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Trigger-happy CETV

The use of pension sharing on divorce, introduced by the Welfare Reform and Pensions Act 1999 as a further method of assisting to reach a matrimonial financial settlement, appears to have taken off with more of a squeak than a bang. This is despite the Government estimating that there would be 50,000 such settlements a year.

Nevertheless, I am often asked questions in relation to pension and divorce matters.

In many cases, a fundamental issue that is completely missed or ignored is the cash-equivalent transfer value. In this article, I will explore the reasons behind this.

For many good reasons, by far the most commonly used method of valuing pension rights for the purposes of financial settlements in divorce proceedings is the CETV provided by the pension scheme itself. However, clients should be aware that the CETV may be seriously flawed in a number of circumstances.

Legislation and regulations over the last five years have confirmed to divorce practitioners that the valuation of pension rights can most easily and cheaply (free, in fact, unless the pension is already in payment) be achieved by asking the pension scheme to provide a lump-sum CETV. Indeed, obtaining a CETV is now an essential aspect of all divorce negotiations and settlements.

Unfortunately, many or most lawyers, barristers and judges remain unaware of the circumstances in which the CETV can give a seriously misleading assessment of the value of an individual&#39s accumulated pension rights

Fundamentally, apart from state pensions, all pension schemes can generally be classified as being either money purchase or final salary. Moneypurchase schemes are those within which each member builds up an individual, identifiable and quantifiable fund which will (hopefully) grow in value over the years with investment profits and by the addition of further contributions. A personal pension is a typical example. The valuation (provided by these pension schemes to divorce lawyers is almost invariably as precise and indisputable as a valuation of a bank or building society account balance. In other words, rarely should you consider using an actuary. Note, though, that advice from a pension consultant may still be appropriate.

Final-salary schemes are an entirely different matter. These schemes are almost only found among big employers, including most of the public-sector schemes (armed forces, teachers, police and so on) and many of the bigger private-sector employers. Here, the value to the employee comes primarily not from the pension scheme itself but from a promise by the employer to pay the employee a pension and, usually, a tax-free lump sum, when he or she retires, the level of that pension depending on the employee&#39s length of service and earnings at or just before retirement. The pension scheme itself only exists to support the employer&#39s promise.

The pension fund built up within the scheme (if, indeed, a fund exists at all, which it doesn&#39t in the case of many public-sector schemes) can be viewed as some sort of collateral security for the employer&#39s promise – a single, huge pot of money, kept totally separate from the employer&#39s business (usually!) which should be enough to meet the cost of all the pension promises made by the employer.

There is no individual pot of money for each employee. The CETV provided by the scheme is an actuarial assessment of the value of the employer&#39s promises to that employee. This value does not, therefore, depend on investment returns, it depends on the ongoing value of the employer&#39s promises.

But not all the promises are included in the CETV and, even where they are, the calculation methodology of the CETV often unfairly represents the true value of the individual&#39s accumulated benefits (usually on the low side), sometimes significantly so.

In what circumstances might the CETV be dangerously misleading? Probably more than you might think. Below we can look at some of the more common examples.

Armed forces and uniformed services

The CETV woefully undervalues the value of benefits for these people, primarily because it is calculated on the false assumption that the benefits will be payable from a scheme normal retirement age (60, for example) when these employees are able to retire on full pension from a much earlier age.

Benefits payable from, say, 45 or 48 years of age are clearly much more valuable than if they were to start 10 or 15 years later. We are not talking small differences here – an independent actuarial assessment (with no axe to grind one way or the other) could easily be more than double the CETV provided by the scheme.

Lump-sum death benefit

Usually known as a lump-sum death-in-service benefit and up to a level of four times the member&#39s annual salary, the value of this promise is rarely included and is more likely to be completely ignored in a CETV. Yet, depending on age, it can represent a significant part of the member&#39s employment rights.

Even if the CETV is relied on in divorce settlements, the spouse&#39s adviser should consider requesting some form of replacement benefit for the spouse&#39s loss of this potential payment (set-off or replacement insurance policy?).

Scheme member in poor health

A difficult one, this. The CETV is calculated on the assumption of the employee enjoying normal life expectancy. If the employee were to die before retirement, they would receive no benefits. Moreover, if divorced, there may be no benefits payable to anyone else, either (except, often, the death-in-service benefit).

Here, the CETV has clearly overstated the value of the employer&#39s pension promise and the situation is little different where the employee dies shortly after retirement. If, though, the employee is given the opportunity to transfer the value of their benefits to a personal pension, they could secure the value of that fund for a nominated beneficiary.

If the member&#39s spouse is in a poor state of health, then it could be argued that, even if the couple had remained married, the spouse would have received no benefits from the member&#39s scheme as it is certain or highly likely that they would have died before or shortly after such benefits were due to come into payment. This being the case, the argument might continue, why compensate the spouse for the loss of entitlement, following divorce, to a benefit they would never have received anyway?

The answers to these questions will differ from scheme to scheme and from individual to individual but, certainly, specialist pension assistance might profitably be sought by the client or legal advisers.

Expected early retirement or voluntary redundancy

Here, the CETV will be actuarially reduced not only because of fewer years&#39 service by the employee but further by an actuarial factor which assumes that the pension itself, when it comes into payment, will be paid at a much lower level.

However, many early retirements or voluntary redundancies are encouraged by employers attempting to shed staff and this encouragement often takes the form of pension benefits which do not suffer a reduction. Thus, the CETV may understate the true value of the pension benefits.

To summarise, it should be accepted that the CETV will prove at least mostly adequate for the majority of divorces, where money-purchase schemes are involved, but I would strongly urge practitioners to note the circumstances in which a CETV is likely to be dangerously misleading.

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