Examination of witnesses (Question 20
- 39)
WEDNESDAY 24 JUNE 1998
MR JOHN
DENHAM, MP,
MR CHRISTOPHER
EVANS and MR
WILLIAM ARNOLD
Mr Leigh
20. When I was a young pupil barrister I
worked for a senior barrister who is now a High Court judge, who
used to knock off five divorces every day and have a regular income,
five every morning actually. What sort of comprehensive advice
on pension splitting could he give to his clients if he were doing
five divorces every morning?
(Mr Denham) It depends what advice you would require
in particular circumstances and I would separate out the two issues
as I did earlier for Chris Pond into the question of the treatment
of the assets for the purposes of the divorce, and the second
question which is the financial advice to the individual about
the best course of action. It is important to understand that
there is a sequence of events which begins as it were with a valuation
of the rights in the pension scheme which is presented to the
courts (or prior to the courts) for agreement between lawyers
just as other valuations take place, so property would be valued,
any savings would be valued, so there is a presentation of a value
of the pension scheme. It becomes, I suppose, part of the list
of assets which somebody has to look at and then say that would
be a fair division or this is a settlement which we should look
at. It is true that there may be some circumstances in which the
process would be more complicated than that, issues where people
might wish to query the valuation, although we would want to minimise
that, and certainly situations where people would query the valuation
where more detailed investigation might be necessary. In principle
I do not think that is different from a situation where somebody
wishes to challenge the valuation that has been put on a property
or some other asset, antiques or whatever it might be, held by
the marriage which would also require some expert advice. It is
very important because the value of the pension assets is likely
to be much more substantial than most other assets, probably in
many cases it would be the most substantial asset in a marriage.
Chairman
21. Just to probe that, are you really satisfied
that the training that is available just now to people who are
advising people on divorce is up to the fundamental change that
we are talking about here without putting something in, I guess,
to the Lord Chancellor's Department or the Lord Advocate's Department
about getting some training and a diploma that prospective lawyers
have to get before they actually get a practice certificate?
(Mr Denham) I wonder if I could ask Mr Arnold
for an indication of what things are likely to happen between
now and the recommendation.
(Mr Arnold) Certainly we will be covering this
in the judicial training that is given for the implementation
of Part 2 of the Family Law Act. As the Minister has said, we
know that the Law Society, the Solicitors' Family Law Association
and so on, are already taking major steps to train their members
with a view to when the Act comes into force.
22. So you are confident that when this
legislation hits the statute book immediately thereafter practitioners
will be up to speed on some of the very complicated, high value
decisions that they will be taking about some of these matters?
(Mr Arnold) Certainly at the moment we have no
reason to feel that that will not be the case. The main decision
that people have to take on pensions will not be that dissimilar
to the kinds of decisions on other assets on which lawyers have
to advise their clients.
Chairman: Thank you.
Can we move to the area of personal pensions now.
Mr Pond
23. Personal pensions is an area of concern
because of what happened with the mis-selling fiasco. One of the
issues which I think we are concerned about is the question of
administrative charges that could be made by pension providers,
whether it be an occupational pension or especially a personal
pension. The intention in the consultative document, we understand,
is that the costs of this division should fall on the two members
in the marriage and not either on the pension fund or on the state.
I think most people accept that principle. The difficulty is,
how do we make sure that the charges that the pension scheme imposes
for splitting especially personal pensions are fair? I can see
circumstances where there are some schemes that would say, "Oh,
let us go thirds: the husband can have a third, the former wife
can have a third and we will have a third." Given that people
may have taken these schemes out some time ago, they will not
have been able to shop around to make sure in advance that the
scheme they have taken out, once this legislation comes into force,
is fair in that respect. How can we provide that?
(Mr Denham) I think it is obviously important
to ensure that, as the Act will say, the costs are reasonable.
The position is that, just to go through the process, people will
be aware of proposed charges ahead of the divorce although, as
you say, somebody will already be a member of the scheme but at
least people will go into the process of settlement aware of the
charges that would be levied and they would have to be identified
by schemes in advance. In other words, it is not something that
people could think up because an individual came along and said,
"I think my pension is going to be part of the divorce action".
