Pension Values And Offsetting – Quo Vadimus

The purpose of this article is to consider in the context of Financial Remedy, the issue of pension values and offsetting, especially in light of the case law and in particular, the case of WS v WS [2015] EWHC 3941 (Fam), [2016] am Law 564.

The facts in WS v WS were briefly, that the Wife (“W”) was 56 years of age and the Husband (“H”) 61 years.  They had married in 1985 and separated in 2012.  There were 2 children born of the marriage who were both majors at the time of the marriage breakdown.  The Court found that during the marriage both parties had made full and substantial contributions and no proper distinction could be made between them:  the W having had a high-earning career in investment management and the H despite his redundancy as a stockbroker in 1990, had continued to work as a consultant on various projects.   The assets consisted of a mixture of properties (residential and commercial)[1], cash, listed and unlisted investments[2] and pension funds.

It was common ground between the parties that there should be a clean break and that the matrimonial property should be divided equally.  Aside from the  minor issue of ascribing an agreed monetary value to a company loan and farm partnership assets and whether 10% should allowed for illiquidity of one company, the main issue to be decided by the Court was the methodology for offsetting between the parties’ pensions in order to effect an equal division of the matrimonial assets[3].

The nature of the parties’ respective pensions differed.  The H had a defined contribution pension held in a SIPP and a small money purchase pension plan.  Due to the recent pension reforms[4] and after taking the 25% tax-free element, the value of the H’s pension fund stood at approximately £970K. Due to the pension reforms, the H was able to take his pension funds as cash subject to the payment of tax.

The W by contrast, was in receipt of a pension from her previous employment with a bank, which was a defined benefit scheme based on her final salary.  The W had taken the 25% tax-free gratuity some time previously and the pension continued in payment linked to the RPI[5].  The pension was taxed at source.  The W’s annual income from the scheme was £92,086 gross and £50,600 net.  The W had no other potential pension entitlements.

In their evidence, the parties referred to the difference between their respective pensions:  the W alleging that she could not cash in her pension but could only take the income which ceased upon her death, whereas the H could withdraw his funds and subject to the payment of tax, invest them as he chose.  Conversely the H pointed out that whereas the W’s pension was index-linked and guaranteed for life, his was subject to the vagaries of the market and investment decisions.

Although the idea of a pension sharing order had initially been floated[6], neither party pursued this suggestion, it being recognised that the pension sharing would take the H well over the lifetime allowances with severe taxation consequences.  Therefore the Court was asked to consider offsetting. It was accepted that the W’s bank pension was more valuable than the H’s money purchase scheme.

As the Court pointed out, the difficulty was finding an appropriate methodology for calculating the offsetting sum.  In order to give effect to offsetting, the Court was essentially asked to consider 2 options, namely option A[7] or option B[8].  The parties adopted alternate positions in respect of the options:  the W rejecting option A and the H inviting the Court to reject option B.

In all the circumstances, the Court ruled that although in practical terms, neither option was entirely straightforward, Option B (and the Duxbury approach) was the correct course to adopt.  The Court was particularly concerned that the H would struggle with the realities of putting Option A into practice with the consequent delay and cost.   As the Court indicated[9]:

“An important element in the decision as to whether a lump sum payable under Option A is achievable or unrealistic is the quantification of the pension offset payment.  It is quite apparent when looking at the rival arguments and different figures suggested that there is no obviously right figure or correct calculation.  However I consider that …. argument of a conventional Duxbury approach is correct, and that is certainly preferable to an annuity based calculation”.

Before reaching its decision, the Court summarised the relevant case law and referred to 2 articles in Family Law[10] entitled “Apples or Pears” dealing with the difficulty of finding a suitable method of calculation in respect of offsetting.

The Court started with considering the leading case of Martin-Dye v Martin-Dye [2006] EWCA Civ 681, [2006] 2 FLR 901[11].  In that case both parties had pensions in payment at the time, with a combined CETV of £1,040.807[12].   The district judge in the first instance decided that a fair division of the assets would be 57% to the wife and 43% to the husband. The husband challenged the district judge’s treatment of pensions and rejection of a pension sharing order on appeal.  The appeal was dismissed but allowed a second time by the Court of Appeal.  The Court of Appeal[13] found that the district judge’s decision was flawed on 2 grounds.  Firstly, in dividing the assets, the judge ignored the essential differences between saleable property and an income stream derived from an inalienable pension in payment and the judge’s perception of these differences was hindered by the way the husband’s case was presented and by the unquestioning use of CETV labels. Secondly, in rejecting the husband’s application for a pension sharing order without sufficient reasons.  Thorpe LJ stressed[14] that a pension in payment is no more than a whole life income-stream akin to an annuity and that pensions[15] in payment and cash equivalent benefits were to be characterised as ‘other financial resources’ within section 25(2)(a) of the Matrimonial Causes Act 1973.   Thorpe LJ[16] held that in a case where a clean break was inevitable the court had 2 alternative ways of treating the pensions:  either by offsetting or a pension sharing order and that a pension sharing approach should have been adopted. Dyson LJ agreed[17] that the better course was to take pensions out of the assets altogether and make a pension sharing order.  Dyson LJ[18] rejected the submission that is was sufficient for the judge to bear in mind the different nature of pensions when conducting his or her appraisal of the parties’ resources given that such an approach was unsatisfactory as it lacked transparency.  It is to be noted that Dyson LJ indicated that it was difficult to see how the adjustment would have been calculated, with no formula having been suggested in argument.

