APPENDIX 18
Memorandum from Professor Heather Joshi
and Dr Hugh Davies (PS 26)
COMMENTS ON CONSULTATION DOCUMENT AND DRAFT
BILL
Policy views expressed here are those of the
authors, not of the Pensions Institute which takes no institutional
policy positions.
Heather Joshi is currently Professor of Economic
Demography and Deputy Director of the Social Statistics Research
Unit, City University, Northampton Square, London EC1V 0HB. From
October 1998 she will be Professor of Economic Demography and
Deputy Director of the Centre for Longitudinal Studies at the
Institute of Education, University of London. Hugh Davies is Lecturer
in Economics at Birkbeck College, University of London, 7-15 Gresse
St, London W1P 2LL.
1. TERMINOLGY
1.1 We adopt the usage of the consultation document
for the terms "scheme member" and "ex-spouse".
While both partners to a marriage may be members of a pension
scheme, in practice (as the consultation document points out),
the man is likely to have more valuable pension rights than the
woman. Since any net transfer of pension rights is usually likely
to be from the man to the woman, we will often use masculine pronouns
to refer to the scheme member, and feminine pronouns to refer
to the ex-spouse. This should not be taken to rule out cases where
a wife's pension rights may exceed her husband's.
2. GENERAL
2.1 Although British women's participation rates,
and hence pension coverage, have improved over the past twenty
years, this does not mean that all married women now have equivalent
pension rights to their husbands. Particularly older women and
those with lower educational attainment are likely to be relying
on pension rights from their husbands for some time to come, and
there will probably always be a minority of couples who organise
their lives with a sole (or major) breadwinner. If such marriages
fail it will be necessary for divorce arrangements to recognise
the implicit function of these partnerships in providing old age
security.
2.2 We therefore welcome the draft Bill. The
Government's proposals are broadly in line with suggestions we
made some years ago.[18]
2.3 In particular, we welcome the approach of
splitting pension rights at the time of divorce. This is likely
to give the ex-spouse greater certainty than the present approach
(in the law of England and Wales), and will base her pension entitlement
on her own life. The pension income of the ex-spouse will not
be contingent on the behaviour and survival of the scheme member.
Payment will start when the ex-spouse reaches pension age, and
will not be affected by the re-marriage of either party.
2.4 The idea that pension rights should be treated
like any other asset has many attractions, but also drawbacks,
as discussed below.
2.5 The Government's consultation document begins
(Chapter 1, paragraphs 3 and 4) by stating that consultation is
invited not on the principle of pension sharing, but on whether
it would work in practice. This is where the difficulty begins,
for the draft legislation is little more than an empty box. The
details (on which whether pension sharing "would work"
surely depends) are consigned to (as yet unwritten) regulations.
Although copious "Explanatory Notes" are provided, these
do not always live up to their title. This will not be helpful
to practitioners and their clients. The benefits of flexibility
have drawbacks if they prolong negotiations, increase legal costs
and perpetuate legal uncertainty.
3. INFORMATION
3.1 One effect of the proposed legislation will
be to increase the amount of information about their pensions
prospects which must be provided to a divorcing couple and their
advisers (e.g. at Stage 3 of the process outlined in Chapter 3
of the consultation document). It should also increase knowledge
about pensions among the legal profession. All this is certainly
desirable.
4. VALUATION OF
PENSION ASSETS
4.1 It is proposed (in the explanatory notes
rather than the legislation) that the method of valuing Final
Salary Pensions for the purpose of pension splitting should be
the same as that used for valuing pension rights when a person
changes jobs (i.e. the Cash Equivalent Transfer Value). At first
sight this seems to be a desirable principle, but there are some
difficulties.
