The Government’s June emergency budget has resulted in some turmoil for those dealing with pensions in divorce and dissolution. In this article we look at what has happened, and why.

This article is a shorter version of our PENSION relief brief on the same subject. Professional working in the family law sphere who would like to receive the full article with access to the accompanying fact sheets RPI to CPI offsetting and pension sharing can request the free email newsletter by filling in the form here.

The change in Inflation index benefits

In 2003, the government announced that it would target the Harmonised Index of Consumer Prices (HICP) as the inflation measure. This index was subsequently renamed the Consumer Prices Index (CPI). Pensions and state benefits remained linked to the Retail Prices Index (RPI) and its derivatives.

Whilst the general purpose of these indices is similar - they measure how costs increase over time - there are important differences between CPI and RPI.

The change in pension benefits

In a series of announcements in June and July, the Government announced that they were changing the measure of inflation used by State and statutory pensions from the Retail Prices Index (RPI) to the Consumer Prices Index (CPI). There was no prior consultation and the industry is just working through the implications.

Why altering the index is so important

For a defined benefit pension, its value is the current value of the regular pension that will be paid some time in the future. If, as with the public sector pensions, the pension payments are linked to inflation by way of indexation, altering the index is likely to change the value. Altering the inflation index for a pension scheme instantly changes the pensions for all members - including deferred and pension credit members under pension sharing orders. Because the index dictates how the actual pension will increase in the future, the change immediately affects all pensions in a scheme, whether they were accrued in the past or will result from service in the future. Consequently, the value of that pension is changed.

The cash values of pensions produced by schemes are versions of current cash values, whether they are Cash Equivalent Values (CEVs), Cash Equivalent Transfer Values (CETVs) or Cash Equivalent Benefits (CEBs). Therefore, any change to the indexation of a pension must be reflected in the calculations done to calculate its value.

Pensions affected

Where a pension promise includes an undertaking that it will increase in line with an inflation increase, changing the relevant index will have an effect on the value of that pension. In short, the June 2010 budget has implications for the value of all state and public sector pensions.

It is likely that there will also be a knock on affect for private sector defined benefit pensions. How quickly and completely private schemes move to using CPI is currently unknown, which makes estimating their future value even more problematic.

The change does not affect the value of money purchase pensions, or the income from RPI-linked pensions bought with an insurance company.

So how does this affect pensions on divorce?

The first practical issue is that state sector schemes have stopped issuing CETVs or implementing Pension Sharing Orders, until they receive new calculation factors reflecting the change. These are expected in October 2010. Some private sector schemes have followed suite, while others are still quoting CETVs though may have changed them by the time a PSO is issued.

As an initial step, consideration should be given to deferring pension offsetting and sharing settlements whilst the implications for the specific case are assessed.