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In Pensions on Divorce, Public Sector Pensions

Public sector pensions remedy (McCloud) changes to benefits from 1 October 2023 – implications for Pensions on Divorce settlement

The purpose of this blog is to point out one aspect of the changes taking place for most Public Sector Schemes from 1 October 2023 and as a result of that, what action may be needed.

In general the calculations and results within reports may be invalidated over time due to various factors such as large changes to CEVs. These large changes to the CEVs could be due to things like large salary increases, extra accrual of benefit, the taking of benefits on retirement as well as other reasons. But in addition to these reasons why a CEV may change, a further potential cause has now been added as a result of the regulations coming into force on 1 October 2023 in respect of the Public Sector Pensions Remedy (consequent to the McCloud ruling).

Generalised summary of what to look out for

Action may be required where all of the following conditions apply:

  • A Pensions on Divorce report has been completed, but a Pension Sharing Order (PSO) has not been implemented.
  • A Public Sector pension is involved; so a pension from employment with one or more of the NHS, civil service, teachers, police, armed forces and fire and rescue service. The judiciary has been excluded from this list, because this issue does not arise. Local Government workers have not been included because their scheme has different conditions.
  • The scheme member was an active member of the scheme immediately prior to 1 April 2012 and has some service in the same employment between 1 April 2015 and 31 March 2022
  • The intention is to implement a PSO on that public sector pension.
  • When the report was produced, there must have been two sections to that public sector pension (being the 2015 Scheme section and a pre-2015 Scheme section). The sections are actually referred to as separate schemes. The PSO may only be being applied to one section of that scheme, but the overall pension from both sections together must have accrual of benefit in between 1 April 2015 and 31 March 2022 (inclusive).
  • The report was based on Cash Equivalent Values (CEVs) which were produced before 1 October 2023.
  • A further CEV has been requested after 1 October 2023 but before the PSO has been implemented.

Action required

The parties will need to consider re-visiting the report to assess whether the results are still reliable/valid.

Reasoning

 Any agreed pension share may not work as intended, and could lead to a materially different outcome, because the CEV of the underlying pension in each section may have significantly changed. This change is due to a movement of the benefit accrual for the 2015/2022 period from the 2015 Scheme section to the Pre-2015 Scheme section from 1 October 2023.

I illustrate here a very simplified hypothetical example to indicate what may be happening.

A Pensions on Divorce report has been provided with calculations effective as at 31 July 2023 with a PSO indicated of 50% of the Pre- 2015 pension based on the following CEV values

  • Pre-2015 Scheme section – CEV = £50,000
  • 2015 Scheme section – CEV = £100,000 (£70,000 of this is in respect of the 2015/2022 accrual period)

So the intended share is 50% of £50,000 equalling £25,000 pension credit CEV

The pension scheme member is wondering whether the CEVs may be out of date and so obtains revised CEVs with an effective date of 1 November 2023, which are provided as follows

  • Pre-2015 Scheme section – CEV = £130,000 (£80,000 of this is in respect of the 2015/2022 accrual period)
  • 2015 Scheme section – CEV = £30,000

If a 50% PSO is implemented on the Pre-2015 pension as at say 15 November 2023 then the pension credit CEV would now be based on the new CEVs, and so would become  £65,000 (50% of £130,000), and effectively £40,000 higher than intended.

The cause of the unintended consequence in this example is that, based on the draft legislation published to date regarding Public Sector Pensions Remedy (McCloud), the methodology for calculating Pension Credit and Pension Debit amounts on the application of a Pension Sharing Order (PSO) differs depending upon whether the latest CEV (provided for divorce purposes prior to that Pension Sharing Order being sent to the Pension Scheme) is dated before or after 1 October 2023.

For divorce purposes only, if the latest CEV requested is dated before 1 October 2023, then the PSO would be based on assuming the 2015/2022 accrual had NOT moved to the Pre-2015 Scheme section, and so the pension credit CEV in the above example at 15 November 2023 would still be £25,000.

But if a CEV is requested after 1 October 2023 (or was requested before but is dated after 1 October 2023) then the PSO would be based on the actual re-allocated position of the 2015/2022 accrual into the Pre-2015 Scheme section, and the pension credit CEV would be £65,000 in the example above.

Hence, as a result of the pension scheme member requesting and being provided with a CEV dated after 1 October 2023, the PSO is implemented on a higher CEV of his Pre-2015 Scheme benefits and results in providing his ex-spouse with a greater amount of pension credit than was intended (£65,000 compared to £25,000).

A preventative action to avoid this particular issue could be to ensure that no CEV is requested for these pensions after 30 September 2023 where agreement and financial settlement terms have been negotiated on CEVs issued prior to this date. An undertaking by the pension scheme member to this effect may be considered necessary.

