Pension Valuations

There is some argument about whether pension accumulated prior to the marriage should be included or excluded (that’s one for the lawyers).

If the outcome will definitely be a pension sharing or attachment order, then there is a good argument for not spending good money calculating whether the CETV is reasonable. However, this assumes that the way that the shares are implemented is not detrimental to either or both parties. Often they are not, and this is an important area where actuaries can and should add value. Lawyers instruct actuaries and often there are joint instructions. Each lawyer asks for the report to address issues that favour the interest of their client. The subject of pre-marriage accumulation is a case in point. So the actuary is instructed to compile an increasingly complex report, which the lawyers can use to pursue the arguments, and up goes the cost of the actuaries report.

Professionally, the actuary’s report should look at the value of the pension before it is shared (or attached) and the value afterwards; to ensure that the proposed action will not cause financial harm. This is further work and adds to the cost, which is perhaps why it is possibly not always done. Many lawyers have the view that an actuary’s report is a commodity, and therefore they are instructed to cost rather than added-value. Lawyers shop around to get the cheapest quote. You wouldn’t choose your builder this way but this is often what happens. I don’t blame the lawyers, pension and actuarial work can be very confusing. Those of us involved in this work have failed to provide lawyers with the information needed to issue actuaries with suitably focused instructions. Some of us are working hard to remedy this.

Most people start looking at pensions with the idea of achieving a 50/50 split, but have given little thought to what this means. Share a house 50/50 and most can work out the likely result. Because pensions are promises of a future income stream, sharing 50/50 using the capital value will rarely result in equality of incomes. If that is what the parties have agreed that is fine, but often the ­object­ive is to achieve equality of income. That is where another set of problems arise.

Often, a pension sharing order will produce two pensions which will become payable at different times. Depending on the rules of the scheme, the first person may start drawing their pension many years before their ex-partner, so the incomes are far from equal in the beginning. This results in attempts to equalise the incomes at some point when both are receiving a pension; more expensive work for the actuary! The actuary’s instruction may be to calculate shares so that the income is equal when the youngest person reaches retirement age. This makes sense to many because it feels fair. But what about the pension income that the first pensioner receives for all those years before the second pensioner can retire? That can be taken into account in calculating the shares, more work for the actuary! But is that fair, isn’t the first pensioner likely to die before the second? If so, then this should be allowed for in the calculations. More work for ….

The idea of just splitting the pension 50/50 begins to sound like very good sense. This takes us back to how the pension share is implemented and this is the real elephant in the room. Pension shares are ­base­d on the Cash Equivalent Transfer Value. The value the scheme will give if the member leaves and takes their pension with them. Putting aside the fact that this is equivalent to a fire-sale value, and is therefore often fundamentally flawed, the CETV has another more significant impact if the pension is to be shared. The valuation assumes that the member has left. This is VERY significant because some schemes have different retirement ages for those who retire from the scheme and those who have left. Prime examples are public sector pension schemes for the uniformed services.

This takes us back to the main issue, how will the pension share be implemented and what is the impact on the value for each person and is there an overall detriment? Ignore these important issues and all you do is store up big problems for the future. Less than 10% of divorces result in a pension sharing order, I wonder why!

The simplest and often cheapest answer for many is offsetting. Quick, cheap and easy. A great idea if you get the value of the pension more or less right, but a big problem if you don’t. It is a fact that CETVs under value pensions. The issue for family lawyers and their clients is how significant is the difference. The answer is that the difference can be very significant. CETVs of a third of the fair value are not uncommon for some public sector schemes; others are often out by a fifth.

Don’t shoot the actuary, s/he is only the messenger. Just make sure that they are instructed to deliver the right message to the right people.