It is part of the setup arrangements which all pension providers
will need to undertake, so those charges would be available. If,
beyond that, people felt that that was unsatisfactory, that the
administration charge that was being levied was going to be too
high, then the personal pension scheme member would under the
existing arrangements have the ability to go to the Pensions Advisory
Service (which is more generally known as the Occupational Pensions
Advisory Service) which can give advice in this area, and through
that to the Pensions Ombudsman who also has power to deal with
issues of maladministration. We do recognise the importance of
the issue that you raise. The legislation does give us some powers
to make regulations in this area and it is an issue that we will
all want to discuss further with the various regulators, in particular
those responsible for regulating the financial services industry.
Mr Gibb
24. What research has the Government carried
out into the likely charges affecting these pensions, what the
percentage will be, what the fixed costs would be?
(Mr Denham) If I could refer you to the consultation
document, page 31, we have given an indication, coming from discussions
with the industry through the consultative process that we have
been working through since last summer on this legislation, about
the likely scale of charges which are going to arise. I think
it is fair to say that we will probably want to revisit those
assumptions because the costs were supplied to my officials in
that consultative process on the basis of the principles that
we were talking about as the legislation was being drafted, and
I think for both the personal pension schemes and occupational
pension schemes we will need to discuss with them how they see
the detail of the legislation, what level those charges will be.
25. They do seem very low.
(Mr Denham) In the case of a personal pension,
a money purchase personal pension, the valuation of the assets
is really a pretty straightforward exercise. It is the sort of
thing which happens on a routine basis in most personal pensions
every year and is a very simple exercise. The exercise of splitting
that into two funds is also a fairly straightforward exercise,
so I would not have expected that the costs needed to be particularly
high.
Miss Kirkbride
26. Could we also be quite clear about who
pays for the splitting? Obviously there are charges that you would
like the companies to abide by when they are up front, but when
it comes to those costs who will actually take the burden? Will
they be split equally between the divorcing couple because if
there is an extra cost who will pick it up? In the details of
the document it says at the end of the day it will be paid for
by the person whose policy it is, which one presumes will be the
man.
(Mr Denham) The principle in the legislation is
that the costs of all this should be borne by the divorcing couple
because it would be unfair for that to fall on other pension scheme
members. The costs will be known to the court and will be disclosed
to the court or to the parties if an agreement is being drawn
up. The costs will be taken fully into account in the overall
divorce settlement. The question of which individual pays the
cost out of their share is not a separate issue from the rest
of the divorce settlement.
27. It is put in along with all the rest?
(Mr Denham) Yes, it is put in with the rest, and
therefore is taken fully into account.
28. Are the Government entirely confident
that no existing policy holder of a pension scheme will pay any
extra money for divorcing couples, especially because some schemes
might be much more effective than other schemes, depending on
which industry it is?
(Mr Denham) The one area of costs which we think
it is fair to ask the industry to bear is what we call the setup
costs. In other words the schemes will need to identify what their
rates of charges are going to be; they will need to make some
adjustments to their IT systems in advance of any particular individual
coming along and saying, "My pension needs to be treated
as part of the divorce". The estimated costs of that across
the entire industry are I think in the region of five to 10 million
pounds from recollection[1]
in an industry with assets of £800 billion or something of
that sort, so on that scale are small. One of the reasons for
spreading those costs across the industry is to avoid a situation
where no preparations were made and the costs were all loaded
on the first individual in a particular scheme that came along
and picked up their share of the £5 million. It would seem
a little unfair, but for the costs beyond that the intention is
that the schemes can cover the full reasonable costs and therefore
other members of the scheme are not disadvantaged.
Chairman
29. Knowing myself the work that is involved
in this—say 10 hours multiplied by the national minimum
wage of £3.60—why do you not just prescribe that that
is the flat rate cost?
(Mr Denham) The main reason for not seeking to
prescribe the costs is a recognition that the actual costs of
doing this transaction may vary significantly.
30. I do not understand that. I understand
that there are some pretty seriously highly qualified people that
have to do this work, and it is an amount of time that they need
to spend, but I do not see why it should vary enormously from
one case to the next. It is a series of steps you have to take.