For more details on this public sector pensions remedy (McCloud) and some of the implications of this on pensions on divorce settlements, the position statement on Actuaries for Lawyers website provides further information on this topic (link below)

AFL McCloud Position Statement – August 2023

David Bor

Actuaries for Lawyers

About the writer

Disclaimer – The views expressed here are the views of the writer only and do not necessarily represent the view of Actuaries for Lawyers. Whilst every effort has been made to ensure the accuracy of the information in this post, it is important to always check the benefit rules with the schemes before making any financial decisions based upon these. Actuaries for Lawyers cannot be held responsible for any losses incurred as a result of relying upon information contained in the blog section of our website as these do not constitute advice or act as a substitute for providing individual advice in relation to the specifics of a particular case.

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In Public Sector Pensions

Change to the discount rate used by public sector pensions – implications for settlement

On 30 March 2023, the Government announced that the SCAPE discount rate, that is the discount rate used by the Government Actuary’s Department (GAD) for calculations in relation to the public sector pension schemes is reducing from 2.4% per annum above CPI Consumer Prices Index) inflation to CPI + 1.7% per annum. This includes schemes for the NHS, civil service, local government, teachers, police, judiciary, the armed forces and fire and rescue workers. The discount rate is used to place a current value on a future cash payment. For example, this discount rate is used to place a present value of future benefit payments when calculating Cash Equivalent Values (CEVs).

In this blog I have summarised the implication of this change that I believe are most relevant for divorce settlement.

Delays in issuing CEVs and implementing Pension Sharing Orders

The immediate impact of the recent announcement is that delays are expected while the change is implemented. CEVs in the public sector pension schemes are typically calculated using a factor-based approach. These factors are issued by GAD using the SCAPE discount rate along with other key financial and demographic assumptions, and are based upon the age and gender of the member at the date of the calculation. Therefore, an update to the factors will be required following the change to the discount rate. The schemes are expected to suspend issuing new CEV quotations and processing Pension Sharing Orders until revised factors have been issued by GAD. For example, the NHS Pension Scheme and Teachers’ Pension Scheme have both announced that they are suspending the calculation of CEVs and implementation of Pension Sharing Orders.

As a result, I would expect delays in obtaining CEVs for cases currently at the financial disclosures stage and delays in implementing any pension share that has currently been or soon to be agreed. At this stage I am unable to say when the new factors will be available so that schemes can resume calculations. Previously some schemes had their factors available within several weeks, which if repeated may not significantly alter timescales for the production of our reports or to implement a pension share. However, it is possible that longer delays may be experienced.

Nevertheless, it is still worthwhile commencing the data collection process, because some of the scheme providers (not affected by this issue) are very slow to respond to queries, and so contacting them now may avoid having to wait even longer. Also, it may still be worthwhile doing calculations on the old basis, because this may be sufficient to enable the parties to agree a share in principle, particularly noting that CEVs and benefits may in any event alter by the time of actual implementation. Finally on this point of not delaying starting the pension  calculations process the CEV of this pension may not be required for settlement purposes, for example if it is not being shared.

CEVs and Pension Sharing

As noted above the factors used to calculate CEVs are expected to be reviewed to reflect the new discount rate. Given that CEVs are effectively placing a discounted present value on the future pension income stream from a member’s retirement until their eventual date of death, a lower discount used when placing a present value on future cashflows arising from a pension means that the CEV is expected to be higher.

However, I would expect the increase to CEVs to be offset by a similar increase to pension credit factors as these are typically calculated on a consistent basis. These factors are used to calculate the amount of credit pension awarded to an ex-spouse for a given level of CEV transferred to them as part of a pension share.

In many cases the change to CEVs could be cancelled out by the change to credit factors such that the overall impact of a given percentage share is similar when the new factors are adopted. However, there may still be some change to equalisation of pension income calculations, especially where there is a significant age gap between the parties.

In addition, the Local Government Pension Scheme generally offers ex-spouses a choice between an internal or an external share. Under an internal share they would be awarded a credit pension in the scheme as outlined above. However, following an external share the ex-spouse would be able to transfer their share of the CEV to an external provider of their choice. Therefore, under an external share the expected increase to CEVs will result in an increase to the external credit fund available to the ex-spouse which could also impact the relative attractiveness of an internal or external share.

Other considerations

In addition to CEVs and pension credits, there may be changes to other factors used by the schemes. For example, the factors used to calculate adjustments on early or late retirement may change. In general, I would expect a lower discount rate to result in smaller reductions applying where pensions are drawn early but any uplift applied on late retirement may also be smaller. Any changes to these factors would impact calculations to equalise incomes where pensions are assumed to be drawn earlier or later than the normal retirement age for each pension.

