A guide for family lawyers

Most pension schemes ignore the actual health of a member or their spouse in calculating CETVs and in pension sharing calculations. This will over-value the pension asset if either is in ill-health. The effect will be greater if it is the member in ill-health rather than the spouse or partner.

 
If the pension scheme does not ask for information on the health of the member or their spouse, then it is making simplifying assumptions, which ignore the true state of the individual's health.

More appropriate valuations of pensions for use in divorces and dissolutions should provide the option to allow for the health of an individual in calculating the value of the pension asset and inform the decisions made on pension sharing proportions and offsetting.

Ill-health pension values
If a client is in ill-health, the value of their assets is reduced. Usually a CETV does not account for this factor. It is unlikely that a pension scheme will alter its policy on this matter due to an individual case.

If the spouse is in ill-health then the value of their assets will be lowered by allowing for their state of health. Put another way a CETV that does not factor in ill health will produce a higher value for the spouse's pension assets than is realistic. An independent actuarial valuation that does not take the option to allow for the spouse's state of health will normally produce an even higher value.

Offsetting
In the normal course of events the impetus for using appropriate actuarial valuations for final salary (defined benefit) pensions will come from the party with the smaller pension assets, as appropriate valuations are invariable higher than CETVs.

However, where the party with the larger pension assets is in ill-health their pension values will be reduced and it might be for their benefit to provide the impetus for appropriate actuarial valuations allowing for their health.

Pension sharing
If all pensions are valued by all parties allowing for the state of health of the individuals then this has a neutral impact on the decision of whether and how to share pensions.

However if a pension scheme is valuing pensions ignoring ill-health, then it will have an artificially high value that can be captured by transferring the pension to the partner in better health through pension sharing.

The converse is also true and sharing the pension of someone in good or average health, with someone in ill-health, will normally reduce the actual joint assets.

Other approaches
For clients approaching retirement there may be other ways to capitalise artificially high pension valuations, for example through requesting a transfer to a private scheme and then buying an enhanced annuity from an insurer.

So what?
Applying the above is very straightforward as the hard work can be left to an actuary.

First check with your actuary how they will assess whether someone is in ill-health. With the help of a life underwriter, who is an expert in evaluating the risks of individuals, they should be able to provide a proportionate solution using a simple form.

Second, if you use a financial advisor check they can allow for the health of the individuals in any advice they provide.

When obtaining a value for your client's pensions, or checking that of their partner's, remember their health. Ill-health reduces the value of a pension asset. Similarly remember their health when determining the division of assets.

It may be possible to maximise the value of pension assets by ensuring that the party in better health gets the pensions, because they will benefit from the income for longer. Against this is the cost of pension sharing and the loss in value caused by the way some schemes implement pension sharing orders. Again, your actuary will be able to do the numbers on this.

Finally, never be afraid to ask your actuary their advice: theirs is a dying profession!

Nigel Bradshaw MA, FIA is Chairman and Design Director of Bradshaw, Dixon & Moore Ltd.

© Bradshaw Dixon & Moore Ltd - Jan 2008

Issues for the family lawyer

1 in 5 of us are obese. 1 in 4 of us smoke. 1 in 6 of us have an adverse family history. All these factors mean that a lot of us are in less than perfect health. Less than perfect health may mean a shorter working life and earlier death.

This article explores the effect of less than perfect health on both the valuation of pension assets.

 
Extreme ill-health
The extreme ill-health of one party in a divorce or dissolution has many implications, which are generally recognised. In addition to the greater emotional issues, the needs of the ill person might be very high, albeit for possibly a limited time. This may impact on the shape of the final settlement.

Where the person cannot carry on working an ill-health, early-retirement pension may have been, or imminently will be, paid. This may be for an enhanced income compared to the normal pension accrued to date. This pension may be payable for a shorter period, for example in the event of cancer, or for nearer to a normal life expectancy, for example on leaving work due to a mental problem.

Careful actuarial consideration of the value of the pension assets is needed in this situation. Such advice could also cover insurance policies, which are now more likely to be paid out.

Less than perfect health
Less well understood is the implication of one or both parties being in less than perfect health. Obesity, smoking and an adverse family history are potential issues, as are other illnesses and injuries.

A certain amount of wear and tear is to be expected as we get older, as is an inevitable tendency to fill-out a little. Therefore, we should not worry about every ache and pain of our clients, nor feel the need to quiz them on intimate medical details.

The impact of ill-health on pensions
Ill-health lowers life expectancy and hence the time over which a pension will be paid. Therefore, the value of a pension of someone in ill-health is less then an equivalent pension for someone in average or better health.

For example, someone in ill-health as defined above might be expected to experience twice the rate of mortality of the average. The value of a pension of £20,000 per annum to them at retirement to them might only be £375,000, compared to a value of £450,000 for someone in good health.

Nigel Bradshaw MA, FIA is Chairman and Design Director of Bradshaw, Dixon & Moore Ltd.

