High Court which gave judgment in
favour of Royal Mail's interpretation of the British Telecommunications Act (the Act)
(namely that liability for ex-employees who had worked mainly in the
telecommunications side of the business but had left the business prior to separation
in 1981, remained with BT and not Royal Mail). The judgment was subsequently
overturned on appeal.
38. In December 2010, Royal Mail was refused permission to appeal to the Supreme
Court. As there are insufficient grounds to refer the case to the European Court, there
is no option but to accept that the liabilities remain with Royal Mail.
39. There can be a long period (potentially up to 50 years) between exposure to asbestos
and development of asbestos-related diseases. The heaviest period of exposure was
between 1955 and 1975. Actuarial advice has therefore been sought from a specialist
industrial diseases team from Towers Watson to quantify the potential value and
profile of such claims going forward.
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Appendix B
LICENCE CONDITION 4 - QUALITY OF SERVICE
PERFORMANCE TO PERIOD 6 2011-12 (21 March to 4 September 2011)
'No.IScheduled Service or Licence I Actuat I Actual I Actual I Actual I Rest of Year (Financial Consequences ‘Commentary from Head Of Service Compliance
[Standardised Measure Full Year I Period 6 I YTD YTD _IPerformanceI Requirement
Standard To Period ITo PeriodI Band ‘To Meet em
6 5 __IALIT or 1vI Licence Target
BUSTESS
Ic Factor Compensation,
lwhich disrupted collections and deliveries in parts of the country. In the
remaining 3 weeks of the period the target was met. Cumulative performance
1 Iretat First class 93.0 " 935 00 0.9 Iremains below the full year licence standard. We stil need to achieve an
laverage rest of year performance of 93.5% for 1C Retail to achieve the full
year target of 93.0%
[Retail Second Class 355 i wa oo Tabara the leence Standard fore period and iat
Te TC REUAM Pe MOMNEE TN UNE erTOa WAS MPBCCET BY OTE
Jatsruption in week one which disrupted collections and deliveries in perts of the
3 [Bulk First class 91.0 0" o16 oo oo ouney.
7 leuk Second Clase ws 1 7 00 Do [Above the Licence Standard for the period and 0.2% below comulatvely
3 [Bulk Third Class o75 Z DAN oo ‘0 —_[Above the Licence Standard for the period and cumulative
lard Parcels above te cence standard forte period and cumulative, The Standard
§ [Standard Parcels 80.0 t 857 oe 00 _larcels result af 98.22% for P& is the best e
7 IEuropean Taternational 50 52 1 7 oo co etlebove te hence stander in Period 5. “The Period 6 result & awated From]
Remains below the licence Standard cumulatively. There remains an underlying
«ISpecial Delivery Next Day tn 99.52 Not Applicable _[/s8ue with Special Delivery QofS as the Licence Standard has not been
[Non-Account Customers locheved in any period since Perio 6 of 2008-09. Also impacted inthis period
ov the cul
it modest improvement forthe Mth period in 8 vow with B6/Ii8 PCRS now
lyear-to-date at or above the Licence Standard for geographical 1C Retail
Postcode Area: ist Class Delivered performance. OF the 10 poorest performing PCA's 6 are inthe South
9 [Stamped And Meter Vv 9s 0.0 East, where transformational activity is contributing to the performance in the
[Delivered From UK IGU, BR, TW, RH, ME and KT PCA's. The rest of year requirement for the
poorest performing PCA's remains achievable but extremely challenging
Percentage Of Collection Below the Licence Standard for tie period and just falling Below the ful year
10 [Pointe Served Each Day 0" 99.91 00 0.0 [standard cumulatively. The result in the period was impacted by the civil
Uso) ti se
[Percentage Of Delivery Below the Licence Standard for Ue period and falling Below the fal year
11 JRoutes Completed Each Day 99.83 in 99.96 00 0.0 I standard cumulatively. The result inthe period was impacted by the civil
uso) [disruption in week one.
Percentage OfTtems [Above the Licence Standard.
® Ipetivered Correctly 1 99:30 oo ba
Tokar Ey = 35
NB. Financial Consequences Key Points To Note:
If the results continue at the Period 6 level forthe remainder of the reporting Ferner a MBIA - Period 6 for all measures except International was 08.08.11 to 04.09.11 (4 weeks)
lyear the financial punitive consequence would be C-factor revenue adjustment of Feet Year-to-date for all measures except Intemational was 21.03.11 to 04,09.11 (24 weeks)
le9.5m. + Period 5 for International was 01.08.11 - 31.08.11
IGreen = Performance is at or I* Of the 10 results available, 5 are at or above the full year licence standard in the period
labove the full year Licence _I* The civil disruption in week one has had an adverse impact across the board,
IStandard
‘ANALYSIS COMPLETED BY > STEVEN HAWKSWORTH - HEAD OF SERVICE COMPLIANCE
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