For cases involving public sector pensions that are not expected to be shared I generally do not expect any changes to CEV factors to impact calculations. This is because there is no change to the underlying benefits but the value that the relevant scheme would place on that benefit entitlement. This might apply for example where the party holding a public sector pension has the lower pensions overall.

Similarly, I would not expect the offset value of public sector pensions to change as a result of the change to factors as this would typically be calculated based on an independent valuation of the underlying benefits.

If you would like to learn more about public sector pensions and keep up to date on your pensions CPD you may wish to attend one of our upcoming seminars. You can find additional information here:

https://actuariesforlawyers.com/future-webinars/

Linda Perkio

Actuaries for Lawyers

About the writer

Disclaimer – The views expressed here are the views of the writer only and do not necessarily represent the view of Actuaries for Lawyers. Whilst every effort has been made to ensure the accuracy of the information in this post, it is important to always check the benefit rules with the schemes before making any financial decisions based upon these. Actuaries for Lawyers cannot be held responsible for any losses incurred as a result of relying upon information contained in the blog section of our website as these do not constitute advice or act as a substitute for providing individual advice in relation to the specifics of a particular case.

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In Public Sector Pensions

Public Sector Pensions Remedy – How concerned should you be?

In April 2015, most public sector pension schemes were reformed largely due to the cost to the government of continuing to operate the existing “legacy” public sector schemes. The new 2015 Schemes, referred to as the “reformed schemes”, were based upon a career average revalued earnings design, effectively average salary allowing for cost-of-living increases, (replacing the previous final salary structure) and had higher normal retirement ages to save on costs. As part of the reforms, those with 10 years to retirement at a cut-off date of 1 April 2012 were permitted to remain in the legacy scheme after the new schemes were introduced in April 2015.

In December 2018, the Court of Appeal found that some of the reforms unfairly discriminated against members of the judicial and firefighters’ pension schemes and required that this unlawful discrimination be remedied by the Government, commonly referred to as the McCloud/Sargeant judgement. The Government subsequently decided to offer remedy to all the public sector schemes and not just limit this to the judicial and firefighters’ pension schemes.

The regulations to implement retrospective remedy in respect of the McCloud/Sargeant judgement for the main public sector pension schemes are due to take effect from 1 October 2023. As we are getting closer to this date, some of the schemes have launched consultations or published draft regulations and this issue is generally getting more attention.

Actuaries for Lawyers has recently carried out an exercise to model the potential impact of remedy on CEVs under a range of schemes and circumstances and consider the implication for divorce settlement. Based on this analysis, we expect that these changes could have a very material impact in some cases, while in many other cases there may be no change to the value of benefits at all.

In general, for members who have not yet retired, I understand that any Cash Equivalent Value (CEV) calculations will be based on the higher of legacy benefits or reformed benefits for the remedy period (2015 to 2022), which will in turn impact the benefits awarded to an ex-spouse if the impacted pension is shared on divorce.

When the impacted member retires from the scheme, they will then have legacy benefits for service prior to April 2015, reformed benefits for service from April 2022 and a choice between the two benefit structures for their service from April 2015 to March 2022.

In this blog I comment on some circumstances where extra consideration might be needed where public sector pensions form part of a financial settlement on divorce.

Scope

Not all members of public sector pension schemes will be entitled to an assessment of remedy. The consultation document issued by the Government on 16 July 2020 entitled “Public Service Pension schemes consultation: changes to the transitional arrangements to the 2015 schemes” set out the eligibility criteria for a public sector pension scheme member to qualify for a remedy assessment. This was stated to be as follows: All individuals who were members or were eligible to be members of a legacy scheme immediately prior to 1 April 2012, and have a period of service after 31 March 2015 during which they were members of a legacy or reformed scheme, will be given such a choice where those periods of service are continuous (including those with a qualifying break in service of less than 5 years). This is irrespective of whether they have submitted a legal claim or not, or whether they are currently an active, deferred or pensioner member.

Uniformed services schemes

Members of the uniformed services legacy schemes, including Police, Firefighters’ and Armed Forces, generally accrue benefits at a faster rate compared to other schemes and benefit from favourable early retirement terms, once they have reached the minimum age and completed the minimum length of service, to retire from active service on an unreduced pension. The benefit structure of these schemes means that once retrospective remedy is implemented, some members of these schemes are expected to see large increases to the value of their benefits. For example, a 50-year-old firefighter who has served at least 25 years in the Firefighters Pension Scheme 1992 could see the CEV of their benefits built up in the remedy period (between 2015 and 2022) more than double. This is primarily because at this age, the legacy benefits can be accessed immediately without reduction while the reformed benefits are not payable until the member’s State Pension Age, which for an individual currently aged 50 would be age 67. This means that legacy benefits could be drawn unreduced 17 years earlier than the reformed benefits. Therefore, benefits calculated in line with the legacy structure are significantly more valuable than the reformed benefits.