© Bradshaw Dixon & Moore Ltd - Jan 2008

We would really like to hear your views on this subject. If you have relevant practical experiences that would be of interest to others, we would be happy to publish them here.

Please use the comments facility, or email us at ancillaryactuary@bradshawdixonmoore.com.

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

A fair valuation of a pension is the cost of purchasing or replacing the benefit in the commercial market. A CETV is a number for a different purpose. As in most cases, one party in a divorce or dissolution will lose part or all of a pension benefit, the value used should be a fair value, otherwise the outcomes will not be those that are intended.

It is unlikely that you would accept a valuation of the family home based upon the cost of the materials and labour that were required to build it, so is it fair and reasonable to make decisions on valuable pension assets based on the wrong numbers? The analogy is not perfect but the effects are the same.

How fair is fair?
A CETV may understate the value of a pension by a significant amount. The problem for lawyers is that it is almost impossible to know how unfair a value is without doing some detailed calculations. As an indication, it is not unusual for a public sector CETV to understate the pension value by 30% or more and that means that it cannot be a scheme funding issue. Public sector schemes are not unique in this respect and similar differences occur on private sector schemes.

Clearly, if the CETV itself is small, even a significant discrepancy is immaterial compared to the cost and effort involved in getting a fair value calculated.

Why it matters that CETVs are not 'fair' values
It could be argued that if a pension sharing order is made, the fact that the CETV is not a fair value is immaterial. If you slice an apple in half, neither the size of the whole apple or the two halves matters. The only concern is that it really is cut in half. The same is true of final-salary pension schemes. If the value of the assets allows all the pensions to be shared equally, by a making pension sharing order, the fairness of the CETVs may be ignored. However, difficulties arise where one asset is offset against others. If a fair valuation is made of each asset, then offsetting is a simple matter but if a pension is offset solely on its CETV the result could be very unfair.

The cost of making and implementing pension sharing orders may mean that it is uneconomic to share all pensions equally, in which case an element of offsetting is inevitable. An important point to remember is that the intention to make a pension sharing order does not mean that the fairness of the pension value can be ignored.

 The most important factors are:

• how the exact “split” is arrived at
• the nature benefits created by the pension credit, and
• whether pension sharing will reduce the total value of the asset.

How can a lawyer fulfil their duty of care?
Primarily, the lawyer must properly identify where the problems may arise. If they are not themselves suitably trained or experienced, they need to obtain professional assistance. Valuing pensions is a technical task requiring the application of actuarial techniques. The work can be done by suitably trained and qualified pension technicians and financial advisors but some level of actuarial input or oversight is often desirable.

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

© Bradshaw Dixon & Moore Ltd - Dec 2007

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.

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

Introduction
The calculation basis for Cash Equivalent Transfer Values (CETVs) for final-salary pension schemes is changing. The new basis is due to come into effect in October 2008, but this does not mean that thereafter CETVs will always produce a fair value.

Legislative background
The Divorce etc (Pensions) Regulations 2000 and the Pensions on Divorce etc (Provision of Information) Regulations 2000 set out how benefits under a pension arrangement must be calculated. Regulation 2 of the Pensions on Divorce etc (Provision of Information) Regulations 2000 imposes upon the person responsible for a pension arrangement the requirement to supply pension information, including a valuation. Regulation 3 sets out how the valuation is to be made and calculated, and retains the requirement for the valuation to be consistent with GN11.

It is important to recognise that these regulations concern the manner in which the benefits are valued by the scheme (the CETV). They also provide that a pension sharing order is made by reference to the CETV calculated and quoted by the scheme. The CETV is therefore a consistently calculated number. It is incorrect to regard the CETV as unchallengeable.

Changes to the calculation basis
The new, as yet to be published Regulations are the result of a consultation process that ran between June and August 2006. In January 2007, the DWP published its "Response to the Consultation". The Government intends to regulate on the calculation basis, which is different in a number of technical ways from the current GN11 basis. Broadly, the values will be according to the expected cost of providing the benefits if the member remained in the scheme until retirement. This is some way short of the proposals in EXD54 and, despite two years of debate and consultation, in the values it produces it is broadly the same as the current GN11 basis. We still await the actual legislation.

The revised calculation basis only affects CETVs for defined benefit pensions. These are likely to be the biggest concern for lawyers, largely because they can understate the true value of the benefits by 30% or more. CETVs for defined contribution pensions are unaffected by the change in the calculation basis but that is not to say that the CETVs for these schemes represent a fair valuation of the benefits.

As before, CETVs for public sector pension schemes are to be calculated using factors provided by the Government Actuary’s Department.

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

© Bradshaw Dixon & Moore Ltd - Dec 2007.

If you have any comments on this subject we would be happy to publish them here. Please either use the Comments facility or write to us at ancillaryactuary@bradshawdixonmoore.com.