Three types of valuation

Practitioners need to be aware of the difference between disclosure values, market-consistent values and offsetting values. They are the equivalent of the forced-sale price for a house, the estate-agent’s price and the actual sale price.

Disclosure values (the forced-sale price)

Ancillary relief requires the CETV must be disclosed for pensions not in payment. However the CETV was not designed for the purpose, as the name, Cash Equivalent Transfer Value, gives away. We have identified 6 reasons why the CETV is not appropriate for use in a divorce, which you can download from the last box in the right hand column.

A number of schemes now refer to CEVs for values produced for divorce where the individual is still an active member of the scheme and therefore does not have the automatic right to transfer. CEVs are just CETVs less the value of all spouse’s benefits. They do not address any of the 6 reasons why CETVs are inappropriate.

Pensions in payment cannot be transferred out, so no CETV exists. Instead schemes have to provide a CEB, Cash Equivalent Benefit. Unlike CETVs, there is no right to a free CEB once a year. With charges of up to £1,000 +VAT and three month turnaround often quoted, most parties would prefer to use our PiP Express Pension Valuations at £100 +VAT with a five day turnaround.
 

Market-consistent values (the estate-agent’s price)

For most assets the value used in divorce is the market price. For some assets such as stocks and shares there is a readily available value from the financial markets. Individual assets such as the family home are normally valued on a basis such as a sale within 6 months.

Although it is not possible to sell a pension, we can create the price that would be used if it were. Pensions are just streams of cash that will be paid in the future, subject to certain contingencies such as the pension holder still being alive. The financial markets value such assets all the time and we can use the assumptions underlying these valuations to create a pension market price.

This is how actuaries produce market-consistent valuations appropriate for use in a divorce.

Offsetting values (actual sale price)

When offsetting pensions it is often argued that the value of a future income is worth less to a cash-strapped divorcee than its market price. Therefore the market-consistent value, or usually but incorrectly the CETV, is reduced in an offset arrangement.

Historically, the custom has been to multiply the pension by a single fixed percentage in all cases, but now less arbitrary or severe reductions seem common. Our Pension Offset Report is the only objective, evidence-based approach of which we are aware.

From a simple indication of the future wealth of divorcees using five broad categories, our expert report provides offsetting values useable in Court.

In one case, we were jointly instructed that a divorcee was financially likely to be “struggling” in future, needing personal loans at times to keep her afloat. We were able to show that a 37% reduction in her husband’s pension was appropriate.

By contrast, in a single-instructed report our 2% reduction supported the claim of a husband for using an unadjusted pension value, as the wife was going to be financially “in-balance” after the divorce settlement. We report on the assumptions we use explicitly, enabling both parties and the Court to discuss the basis of the reduction in simple to understand terms.

Anecdotal evidence suggests that the approach to pension offsetting in divorce varies across the UK. If the stories are to be believed, adjustments or “discounts” applied to the pension value can be something of a postcode lottery.

To get a better idea of what is really happening in this area we have decided to do some research. In the first phase of the project, we want lawyers and other professionals to participate in an anonymous on-line survey. Once we have analysed the data and published the results, we will facilitate a debate through this blog.

If you are a professional working in divorce, we would like you to participate in the survey. It will only take about five minutes of your time. Click here to go to the survey, hosted by SurveyMonkey (which claims to be the world's leading provider of web-based survey solutions).

We occasionally publish articles from guest writers. So, when we came across the following article by the pensions guru Steve Bee it was obvious that it would help some of our visitors to understand annuities a little better. With Steve’s kind permission we are publishing the article here.

If you enjoy the style, you may care to visit Steve’s own blog http://www.jargonfreepensions.co.uk/. You will gather that making pensions understandable is just one of Steve’s talents, he is also an acomplished cartoonist!

There are plenty of insurance products that we all know about and, at a pinch, could probably have a decent stab at explaining. I’m sure most of us understand life insurance and home insurance and car insurance, even pet insurance and travel insurance. Insurance is something we come across at various stages of our lives on the planet and by and large we know why we might need it and what it’s all about. That is until we get older and end up having to deal with strange insurance products like annuities. Most people, I’m sure, wouldn’t know where to begin if put on the spot and asked to describe an annuity. That, by the way, probably includes most of the people who work in financial services too. Annuities are hard to understand. So, what is an annuity when it’s at home?