The immediate impact on CEV calculations is not expected to be as large for younger members who have not yet reached the age or completed the length of service required to draw their benefits immediately without reduction. However, it is worth noting that these members may still see a large benefit increase at the time of their future retirement.

By contrast, the non-uniformed public sector schemes generally do not have the same generous early retirement terms and as a result the difference in value between legacy and reformed benefits is generally smaller. For example, a 50-year-old member of the Civil Service Pension Scheme might not see any increase to their CEV at all as a result of remedy. This is because while the normal retirement age for legacy benefits is generally earlier, making retirement at an earlier age more attractive, the accrual rate (that is the rate at which the pension builds up for every additional year of service) for the reformed scheme is more generous. This means that even though the benefits on retiring early in the reformed scheme may be reduced to an early retirement factor, the higher accrual rate for pension benefits in the reformed scheme may more than compensate for this. Hence in this case, the benefits originally built up in the reformed scheme for the 2015 to 2022 remedy period may have a higher CEV than the alternative benefits that would have been granted to the member had they been a member of the legacy pension scheme for this period of time.

Large salary increases

In general, I would expect the value of public sector remedy to be higher for members with large salary increases compared to those with more modest salary growth.

The reformed schemes introduced in 2015 were based upon a career average design instead of the final salary structure in place under the majority of legacy schemes. This means that instead of the pension being based on a proportion of a member’s final salary at the time of retirement or leaving the scheme, the pension payable under the reformed schemes is based on the average pensionable salary that the member has earned during their membership. For each year the member earns a pension equal to a proportion of their pensionable salary for that year. Instead of being linked to their future salary increases this pension is then revalued before retirement in line with some measure of inflation.

This means that for a member who has experienced large salary increases, their benefits built up in the reformed scheme may not have increased to the same extent. Therefore, public sector pensions remedy may result in a significant increase to their pension accrued in the remedy period, as when benefits are recalculated in line with the legacy structure, they will be based on the increased salary.

Implementation timing

It is difficult to precisely predict when a pension share will be implemented as the pension scheme has up to four months to implement a pension sharing order from the date that the pension share takes effect or the date that the scheme has received all the required information to implement the order if later.  The pension share takes effect on the later of 28 days after the order has been sealed by the Court or the date of the Final Order (Decree Absolute). The date of implementation is the date at which the CEV is calculated, and the pension credit benefits are determined based upon that CEV. This means that as we get closer to 1 October 2023, there is a risk that pension shares that are agreed based on calculations carried out before remedy takes effect could be implemented after this date.

Based on the information published to date, it appears that pension sharing orders implemented before or after 1 October 2023 will be subject to different regulations and procedures. However, it is not entirely clear to us how schemes will implement pension sharing orders that take place after 1 October 2023.

Where there is a possibility that a pension sharing order may not be implemented until after 1 October 2023, it may be prudent to check with the scheme administrators precisely how they are intending to implement the order, prior to serving the final order upon the relevant scheme.

If you would like to learn more about Public Sector Pensions Remedy and the implications for divorce you may wish to attend one of our upcoming seminars, where there will be a session dedicated to this issue. You can find additional information here:

https://actuariesforlawyers.com/future-webinars/

Linda Perkio

Actuaries for Lawyers

About the writer

Disclaimer – The views expressed here are the views of the writer only and do not necessarily represent the view of Actuaries for Lawyers. Whilst every effort has been made to ensure the accuracy of the information in this post, it is important to always check the benefit rules with the schemes before making any financial decisions based upon these. Actuaries for Lawyers cannot be held responsible for any losses incurred as a result of relying upon information contained in the blog section of our website as these do not constitute advice or act as a substitute for providing individual advice in relation to the specifics of a particular case.

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In Pensions on Divorce, Private Sector Pensions, Public Sector Pensions

Market Movements – What these may mean and what you should watch out for

An important area of concern when dividing up pension rights fairly for divorce settlement purposes has been the large recent changes in inflation, with the Consumer Prices Index (CPI) nearing its highest levels for almost 30 years (according to recent ONS figures). At the same time interest rates have increased significantly over a short period of time with the Bank of England official Bank Rate increasing from a low of 0.1% in December 2021 to 1.25% in June 2022. This can affect pensions settlement in many different ways given the impact on future revaluation rates, pension valuations, and annuity rates. As a consequence of this, there are a number of issues that are worthy of consideration by pensions on divorce practitioners.