(Mr Denham) There can be quite significant variations
in cost.
31. Give me an example of that.
(Mr Denham) If you look at the overall costs of
running occupational pension schemes, the average administration
cost is round about eight per cent, but there is a wide variation
in individual schemes, down to as low as two per cent and up to,
in some extreme cases, 30 or 40 per cent. What that means is that
there may be a big difference in costs. Take the very large occupational
pension scheme which provides all of its services in-house and
will do all of its work from its existing staff, and the small
occupational scheme which may have only four or five members whose
administration is contracted out, who will have to hire in for
the purpose additional outside expertise in order to carry out
the activity. The difficulty of prescribing costs is that you
will either set a level which is too high for a significant number
of schemes and once a cost is set that is the cost, I suspect,
that will be charged. That is almost inevitable, or you will prescribe
a cap which is below the real costs that would fall on individual
schemes. The balance of judgement on this case was to say, "Let
us lay down that it should be reasonable and then look at the
safeguards which are there in the regulatory system." Before
we get it too much out of proportion we have some 10 years' experience
of transfer values being quoted by schemes which, if the individual
chooses to ask for it, is a cost that may fall on the individual.
There is no evidence that I am aware of over the last 10 years
that schemes have been choosing to charge disproportionately for
that service which is provided. What we need to make sure is that
there are safeguards in the regulatory system against possibly
a very small minority of cases which might arise of overcharging
but, given a very similar system of valuations being in operation
for over 10 years, that has not given rise to problems that we
are aware of. I think we need to be careful not to overstate the
problem.
32. I think that that suggests that Ministers
are being a soft touch for hard headed actuaries. I hope we are
not going to let people make money out of this. I do not think
it is a complicated process at all. I think it takes a length
of time and I think that there should be an absolutely basic amount
of money that is then set in the rule book so that there is no
scope for people just inflating and enhancing the value as we
go along.
(Mr Denham) Perhaps I can prove your point and
also say a word about actuaries who in my experience are lovely
and warm people and not hard headed at all, but the actuarial
valuation and the way in which they advise on costs will be set
out in guidance notes to actuaries, so to go beyond that would
require actuaries to go outside or essentially breach the professional
standards which they are expected to achieve as actuaries. We
have not seen any of those sorts of problems in the analogous
bit of legislation and it would be wrong to set up a charge that
was too high in order to cope with those schemes which would have
very high costs, which do need to be recouped.
Mr Pond
33. I am glad there is a scheme on that
one because obviously in terms of the balance of assets which
we were talking about before, the charges could be an important
element of the decision about how that was spread. If it was expensive
to split the pension people might decide to leave that where it
was and to split up other assets. In terms of the consultation
document's proposals on what can happen to the transfer, on paragraph
21 for instance, it talks about the different options available
to a former spouse: either internal transfer, in other words normally
she would take rights in the ex-husband's pension scheme, but
there are also other options to either move into a scheme she
already has or to look at a number of different possibilities,
some sort of insurance or annuity or personal pension scheme,
or some other occupational pension scheme. In most cases however
it is going to have to be the former two, is it not? Many former
spouses are not going to be in an occupational pension scheme
themselves and therefore will be pushed into the market, back
into the personal pension field again. Because of what I said
earlier on the mis-selling, we all have anxieties about what that
might mean for people. Are you confident that the insurance and
pensions industry is going to come up with the products which
will be really suitable and appropriate for that sort of transfer
so that we do not see many of these pension assets just being
dissipated and lost, moved out of a scheme which might be a very
good occupational pension scheme and into the black hole of the
personal pension sector where, as I say, much of the value may
be dissipated and in fact where the end result is that the total
pension rights are worth far less, once divided, than they were
previously?
