Capital Value losses and gains on Pension Sharing
Aug 10, 2016
How can anyone consider pension sharing a defined benefit/salary related pension without knowing something about capital values?
In this context I mean independent capital values or fair values calculated by an actuary. Cash Equivalent Transfer Values are NOT intended to be fair values and are often anything but. So called replacement values are a crude and potentially flawed substitute occasionally used by those who are either not able to calculate proper actuarial values or who maybe want to avoid the not inconsiderable work.
I am grateful to Peter Moore at Bradshaw Dixon Moore for allowing me to reproduce his factsheet here. BDM use the term Market Consistent Capital Values or MCCVs and they are more important and helpful than many people realise. One way in which MCCVs are very useful is to demonstrate losses or occasionally gains in capital values through pension sharing.
The following massively simplified examples illustrate the point.
Scenario 1 - Let’s say that the CETV is £200,000 but our actuaries say that a fair value of the asset is £300,000. If that entire pension is transferred (shared) from one party to the other the scheme will effectively buy out their liability by paying the £200,000. In which case the asset that is really worth £300,000 is turned into one worth £200,000; a loss of £100,000 (33%).
Scenario 2 - It is possible to avoid the loss by not making the transfer (pension share) at all. If that is not feasible it could potentially be mitigated. In this example transferring 50% of the pension will mean that the scheme pays £100,000 (50% of the CETV) and they have halved their pension liability. The residual pension is then worth £150,000 half its original value (50% of £300,000) and there is the amount transferred (shared) of £100,000. So in this example the total post transfer (share) value is £250,000 (£150,000 + £100,000), a loss of £50,000 (16.7%). You will note incidentally that a 50% transfer (share) has meant that one person has the residual pension actually worth £150,000 and the other a new pension worth £100,000.
Scenario 3 – The loss could be further mitigated by introducing another asset, such as cash into the arrangement. If the transfer is reduced to 25% the transfer (share) is £50,000 and this is topped up by cash of £50,0000 the outcome for one party is roughly the same as in Scenario 2. They have a new pension worth £50,000 plus cash of £50,000, so £100,000 in total. The other person has 75% of the original pension with a value of £225,000 (75% of £300,000). In which case the loss is £25,000 or 8%. Cash and pensions are not exactly the same and other adjustments would be necessary in this sort of arrangement.
Three very interesting scenarios showing the merits of looking at pension sharing in the round and not in isolation of the wider financial settlement.