Settlements involving Public Sector Pensions

Depending upon how you look at it, some may argue that public sector pension CEVs are less affected by inflation than other pensions encountered in a divorce settlement. The main reason for this is that the Cash Equivalent Values (CEVs) of public sector pensions used in pension sharing are calculated by a factor-based method using valuation factors published by the Government Actuary’s Department (GAD) which are only reviewed infrequently. The majority of the factors currently in use were issued in 2018/19 and use a “real” valuation interest rate, that is “after” inflation, to place a value on future inflation linked pension income streams. The current valuation rate of interest is CPI + 2.4%, that is a “real” rate of 2.4% per annum and this has remained unchanged since 2018. This means that if you are calculating the CEV of an inflation linked public sector pension income of £10,000 per annum, the calculation would remain unchanged at present, irrespective of what future inflation might be.

It should however be remembered that public sector pensions receive inflationary revaluation in April each year, so if CPI inflation indexation is 10% in April 2023, the pension income would increase from £10,000 to £11,000 at that point in time and this would cause the CEV to increase by 10% at that instant. When it comes to pension sharing however, the majority of public sector pensions only offer an internal share to an ex-spouse (requiring the ex-spouse to become a member of the scheme in their own right). The internal share terms are calculated by similar GAD valuation factors used to calculate CEVs  and noting that an internal share calculation is like a CEV calculation but in reverse (an ex-spouse pension income is generated from a CEV credit rather than a CEV being calculated from a member’s pension income) then it is no surprise that the required pension share percentage to equalise pension incomes is unchanged, however both parties will have more valuable benefits post share than had inflation not spiked upwards, as the high rate of CPI inflation means that the actual amount of both their pension income benefits will now be higher from 2023 onwards when the next pension increase is added.

The above points are in generality, and so may not be applicable in all situations for example if the Public Sector pension is not being shared then the current holder of this pension is expected to have a significant increase next April that is not reflected in the current benefit or the current CEV. Another example could be where a pension credit is received just before next April (so in March 2023), then the pension credit member would not benefit from the April 2023 increase.

The cushioning of public sector pensions against being adversely impacted by inflation changes is not repeated in quite the same way for other types of pension arrangements as is considered below.

Defined contribution pensions

Although defined contribution pensions (those for which a fund of money is built up, which can be drawn upon in retirement or used to purchase an annuity in retirement) are the most obviously affected by changing market conditions, this can also make them the simplest to deal with. As the value of such a pension is generally based upon the value of the underlying assets in which the pension is invested, this means that the value of a defined contribution pension may significantly change when market conditions change. The simple point to remember with these, therefore, is to ensure that the CEV to be used is up-to-date (although in the interest of practicality, this can usually be considered to be within a few months of the date of any pension share being implemented noting that any material changes due to additional contributions being made or large drawdown payments being taken should always be considered when agreeing final settlement terms).

Another potential issue with market movements and defined contribution pensions lies in annuity rates, which the Pensions Advisory Group recommends should usually be considered when assessing the likely lifetime income available from a defined contribution pension arrangement. High interest rates makes UK Government Bonds cheaper to purchase and the falling prices of these have seen yields correspondingly shooting up in recent months. As insurance companies selling annuity business can now buy UK Government Bonds much more cheaply to back up their commitments to pay long term lifetime incomes, they are able to offer much more attractive terms to those seeking to buy such annuities. This is good news for those with defined contribution pensions (assuming that valuations of these pension funds have not fallen) as it means that lifetime incomes can now be secured much more cheaply than was the case a few months ago. In recent cases worked on by Actuaries for Lawyers, some annuity rates for annuities with a fixed escalation rate have improved by as much as 10-20% over the last few months, and so the expected annual income available from a pension fund when purchasing an annuity has similarly increased.

Private sector defined benefit pensions

The pension benefits paid out by defined benefit pension arrangements (such as the Railways Pension Scheme, Barclays Pension Scheme, BAE Systems Pension Scheme etc) are also affected by changes in pension revaluation rates before retirement and pension increases in payment as the scheme rules usually require that these benefits are linked to future rates of inflation in some way. In particular, the future pension income available when the pension comes into payment might increase significantly when the pension is revalued between leaving service and retirement.

One key area of difference however between private sector defined benefit pensions and public sector pensions however, is the very different method used for calculating CEVs. When private sector defined benefit pension CEVs are calculated, the scheme actuary is obliged to have some regard to future market conditions when making recommendations to the trustees of the scheme as to actuarial assumptions to use when placing a present value on the future pension income available to a scheme member. The assumptions used will be dependent on the investment strategy adopted by that particular scheme which in turn depends on a number of factors, such as the funding position and maturity of the scheme. The general principle used when calculating a CEV is to estimate the amount of money needed at the calculation date to pay the future pension benefits due to be paid to the member when they fall due. These assumptions are required to match the changes in market conditions. For example, on a recent case Actuaries for Lawyers saw a pension scheme provide a CEV in mid-2020 of around £800,000 which dropped to a more recent CEV of around £700,000 mainly due to a change in the Scheme Actuary’s assumptions of future market conditions (in this case, the most significant such condition is likely to be the assumption of future investment return).