Put simply an annuity is an insurance product and, like all insurance products, it is designed to protect people against the effect of unpredictable events. In the case of an annuity people are essentially insuring against living longer than their lifetime savings. An annuitant typically exchanges his or her lifetime pension savings in return for a guaranteed level of income for life; an income that will continue to the day they die however far in the future that may be in any individual’s case.

That is a simplification, of course, and there are many different annuity products available these days to meet some of the various and varied needs of retired people. But in essence the nature of an annuity contract is that it is an insurance arrangement. As such it is a one-way ticket.

Consider a hypothetical group of, say, ten thousand people all aged 65. The group as a whole may have an average life expectancy of maybe another 20 years or so beyond the age of 65, but that does not mean any particular individual within the group can count on that. Some may die soon after the age of 65 whereas others may well live on beyond the age of 85, 95 or even 105. No-one in the group can know their fate with certainty at the age of 65.

For the ten thousand people in this hypothetical group of 65 year-olds it could make good sense for them to pool their lifetime savings to ensure that none of them outlive their savings. Those who die early after making such a contract with the others could be said to have lost out on the deal, as those who live on to a great age could be said to have gained from it, but all in the group could equally be said to have been in receipt of the contracted benefit; an income for life.

In everyday language the nature of an insurance contract like an annuity gets caught up in the way we speak and as a result it is possible to lose sight of what we’re talking about when the subject comes up. The fact that we are all today lucky enough to have the chance of living longer than ever before translates into statements like “Annuity rates are getting worse!” and “Annuities aren’t as good value as they used to be!” and similar.

You might be surprised to know that back in 1866 when the ages at which people died were first recorded the average life expectancy in the UK was just 29. By 1941 that average had increased to 57 and by 1966 to 68. Today it is 80. That doesn’t mean that people in the nineteenth century and the twentieth century didn’t live to the age of 100 or more. Some did, just as some do today. It’s just that the number of people who died early, particularly in infancy and through uncontrolled diseases, in the past had the effect of reducing the average.

The difference today is not really that we are able to live longer than humans have ever been able to live in the past (although there has been some small increase in lifespan), but rather that more and more of us are reaching old age. The average age of death is therefore going up as a result. Annuity rates, of course, reflect that. That’s all.

Steve Bee

www.paradigmgroup.eu

The general issues with police pensions are similar to those of the armed forces.

1.        CETVs are not appropriate valuations for use in divorce

2.        Distorted CETVs means distorted pension share percentages

The age at which an officer is assumed to leave service or retire is particularly important, as it affects when the pension starts and hence its value.

Depending on the retirement age used, the value can more than double for this reason alone. Except in specific cases, it is unlikely to be realistic to argue for the CETV approach in which an officer is deemed to have left service on the valuation date.

The low CETV value also affects the pension share percentage required to meet a specific objective. The adage “a 50% pension share never equals a 50/50 split of the pension” has never been more relevant.

A simple case from our files with one PPS 1987 pension makes the point. The CETV was £285,000. Our valuation, based on retiring with an immediate pension at age 50 was £640,000. The percentage pension share required to equalise income was 70%, or 87% to equalise capital values.

Help is at hand

If instructing on police cases sounds confusing then we can help. We have produced a fact sheet that shows you the effect of different instructions and the factors you should take into account when setting them. We have a similar fact sheet for armed forces pensions. Both are free, just click here to request both factshhets..

 Pension credits from age 60

Unlike the armed forces schemes, which have reduced the age at which pension credit members must take their pension, there have been no such changes to the police schemes. Pension credits must still be taken from age 60, and it is not possible to transfer them out of the scheme to get around this.

There is talk of this changing, but this would strictly require Amendment Orders to the schemes’ primary legislation so it seems unlikely to happen in the near future.

Pay increases versus salary expectations

A general issue, but surprising common on police cases, is querying the future salary expectations we make when producing reports. Normally a reasonable comparison is made between current increases in pay scales - about 2.5% - and our stated assumption of about 5.25%.

The short explanation is that the important figure is the rate of increases above inflation, which is about 2% in each case. It should be recognised that due to promotional increases or payments for extra responsibilities, salaries generally go up faster than increases in pay scales.

We are aware that reports can raise numerous such questions. However, rather covering them all in each report, we are extending our FAQs on our website to help you and your clients answer specific your queries.