As the Court indicated in the WS decision, because of the Court of Appeal decision in Martin-Dye to prefer pension sharing, there was no further guidance or discussion as to how to calculate the value of an offset payment when that might be appropriate[19].

The Court[20] referred in passing to the case of Vaughan v Vaughan 2007 EWCA Civ 1085, [2008] 1 FLR 1008 and the Court’s recognition of the difference between disposable capital and the capital value of pension rights but the latter often being a very significant component of the parties’ future economies.

The Court [21]indicated that in light of the recent liberalising changes to pensions, the husband would no longer be obliged to invest his funds in annuities.  The court cited the case of SJ v RA  [2014] EWHC 4054 (Fam)[22] in which the wife’s application for a pension sharing order to provide her and the husband with unequal income which given that she was younger and female would have provided her with a greater share of the combined fund values, was roundly rejected by the Court, who held at paragraph 83 as follows:

“ I would regard such an approach as unfair and anachronistic in a case where assets exceed the parties’ needs.  The recent well-publicised changes to pension regulations will mean that pension investments are virtually to be treated as bank accounts to people over 55  ……………………….In cases where distribution ….is not guided by need it is incorrect to distribute the pension fund on the basis of equality of income and there is no need for actuarial reports in the overwhelming majority of such cases ……Moreover I suspect that annuities will, in the overwhelming majority of cases become a thing of the past”.

The Court in the WS  case went on to consider the December 2015 Family Law article[23] and a quotation from Sir Peter Singer in the case of JS V RS [2015] EWHC 2921 (Fam) at paragraph 74, namely,

“ I am aware from my general reading that there is at present debate but as yet no conclusion on precisely this topic of appropriately arriving at an offsetting figure”.

When considering  the Family Law article[24] the Court in WS noted the fact that 14 leading pension experts were asked to answer 3 short mock pension offsetting problems with divergent results, leaving a “a fascinating but confused picture”.  The Court also noted the submission in the same article that the Cash Equivalent (“CE”) is often wholly misleading as to the true value of a defined benefit scheme and the discussion of the potential use of the Duxbury algorithm to calculate the sum required.

In the WS  case the Court[25] when considering the competing submissions put forward by counsel as to pension provision, was persuaded that the Duxbury calculation/approach[26] was the correct one[27], which was strongly supported by Mostyn J in JL v JL (No 3) [2015] EWHC 555 (Fam), [2015] 2 FLR 1220 who referred to the Court of Appeal case of H v H (Financial Remedies) [2014] EWCA Civ 1523, [2-15] 2 FLR 447[28].

In  JL[29], Mostyn J indicated that he had used the Duxbury algorithm to calculate the wife’s needs and in particular, her pension share because:

“it was a perfectly reasonable assumption to make given the greatly increased flexibility afforded to the holders of pension funds by the Taxation of Pensions Act 2014 …… it would have been unreal to take some annuity figure calculated by a pension expert for the trial before …. the pension reforms were announced in July 2014”.

In JL [30] it was pointed out that the Duxbury algorithm is underpinned by 10[31] underlying assumptions which include three key financial predictions[32] .

Mostyn J[33] referred to Ryder LJ’s comment in H v H[34]  about the rate of return to be adopted and his rejection of an “industry standard” which voiced as follows:

“I am very firmly of the view that there is no ‘industry standard’ even less an acknowledgement by the Family Division judges that there should be such a rate.  For my part, I would firmly decline the implied invitation to identify such a rate or to give guidance that there should be a parallel process to that employed by the Duxbury Committee to produce such a rate. I am entirely neutral on the question of whether it is a cost effective exercise to embark on such a process.  That must be a matter for others”.