This change in CEV means that the pension credit available to an ex-spouse following the implementation of a pension share may change materially if market conditions experience significant change. This may mean that on cases where a significant portion of the parties’ pension rights (which may be subject to a pension share) are held in a private sector defined benefit pension scheme, it might be prudent to obtain an up to date CEV if there has been a material change in the yields on medium dated UK Government bonds since the previous CEV was calculated, even if the latest CEV is less than 12 months old and there may even be a fee charged to obtain an up to date value. This is the position we are in at present as in the last few months, there have been considerable movements in the financial markets due to factors such as the significantly increasing price of energy, the war in Ukraine and consequential significant increases in CPI and RPI measures of price inflation over the past 12 months.

These issues as well as other factors have caused the yield of 20 year Government bonds to increase to a high of around 2.5% per annum at the beginning of June 2022.  Whilst this may all appear quite technical, what is important here is the implication of the above on the calculation of CEVs.  As CEVs are effectively placing a discounted present value on the pension income stream from the member’s normal retirement age until their eventual date of death, the higher the yield on Government bonds, the higher the discount used when placing a present value on future cashflows arising from their pension and consequently the lower the CEV would be expected to be.

When it comes to pension sharing calculations, there will undoubtedly be overlap between some of the observations highlighted above. Hence the reduction in a private sector CEV being subject to an external pension share may result in a higher pension share percentage being required to equalise pension incomes, however this may be countered to an extent by the better annuity rates now available to the ex-spouse reducing the required pension share.

Which of the above factors may dominate may be difficult to predict and will vary based upon the circumstances of the case which is being considered.  The issues highlighted here underline the importance of obtaining expert advice from a pensions on divorce expert so that the possibility of unexpected consequences occurring following a pension share can minimised.

Joseph Lennard

Actuaries for Lawyers

About the writer

Disclaimer – The views expressed here are the views of the writer only and do not necessarily represent the view of Actuaries for Lawyers. Whilst every effort has been made to ensure the accuracy of the information in this post, it is important to always check the benefit rules with the schemes before making any financial decisions based upon these. Actuaries for Lawyers cannot be held responsible for any losses incurred as a result of relying upon information contained in the blog section of our website as these do not constitute advice or act as a substitute for providing individual advice in relation to the specifics of a particular case.

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In Private Sector Pensions

Pension Scheme Buy-ins, Buy-Outs, and some considerations for pensions on divorce

Buy-out is the ultimate goal for many private sector defined benefit pension schemes. But what is the difference between a buy-in and a buy-out and what do these scheme events mean for individual members going through divorce?

What is a buy-in?

A pension scheme buy-in is an insurance contract where the scheme pays a premium to an insurance company who then takes responsibility for funding the benefits of some or all pension scheme members.

The insurer will make a regular payment to the scheme in respect of the insured benefits and the scheme continues to be responsible for paying members. For individual members there is not much change following a buy-in. There is usually no change to administration and members still get their benefits paid from the scheme.  Many household name pension schemes have completed buy-ins in recent years including The Marks & Spencer Pension Scheme and The Merchant Navy Officers Pension Scheme.

Considerations for pensions on divorce

When collecting information on pensions for divorce, it might not be immediately obvious if a pension scheme is covered by a buy-in policy. However, this could still have implications for a divorce settlement. Any buy-in policies, also known as bulk annuity contracts, will be disclosed in scheme documents such as Trustee Report and Accounts however these documents do not have to be disclosed as standard under the Pensions on Divorce etc (Provision of Information) Regulations 2000.

One key area that can be impacted by a buy-in policy is the factors used by the scheme. This can include factors used when calculating cash equivalent values (CEVs), the terms for cash commutation and early or late retirement. Following a buy-in, these factors will often be set by the insurer. In theory the pension scheme trustees are still responsible for setting the factors used when calculating member benefits. However, the insurer will set the factors used when calculating the payments made to the scheme in order to fund these benefits so in order to achieve a perfect match the trustees will often adopt the insurer factors.

Insurer factors are generally linked to market conditions and reviewed more frequently than most scheme factors. There could also be a significant change to factors immediately following a buy-in transaction when insurer factors are first adopted. This is especially relevant if a pension is being shared on divorce and the basis for calculating CEVs changes before any pension sharing order is implemented. When Actuaries for Lawyers carries out data collection for private sector defined benefit schemes, one question we now ask the administrators is if the scheme has recently completed a buy-in and if so when the buy-in took place as this could have an impact on CEVs if the buy-in transaction has taken place since the most recent CEV was calculated.

