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.

Pension credits from age 55

First some good news. In April ’09 the Government introduced a new statutory instrument, The Armed Forces Pension Scheme etc. (Amendment) Order 2009, that enabled pension credits to be taken early. This is welcome news and will greatly assist financial planning for divorcing couples in their late 40’s and 50’s.

Previously when pension sharing the pension credit had to be kept within the scheme until the credit member reached 65 when the pension could then be taken. The change means that the pension credit must be taken from age 55. Although the new instrument only refers to the 2005 scheme and for pension shares implemented after 6 April 2009, the administrators have told us that they are applying the age 55 rule for all pension credits.

For old pension credits, set-up to pay from age 65, the ability to take the pension early is optional and will be subject to an income reduction - based on actuarial factors. Solicitors may want to make previous clients aware of this change.

CETVs do not value Early Departure Payments

For members of the 2005 scheme their CETVs do not allow for Early Departure Payments, even if they could be taken immediately. This means for members who are aged between 39 and 55 who have completed 18 years service, their CETV only values a pension from age 65. This despite the fact that if they left they would receive a lump sum and between 50% and 75% of their pension immediately.

We recently reported on a soldier in this situation and valued his benefits, including his Early Departure Payments at £1.3m, compared to a CETV of £600,000.

CETVs are not appropriate valuations for use in divorce

The above is an extreme example of the fact that CETVs were not designed for use in the divorce process. They are the amount of cash a scheme will transfer out should a member leave. They ignore the fact that if the member stays in service just a few more years they might be eligible to take their pension early, rather than waiting until 60 or 65.

Some recent examples from our Express Pension Service include two 1975 Scheme cases, one where our appropriate value was £350,000 compared to a CETV of £110,000, another where our value was £600,000 and the CETV £410,000.

Distorted CETVs means distorted pension share percentages

As the CETV is used by schemes when implementing pension shares, then it should not be a surprise that a distorted CETV means a distorted percentage share is needed to obtain a fair result. In fact this is true generally, but more so with uniformed services schemes.

Hence to equalise income in two recent Armed Forces reports we had to recommend 63% and 75% percentage shares respectively.

Pension in Payment CEBs

Finally a straight plug that we can value Armed Forces pensions in payment, allowing for EDPs and level pre-55 income with the RPI catch-up at 55, for only £100+VAT. Cheaper than a CEB from the scheme for initial disclosure and as they are typically delivered within five working days you do not have to wait three months to get the answer.

Peter Moore

Managing Director

Bradshaw Dixon & Moore Ltd

Actuarial reports are often essential tools in divorce and dissolutions, but the perception is that they can take a while to produce. Little wonder then that family lawyers sometimes seek alternative and occasionally inappropriate solutions.

How quickly a report will be delivered is often the first question asked when a report is commissioned. Unfortunately, obtaining information from the pension schemes takes up most of the time. Turnaround standards and the quality of responses vary significantly between schemes.

Although we already have details of many schemes, or can quickly source them on the internet, certain issues still require direct contact. The main ones are obtaining the method and factors used in pension sharing calculations, and validating personal details, particularly in relation to part-time working and transfers received from other schemes.

Where an individual is in poor health, the impact assessment can usually be made from the information the person provides. Occasionally, it is necessary to obtain reports from their GP’s medical records, which generally takes three to four weeks.

So how can you speed up your reports? 

If you can provide full recent CETV and membership statements for each pension these often contain sufficient detail for us to start work straight away. Some schemes, including may state schemes, automatically refer benefit requests back to the member. Faxed or posted signed client authority forms are still essential to query any specific issues or to obtain the pension sharing details we need. Instruct early, so that if there are delays, they do not create problems.

But how can you get reports in just two weeks? 

There are two requirements,

• all the scheme factors being on record, as is the case for the public sector schemes and some others
• you supplying the necessary information

To receive a pdf with the information required for public sector scheme cases, email us at requirement-table@pensionrelief.com or fill out this short form.