(Mr Denham) The first point is that many schemes
will offer the spouse membership of the former member's scheme
and certainly the National Association of Pension Funds and the
Association of Pensioner Trustees will be advising their members
in the schemes in which they are involved to offer that option,
although it will not be required under the law. Secondly, we will
be developing as part of the pensions review our proposals for
stakeholder pension schemes which are specifically designed to
have good value for money provisions and to be benchmarked at
meeting those minimum criteria. I hope that that will lead to
an improvement in the value for money options which are available
to people. Thirdly, it is important, to come back to the question
of advice, that people will need advice to make sure they get
the best value for money from the scheme and that will vary from
individual to individual, whether this result is a lump sum of
money which they simply wish to keep as a pension right or whether
they wish to build on it by perhaps going into work after a divorce
and a different type of arrangement might be necessary. I think
we can be confident that we can ensure that there are good value
for money pension arrangements available to somebody who decides
or needs to take their money out of the existing scheme.
Ms Hewitt
34. I have a supplementary on this point.
John, I notice that if a former spouse does not notify a destination,
and clearly some people will not because they just will not understand
what is going on, the scheme can then send the pension credit
into a default option and, according to this paragraph, it will
choose the default option, so it might be existing scheme membership
or it might be an insurance policy or an annuity contract. What
are the regulatory arrangements going to be to ensure that those
default options are appropriate and not extremely high-cost, low-value
products?
(Mr Denham) I think on that one, which is a fair
point to raise, if I may, I would like to write to the Committee.
I can certainly assure you that they will be appropriately covered
under the regulations, but I could not give you chapter and verse
here this morning. It is a perfectly fair question to raise.
Mr Leigh
35. You said a moment ago that we can ensure,
I think your words were, good value, and immediately alarm bells
started ringing in my head in that the financial services industry
already feels that it is hugely over-burdened with regulation.
Can you reassure us that these are ungrounded fears in their minds?
(Mr Denham) Well, it is certainly a central aim
of the Pensions Review to enable the Government to fulfil its
manifesto commitment to introduce stakeholder pensions and we
have set out how, by developing collective schemes which are run
in their members' interests, which are required to meet minimum
benchmark standards and which enjoy an appropriate regulatory
regime, we can achieve good value for money and flexibility for
the members whilst ensuring that members are properly protected.
I certainly believe that that is achievable and, Chairman, we
will have to wait until the report of the Pensions Review for
more detail on those proposals, but we have been working on those
for the last year and I am certainly confident that we can produce
schemes which are better in significant ways than certainly the
great majority of personal pensions which have been on sale, with
their high costs and lack of flexibility, over the last ten or
15 years.
36. I was not thinking so much in terms
of stakeholder pensions as I know that is a manifesto commitment,
I was not arguing with that, but I was thinking more in terms
of what we are talking about today and the extra regulatory burdens
which will be imposed on an industry which already feels over-regulated
in terms of pension splitting and the sort of problems which Chris
has been raising.
(Mr Denham) I think that on the question of the
approach of the draft legislation as a whole, we have certainly
sought to keep the process as simple as possible for the industry
which is why you find throughout the legislation, as the consultation
document makes clear, we have tried to use procedures and practices
which are as close as possible to those that the industry is already
using, for example, on the question of valuation of pension scheme
assets, and I think that that brings any burden down to a very
manageable level. It is also worth remembering that a lot of the
impetus for this change has actually come from the pensions industry
itself and over the years it has been organisations like the National
Association of Pension Funds and the Pensions Management Institute
who have been pressing for this because they have not been satisfied
by the arrangements that they can make and they wanted something
that was clear and usable. I honestly do not believe at the moment
that the need for the type of regulatory safeguards on administrative
costs which Chris Pond was raising actually amount to an onerous
burden on the industry, largely because I am not yet convinced,
I can see the potential danger which Members of the Committee
are highlighting, but I am not convinced at this stage that we
are facing a massive actual problem and so we are talking about
provisions which can deal with cases where people may be trying
to exploit the system, not the generality where the process of
valuing a scheme and then splitting the assets is relatively straightforward.
Mr Pond
37. A final point on that, Minister, is
that there is a concern about those pension schemes where the
cash equivalent transfer value is inadequate. They may be under-funded
schemes, they may be those with significant discretionary benefits
excluded or those with very generous early retirement provisions.
Now, we have seen estimates that that may account for 10 per cent
of the schemes, here or there. What proposals do you have for
dealing with those sorts of schemes?