It should be noted that apart from potential changes to factors, a buy-in policy does not impact the benefits that a member holds in the scheme. There is also no change to the ability to implement a pension sharing or attachment order.

What is a buy-out?

A pension scheme buy-out often follows a buy-in where a premium has been paid to the insurer who is then responsible for funding the relevant member benefits. The next step that turns this into a buy-out is that the insurer takes over responsibility for paying the members.

The insurer and scheme will go through a process to agree the final data and benefits and the insurer will then issue individual policies to the members. This means that the link to the original scheme is broken, the scheme can wind up and the insurer takes charge of administration.

For an individual member this means that their scheme benefits are replaced with an insurance policy promising to pay identical (or almost identical) benefits. Buy-outs are becoming increasingly common, whether this is for the entire benefits in the scheme or in some cases just for a group of members such as pensioners or members of a particular benefit or employer section. Household name pension schemes that have completed full or partial buy-outs of benefits in recent years include The Rolls-Royce UK Pension Fund, The Asda Group Pension Scheme and The Old British Steel Pension Scheme.

Considerations for pensions on divorce

Following a buy-out any information collected for divorce purposes will need to be requested from the insurer as the scheme is no longer responsible for administration.

Many of the considerations outlined above for a buy-in also applies following a buy-out. This includes factors which will be set by the insurer unless they were specified in the policy. Benefit security is also high and there is no longer any risk of benefits being reduced following a transfer to the Pensions Protection Fund (PPF).

The individual annuity policy with an insurer which now forms the basis for the member’s pension benefits, can be shared on divorce in the same way as other pensions. It should however now be remembered that the name of the pension arrangement in Section C on Form P1 in the Pension Sharing Annex must now be the name of the insurer and the policy number of new policy rather than just writing in the name of the former pension scheme in which the individual was a member.

Impact of adopting insurer factors

The factors used by different private sector pension schemes can vary significantly. Therefore, the impact of moving from scheme factors to insurer factors will be different for every scheme.

When it comes to CEV calculations schemes are required to be at least equal to the best estimate of the expected cost of providing the member’s benefits in the scheme. As a result, these calculations tend to be based on market conditions at the calculation date and linked to the scheme’s investment strategy. This is similar to the approach taken by insurers when calculating CEVs. This means that the difference between a CEV calculated by the scheme and an insurer will be related to the expected investment returns based on the scheme’s assets before the buy-in and the insurer’s assets after the buy-in. Depending on the different investment strategies CEVs could increase or decrease after adopting insurer factors.

Example: A member with a deferred pension of £5,000 p.a. might have a CEV of £300,000 calculated using Scheme factors based on a very low risk investment strategy immediately before buy-in. The CEV for the same benefit might be £250,000 calculated using cost neutral insurer factors, based on balanced insurer investment strategy. Note that this is an example only and in practice CEVs could increase or decrease following a buy-in. This does however indicate the importance of considering requesting a new CEV be provided, even when the previous CEV is less than 12 months old, where you become aware that a member’s pension benefits have been subject to a buy-out since the previous CEV was calculated.

The impact of changing factors can often be more significant for cash commutation (that is the process of giving up pension income to generate a higher lump sum at the point of retirement). This is because when it comes to the commutation factors used by a private sector defined benefit scheme (such as a final salary scheme) there is no legal requirement to offer members fair value. Clearly this will vary between different schemes but for many schemes these factors are updated only once every three years and tend to be low compared to the value of pension given up for a cash lump sum. Insurers on the other hand are required to offer customers fair value which means that in many cases the commutation terms can be significantly more generous than those offered by schemes.

Example: The maximum tax-free cash available for a member age 65 with a pension of £10,000 p.a. on retirement could be £50,000 using Scheme factors, leaving a residual pension of £7,500 p.a.. After adopting insurer factors the maximum cash available could increase to £54,500 with a £8,200 p.a. residual pension.

Overall, the impact of adopting insurer factors will be different for every scheme. The impact for pensions on divorce also varies depending on the approach taken to pensions sharing. For example, a change to the CEV will be significant if a pension sharing order is considered for that particular pension and cash commutation factors might be important if calculations include equalisation of retirement lump sums.

In summary, whilst buy-outs and buy-ins might not impact on all cases, this topic does underline the importance of instructing a pension expert when dealing with pensions settlements involving private sector defined benefit pension schemes with CEVs in excess of £100,000.

Linda Perkio

Actuaries for Lawyers

About the writer

Disclaimer – The views expressed here are the views of the writer only and do not necessarily represent the view of Actuaries for Lawyers. Whilst every effort has been made to ensure the accuracy of the information in this post, it is important to always check the benefit rules with the schemes before making any financial decisions based upon these. Actuaries for Lawyers cannot be held responsible for any losses incurred as a result of relying upon information contained in the blog section of our website as these do not constitute advice or act as a substitute for providing individual advice in relation to the specifics of a particular case.

