It is widely acknowledged that pensions issues are most typically dealt with on divorce using an offsetting approach i.e. non-pension assets are distributed in such a fashion as to take account of one party’s having greater pension provision than the other.
It is also generally accepted that almost all UK pensions will come with a Cash Equivalent Value (CEV), which is the value placed on the underlying benefits by the provider.
But are those CEVs appropriate values of the pension rights for the purposes of offsetting? This topic has been discussed in great depth in the PAG and PAG2 reports, but here I want to discuss the specifics of public sector defined benefit pension CEVs and where we find these at present.
The public sector schemes (NHS, Armed Forces, Police and many more) are all defined benefit in nature, and CEVs are provided for divorce purposes that are calculated using factors that are set by the Government Actuary’s Department (GAD). There is in general no right to a transfer-out of benefits and so the CEVs are provided solely for pension sharing purposes i.e. how much of a pension is awarded to wife for every £100 pa of pension forgone by husband? The CEV factors are thus used, and then used again in reverse to convert an awarded pension credit into specific pension benefits, with no actual monies leaving the scheme.
There is therefore no requirement for these CEVs to reflect the “fair value” of the underlying pension rights, and for many years this was indeed the case. When I started working in this space in 2017, the CEV of a public sector pension was c. 60–70% of the fair value of the benefits. That is to say, if someone had a pension promise of £20,000 pa from the NHS scheme that was payable in retirement, the CEV of this pension would be expected only to provide an annuity income of perhaps £13,000 pa in retirement.
For this reason, the message hammered home to solicitors has long since been: please don’t use public sector CEVs for offsetting, as they are an undervaluation of the actual pension rights retained. However, the actuarial factors used are revised every few years, with the latest revision being in mid 2023. This wholesale revision, coupled with changes in market conditions, has meant that public sector CEVs are now tending to exceed what might be regarded as a fair valuation of the actual pension benefits.
Let’s consider a recent case that passed across my desk. Husband is 38 and is in the Police Pension Scheme, such that he has legacy benefits in the 2006 scheme (pension and 4× lump sum, payable at age 65) and further accrual in the 2015 scheme (pension only, payable at SPA of 68).
The 2006 scheme pension is £12,000 pa and the lump sum is £48,000. These have a CEV of £192,000, according to the scheme. But if I use the Galbraith Tables—now in their second edition and available on our website—I determine that Husband would only need £117,000 today to replicate the benefits at age 65. The CEV is thus a rather generous overvaluation of the pension rights.
His 2015 scheme pension is £3,000 pa and has a CEV of £35,000. But the monies required today to replicate this pension at age 65 is just £20,000 according to the Galbraith Tables: once again, the CEV is “in the money”. Overall, these CEVs are c. 70% higher than my estimate of the fair value of the rights.
This analysis is in part a function of the way in which the Galbraith Tables work, in that they younger one is, the more generous is the allowance made for future expected investment returns in the period to retirement. As it happens, Wife in this case was aged 43 and she too had rights in the Police Pension Scheme’s 2006 and 2015 sections. Her CEVs were deemed to be c. 40% higher than the expected cost for her to replicate her expected benefits.
It follows that any such comparisons are subject to change over time: the Galbraith Tables were updated in early 2024 to allow for market movements from 2022 onwards, and as noted above, GAD seek to revise the public sector CEV factors once every few years. Once the CEV factors have been updated, they then stand still until the next revision, regardless of what is happening in the market. To this end, public sector CEVs have increased at a time when the expected cost to provide pension benefits has fallen, in light of the higher interest rate environment in which we now exist. These issues were discussed in George Mathieson’s blog of April 2023
So does this mean that what we’ve been telling solicitors about public sector CEVs is now all wrong? Up to a point, Lord Copper. As things stand TODAY it is likely that such CEVs will be an overvaluation whereas before they were likely to be an undervaluation, but overall the lesson is that such CEVs cannot simply be treated as though they are automatically a reasonable estimate of the underlying pension rights held.
The Galbraith Tables are an excellent starting point for seeking to place a ballpark valuation on such defined benefit pension rights as might exist when parties are divorcing, but it follows that actuarial advice should be sought in complex cases. PAG2 makes clear when a Pensions on Divorce Expert (PODE) should be instructed; refer to Part 6. We here at Mathieson Consulting Limited deal with matters like these every day, and are well placed to help solicitors better understand the fair values of their clients’ pension rights.
Jonathan Galbraith
Head of Mathieson Consulting Limited
