This is the second in a series of three posts, adapted from an original, longer article by Peter Moore. You can download the original here.

A CETV, whether it is on the existing or revised basis, is actually intended for a different purpose. There are several reasons why this is the wrong number and we will look at some of them.

CETVs are calculated as if the member has left pensionable service. This may well be the case, but if the member is still in pensionable service, the true value of the benefits will be greater than the CETV.

Some schemes award discretionary increases in benefits such as inflationary increases and have an established record of doing so. Schemes are free to ignore these discretionary increases when calculating CETVs; in which case the CETV will be lower than the true value.

The present calculation basis requires that the values represent the expected cost within the scheme of providing such benefits and should be assessed having regard to market rates of return on equities, gilts or other assets as appropriate. Under the revised basis, the transfer value should reflect a 'best estimate' of future returns having regard to the existing asset mix of the scheme. The subtle and somewhat technical difference between the existing and new basis is that the new calculation basis reflects the current, rather than theoretical, investment asset mix of the scheme. In a family law context, the effect of the revised calculation basis is marginal.

Generally, over a long period, equities (stocks and shares) have historically outperformed gilts. If a scheme's assets are largely invested in equities (or they are assumed to be for the purposes of calculating CETVs), long-term investment returns will be good compared with those of gilts. Consequently, pension contributions from the employer can be lower than would otherwise be the case. As the CETV is calculated on the cost to the scheme of providing the benefits, actuarial assumptions on future investment returns can have a significant effect on the calculated CETV.

UK mortality rates have changed significantly over recent years. People are living longer than was expected even two decades ago. If people live longer, they draw their pension longer, which makes providing pensions more expensive. This translates into higher pension contributions from the sponsoring employer in order that the pension scheme can meet its pension promises. Not using the most up to date mortality tables has implications for the required level of employer contributions but it also depresses the quoted CETVs.

For private sector pension schemes, legislation requires that they are funded to specific levels. At any one time, they are not required to have sufficient assets to meet all their current and future liabilities. Instead, they are required to make assumptions about current and future liabilities along with assumptions about future rates of investment returns on their assets. In simple terms, the result is the total level of funding required to be reasonably confident that the current and future pension liabilities can be met.

An under-funded scheme may at its discretion, reduce its quoted CETVs proportionately. For example, a scheme may be 30% under-funded and therefore reduce its CETVs by 30%. Whilst this is equitable in the context of the intended purpose of CETVs, it has a distorting effect when the CETV is required for divorce or dissolution purposes.

Other than a few notable exceptions, most public sector pension schemes are not funded in the way private sector schemes are. Instead, pension payments are met out of tax revenue. CETVs for public sector pension schemes are therefore a theoretical value arrived at using factors supplied by the Government Actuary’s Department. As there are no underlying pension assets, the issues concerning investment returns and scheme funding do not apply. Nevertheless, CETVs for public sector pension schemes do not represent a fair value in the divorce and dissolution context.

Special considerations apply to some public sector pension schemes. In calculating the CETV, it is usually assumed that pensions are taken between the ages of 60 and 65. In practice, the rules of some public sector pension schemes allow for retirement at much younger ages, with little or no reduction in pension. This is encountered when dealing with people in the uniformed services, such as police officers and soldiers.

Peter J Moore – Director, Bradshaw, Dixon & Moore Ltd.

© Bradshaw Dixon & Moore Ltd - Dec 2007.