Ryder LJ[35] referred to the warning given by Holman J in F v F(Duxbury Calculation) [1996] 1 FLR 833 849  where on the facts, rates of return above and below the Duxbury assumed rate were rejected. The Court in that case opined that particular facts may require higher or lower assumed rates of return which may justify expert evidence and cautioned against any standard practice of experts being instructed to give evidence about an appropriate assumed real rate of return.  It was also stressed that a Duxbury calculation is merely a starting point or guide to one component of an overall lump sum award upon which all the section 25 considerations impact[36].

Mostyn J[37] commented regarding an “industry standard” as follows:

“Of course there is no ‘standard rate’ in the sense that the economic assumptions underpinning the formula are written in marble from which there can be no deviation.  But the Duxbury tables are used in countless cases.  Their underlying methodology and assumptions are widely accepted as the usual starting point, and where there is no countervailing evidence, the usual finishing point.  In that sense they do represent an ‘industry standard’”.

From the above, it is clear that practitioners have to be very clear as to the nature of the pension they are dealing with and in particular, whether the pension is a private or public law pension.  Furthermore, in cases where offsetting may be deemed to be appropriate, the issue of the appropriate or suggested methodology to calculate the value of that offsetting needs be canvassed sooner rather than later.  Whether the Court will be assisted by expert evidence will need to be considered and very much depends on the individual facts of the case.

Pulling the strands together, as outlined above, there appears to be increasing use of the Duxbury calculation as a means of assessing pension offsetting, especially in light of the changes brought about as a consequence of the Taxation of Pensions Act 2014.  However, every case depends on its own facts.  In the absence of countervailing evidence that the Duxbury tables should not be used however, it appears increasingly likely that Courts will use the Duxbury calculations – even if only as a starting point in relation to the issue of pension offsetting.

[1] In excess of £4  million.
[2] The W’s bank accounts and investments in the region of some £2.5 million and the H’s bank accounts approximately £1.9 million.
[3] Which roughly equated to each party having over £6 million before the pension provision was taken into account.
[4] Following the major changes as from the 6th of April 2015 contained in the Taxation and Pensions Act 2014.
[5] The Retail Price Index.
[6] And indeed, at an initial directions hearing, the H had been refused permission for an expert pension sharing report and refused permission to appeal from that decision, one of the parties’ agreements being that “neither of them will seek a pension sharing order but instead invite the court to consider offsetting in its approach to the difference between their respective pension provisions based on cash equivalent values” – paragraph 17 of the judgement refers.
[7] Option A:  Retention by the H of the Former Matrimonial Home (“ fmh”) and 2 companies and for him to pay the W 2 lump sums of £750,000 respectively
[8] Option B:  Sale of fmh and companies and proceeds of sale to be divided equally and the only substantial question for determination was the calculation of the a lump sum payable by the W to offset the difference between the parties’ pension provision.
[9] Paragraph 71 of the judgement.
[10] The first in Family Law [2012] vol 42 page 1234 which according to the court, posed questions without suggesting answers and the second in Family Law (December 2015) entitled “Apples or pears? Pension offsetting on divorce”.
[11] At paragraphs 49-52 of the judgement.
[12] The overall value of the estate at time of the final hearing being approximately £6.3 million.
[13] Thorpe LJ at paragraph 54 of the judgement.
[14] Paragraph 48 of the judgement.
[15] Paragraph 61 – ibid.
[16] At paragraph 63 – ibid.
[17] Paragraph 88 ibid
[18] Paragraph 87 ibid.
[19] Paragraph 52 of the WS  judgement.
[20] Paragraph 53 ibid.
[21] Paragraph 54 ibid.
[22] Paragraph 54 and 54
[23] “Apples or pears?  Pension offsetting on divorce”.
[24] Paragraph 56 – 57 of the judgement.
[25] At paragraphs 60 – 71 of the judgement.
[26] Explained in the explanatory text to Table 14 in the 2014-2015 edition of At A Glance and by way of updating, replicated in Table 11 of the 2016-2017 edition of At A Glance.
[27] Paragraph 71 and paragraph 60(4) ibid.
[28] At paragraph 12- 18  of the judgement of JL v SL (No 3)
[29] Paragraph 6.
[30] Ibid.
[31] Namely, (1) uniform income yield, (2) uniform rate of capital growth, (3) uniform rate of inflation, (4) consistent regime of taxation, (5) constant level of drawdown, (6) consistent rate of ‘churn’, (7) expected survival of expected average of contemporaries, (8) be or become entitled to a full state pension, (9) increase in line with prices and (10) the age at which a state pension is payable will not alter in the meantime.
[32] Namely, average income yield of 3%, average capital growth of 3.75% and average inflation of 3%.
[33] Paragraph 17 of the judgement.
[34] Paragraph 26  and 27 of the judgement.
[35] At paragraph 27 and 28 of the judgement.
[36] Page 15 of the judgement refers.
[37] Paragraph 17 of the JL v  SL of the judgement.