(Mr Denham) In the case of a scheme which is under-funded,
then in distinction to the rest of the legislation, the former
spouse would have a right to join that scheme and, therefore,
would not be forced out of it. For example, if the scheme was
only 70 per cent funded against the minimum funding requirement
and had been given the period of time in the legislation to rebuild
its assets, you would not force the former spouse to take 70 per
cent of the valuation, so they would have the right to remain
within the scheme while the scheme rights were rebuilt, and I
think that is important. The question then is about CETV more
generally and the way in which discretionary benefits are valued.
There is essentially a floor beneath which the cash equivalent
transfer value cannot fall and that is the one which is set effectively
by the minimum funding requirement. It will be open to trustees
to give a higher transfer value if they wish to do so on what
are discretionary benefits. When we looked at the possibility
of prescribing a different type of valuation which could become
immensely complex, the conclusion certainly that we have reached
so far is that you would end up prescribing only the transfer
value that would be implied by the minimum funding requirement,
so you would not necessarily advance anybody's position at all
and you might well end up with some people doing less well than
they would under these arrangements.
Ms Stuart
38. First of all, I am delighted that you
think actuaries are lovely and cuddly. I have always learnt to
worship at their shrine and never question anything they say!
Can I just deal with the current position of CETV and the recent
changes to ACT tax treatment. Now, do they really give us a good
basis for calculating the transfer value at times of, say, high
inflation? If I take the current position, after the July 1997
Budget, there were not any increases in the values, even though
there should have been to compensate for the loss of investment
income tax. On 15th June 1998 there was a change of some 10 per
cent drop to compensate for the high equity market, but there
should have really been an increase. There is some manipulation
going on in terms of tax treatment, the value that we assess it
at, and if you take us into a different kind of financial climate
with a high inflation, is it really a fair measure to use?
(Mr Denham) I think that it is the best and most
broadly agreed way of valuing pension fund rights that is currently
available to us. It is an area where ministers and many other
people are, I think, dependent on the view of actuaries and the
actuarial profession of the best ways of achieving this, but I
think our view at the moment is that it is the best way that is
available to us. Now, it is true that changes in the way that
markets perform can produce changes in the way that pension fund
rights are valued and the ways in which the assets of pension
schemes are valued and that those changes will always take place
over time. The question really is: is there a better way available
to us, given that at a particular moment in time to the point
where you are trying to achieve a clean break in divorce, is there
a better mechanism available to us than this particular valuation
of the rights of a member within a scheme? Now, my judgment is
at the moment that we do not have a better one, though you can
always point to flaws in it, but it is always important if you
look at the changes which take place over time, one is after all
at the end of the day trying to value as best you can the rights
which the member has accrued, particularly in the defined benefit
scheme, so it is the value of the pension promise that you are
trying to judge and your ability to replicate that with a sum
of money you take elsewhere. That is a slightly different question,
but quite an importantly different question, from whether the
value of the assets of the scheme goes up or down at a particular
moment in time.
39. I then have to make a choice. If, for
example, I am a divorcing spouse and I have the choice to stay
in the occupational pension scheme and of becoming one of the
new deferred members or actually to take my cash equivalent transfer
value out and reinvest it. That is quite a sophisticated decision
I have to make. Can you tell me whether there have been any lessons
learned from doing this kind of retrospective assessment of what
would have happened if you had stayed in the scheme in the wake
of the pensions mis-selling which we could use as a basis for
projection?
(Mr Denham) Certainly there has been a great deal
of experience, I think, in the practice of trying to value or
trying to reassess the position that somebody would have been
in if they had remained in their occupational pension scheme instead
of transferring out, and that lies at the heart of the restitutional
process in tackling the mis-selling problem, so there is, yes,
a great deal of experience about trying to do that and certainly,
as I understand it, it is a matter still of some debate. There
are different opinions on how best to do that. Certainly there
is a great deal of experience in the PIA, the Securities Investment
Board and now the FSA about how that should be done.
1 Note by Witness: "£5 million ("Pension
sharing on divorce: reforming pensions for a fairer future: Part
1 Consultation, p. 28)". Back
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