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In Pensions on Divorce, Public Sector Pensions

Uniformed Public Sector pensions and pension sharing – what should you look out for?

Uniformed public sector pensions – the Police Pension Scheme, Firefighters’ Pension Scheme, and Armed Forces Pension Scheme – can be tricky to consider when pension sharing is a likely method of settlement to be used. The biggest issue to look out for is the retirement age that is to be used in any calculations, since the party who holds the Uniformed Services pension may be able to retire at an earlier age than their ex-spouse would be able to retire at from any credit pension awarded to them, especially in the older legacy schemes (the Police Pension Scheme 1987, Firefighters’ Pension Scheme 1992, and Armed Forces Pension Scheme 1975).

Uniformed Services pensions may allow the member to retire from active service on an unreduced pension, as early as attaining 30 years’ service (potentially in their late 40’s) on Police 1987 cases, from age 50 in the Firefighters’ 1992 Scheme and even earlier, potentially from as young as age 37, in the Armed Forces Pension Scheme 1975. The ability to benefit from these favourable terms usually requires the member to retire from active service (that is as a current employee) of the uniformed service in question and further stipulates that they have completed a minimum period of service. In these schemes, the credit pension is not usually payable to the ex-spouse until their age 60 or 65 without reduction and so a simplistic approach such as equalising the Cash Equivalent Values (CEVs) of the parties’ pensions can lead to unexpected and arguably unfair outcomes.

The “minimum period of service” point above is very important to remember as this impacts on the assumed date of retirement when the CEV is calculated which in turn means that the CEV of the pension can change quite dramatically when a service milestone date is reached. For example, when a police officer in the 1987 Scheme reaches 25 years of qualifying service, their 1987 pension will become payable from age 50 (or immediately if they are above this age) which can cause the CEV of their pension to increase quite significantly at this point. This happens because before reaching 25 years of service, their pension is only payable without reduction from age 60 and so on reaching 25 years of service, there are now potentially another ten years of possible pension payments to be included in the valuation calculation. This again can result in unexpected outcomes, particularly if there is a lengthy delay between the calculation of any necessary share and the implementation of that pension share. If the member is expected to remain in service until their retirement, it could also be argued that their pension should be given a higher value to account for the expected reduction in normal pension age on reaching their service milestone date, though there may always be arguments as to whether they will certainly remain in service long enough to reach the milestone date and consequently gain from the more favourable pension benefit terms.

In addition to differences in the parties’ future pension incomes due to their differing retirement ages, there can also be the issue of Early Departure Payments (EDPs) in the Armed Forces Pension Scheme if the husband or wife in a divorce settlement is a member of the Armed Forces Pension Scheme 2005 or 2015. EDPs comprise of a tax-free lump sum and regular income payments made from the date at which the member leaves service in the Armed Forces provided that this is after their 40th birthday but before their assumed Normal Pension Age and they have completed at least 18 years of service (to qualify for Armed Forces 2005 EDPs) or at least 20 years of service (to qualify for Armed Forces 2015 EDPs). The regular income payments would be paid until age 65 (for Armed Forces 2005 EDPs) or until State Pension Age (for Armed Forces 2015 EDPs). One key point here however is that EDPs are not considered pension rights by the Scheme. Consequently, although these may be a source of income that an ex-spouse may “lose the chance of acquiring” post-divorce, they are not affected by any pension sharing order made on the Armed Forces 2005 or Armed Forces 2015 Schemes or included in any CEV calculated by these schemes. This means that it might be necessary to consider periodic payments to the ex-spouse, or possibly to make an adjustment to the required pension share in order to allow for the difference in future income post-divorce, though the extent to which this might be reasonable could be influenced by post-divorce employment income and other income expected to be received by both parties.

A number of other issues could be significant too, for example if a member has retired in ill health and has a non-shareable injury pension included in their pension rights or if a member of the Armed Forces has recently become a commissioned officer (after originally joining the Armed Forces at a non-commissioned rank, referred to as an “other ranks” member). Due to these potential issues, it is usually advisable on cases including a uniform public sector pension to obtain a report from an appropriately qualified pensions on divorce expert.

Joseph Lennard

Actuaries for Lawyers

About the writer

Disclaimer – The views expressed here are the views of the writer only and do not necessarily represent the view of Actuaries for Lawyers. Whilst every effort has been made to ensure the accuracy of the information in this post, it is important to always check the benefit rules with the schemes before making any financial decisions based upon these. Actuaries for Lawyers cannot be held responsible for any losses incurred as a result of relying upon information contained in the blog section of our website as these do not constitute advice or act as a substitute for providing individual advice in relation to the specifics of a particular case.

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