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New CETV valuation rules came into force on the 1st October 2008. The important change for those involved in the divorce process was a change in the basis of the assumptions upon which the CETV is calculated.
It is important to note is that there is no statutory set of assumptions for valuing the CETV. The assumptions are determined on a scheme by scheme basis, previously by the actuary to the scheme, now by the trustees.
The assumptions now have to be on a “best estimate” basis, whereas previously they had to be on a “reasonable” basis.
What is the difference? Well the reason we make assumptions about future experience is because it is an unknown. We might have a view, guided by professional research, that future assumptions are likely to be somewhere within a range. So for example we might think inflation in the future might average between 1%pa and 6%pa. This is the reasonable range.
Within this range we will have a best guess, say that inflation will average 3.6%pa in future. This is our best estimate.
The new rules say that the scheme must use our best-estimate of 3.6%pa, not any number from 1%pa to 6%pa.
CETV’s are not set for the divorce process, they have a totally different use. They are set to work out how much cash a member can take away from a scheme to put elsewhere. Not surprisingly schemes want to provide pensions for their members and don’t want members taking cash away. This particularly applies to Government schemes which are unfunded which means that the Government has to find the cash from somewhere else. The result is that usually CETVs are set on the low side of what is allowed.
The new rules set that low bar a little higher, but there is still plenty of room for variability. This is because there is no one best-estimate of the future, everyone has their own best-estimate. Further it is unlikely anyone is so certain of their own best-estimate that they could not be persuaded to accept another, possibly lower, best-estimate.
So what is happening is that the CETV basis will now be set from a range of best-estimate assumptions, rather than a range of reasonable assumptions. In our example the reasonable range for future inflation is an average of 1%pa to 6%pa, my personal best-estimate is 3.6%pa, but the range of best-estimate assumptions held by different people might be 2%pa to 4%pa. Still a lot of scope for manoeuvre and for lower CETV values.
So what will be the effect of the changes?
1. As trustees have taken over responsibility for the basis the basis will be reviewed. Certain assumptions, notably longevity, have been allowed to become out of date over time and will be updated. These changes will cause CETVs to increase from 1st October.
2. CETVs will still not be the appropriate value for use in a divorce and will still undervalue final salary pensions. There is still flexibility to argue down the value on best-estimate assumptions, and the 5 other reasons why CETVs are not appropriate for use in the divorce still exist.
3. If you are pension sharing from a final salary scheme and taking the credit to an external pension then the amount you will transfer will be greater, as the CETV will be greater. However this route still locks in the loss in value from the CETV being lower than the appropriate value of the pension, and still introduces greater risk to the credit member.
4. If you are pension sharing with the credit being retained in the final salary scheme the overall effect of the change may be minimal. This is because the factors to update the calculation of the pension credit will be updated at the same time as the new CETV basis is introduced, and the two should balance out. However a number of the CETV and transfer bases have not been updated for some years and just the process of bringing them up to date will introduce changes. We are still waiting to see for the different schemes the updated factors to ascertain whether the updating changes are significant or not.
5. Pension sharing 50% of the CETV will still not produce a 50/50 share in the pension due to the different ways that schemes implement debit and credits. Normally the credit member loses out. An actuarial report is still required for equality. For a further explanation see this Ancillary Actuary article.
Nigel Bradshaw is chairman and actuary at Bradshaw Dixon Moore