4.2 Methods currently used to value final Salary
pensions on transfer are far from ideal, as explained by our Pensions
Institute colleagues.[19]
The explanatory note to Chapter I, clause 6 of the draft Bill
shows that the drafters of the bill recognise that the valuation
method could produce a windfall gain for the scheme and provides
an illustrative calculation (though not an explanation)
of how this windfall might be avoided. In the illustrative example,
which presumably reflects the intention of the drafters of the
bill, the scheme member recoups all this windfall gain from the
scheme, with none of it going to the ex-spouse. This seems peculiar.
It can be argued that, since the fraction of pension credited
to the ex-spouse is negotiable, this asymmetry in the treatment
of the two parties could be compensated for in negotiation. Effective
use of this point might, however, require greater technical sophistication
than can be expected of the average solicitor. The valuation method
prescribed in the Bill (and subsequent regulations) is likely
to provide a focal point in negotiations, and it is therefore
desirable that it be transparent, even-handed between the parties
and non-negotiable.
4.3 The legislation envisages that the value
of pension rights may be compared between the two parties (though
the consultation document and explanatory notes tend to slur over
this point) and also that the value of pension rights may be compared
with that of other assets. Legislation does not specify how most
assets are to be valued, presumably because they can be sold on
the market. The problem of valuing pension rights arises because
there is no market in these assets. There are, furthermore, two
considerations relevant here which do not arise so obviously in
valuing the pension rights of an "early leaver" and
which cast doubt on whether the methods used for valuing frozen
pensions are the most appropriate for valuing pensions in divorce.
4.4 If pension rights of different sorts are
to be traded off against each other (e.g. where one party is in
a final salary pension scheme and the other a money purchase scheme
or SERPS) then it is desirable that the same principle be used
to value all types of pension.
4.5 If pension rights are to be traded-off against
other financial assets, then it is desirable that the method used
to value pensions be similar to that used to value other financial
assets.
4.6 The principle which would meet these objectives
is that pensions of all types ought to be valued in terms of their
expected discounted present value. This principle could equally
well be applied to any new types of pension schemes emerging in
the future. We suggest that this unifying principle should be
laid down in the legislation. The legislation should specify the
method to be used for ascertaining the discount rate and life
expectancies to be used in these calculations.
5. PERIOD OVER
WHICH RIGHTS
SPLIT
5.1 As far as we can see, the Bill does not
make it clear over what period the relevant pension rights are
to be calculated. We suppose that, in England and Wales, in the
case of a first marriage for both parties, the total of accumulated
pension rights is to be considered. What is to happen when the
partnership being terminated is a second or subsequent marriage
for one or both of the partners? Are the pension rights to be
valued those accumulated since the dissolution of the previous
marriage?
5.2 As far as we can see, the Bill does not
make it clear whether the relevant pension rights in Scotland
are those accumulated since the marriage or whether they include
rights acquired before marriage (as in the treatment of the matrimonial
home).
6. SURVIVOR'S
PENSION
6.1 It is proposed that any reduction in pension
rights be imposed equi-proportionately on all benefits which would
have been paid on survival of the scheme member to pension age.
These benefits principally consist of the pension paid to the
scheme member (including, possibly, a lump-sum) and the survivor's
pension paid to a spouse who outlives the scheme member. When
someone changes jobs, there is no particular reason to attempt
to unbundle these components, but when the need for valuation
arises from termination of a conjugal, rather than an employment,
relationship things may be rather different. The survivor's benefit
clearly has value to the ex-spouse, irrespective of what the future
holds in store for either party in the dissolved union. While
the scheme member can derive no direct benefit from the actual
payment of the survivor's benefit, he may benefit from the security
offered to a subsequent spouse. The value to the ex-spouse depends
on the excess of her life expectancy over that of the scheme member
(from the date of divorce), whereas the value to the scheme member
depends on his re-marriage probability and on the excess of his
new wife's life expectancy over his own, measured from the date
of re-marriage. We suggest that, in the case of a first divorce
by the scheme member, the rights in the whole of the value of
the survivor's benefit (calculated from the date of entry into
the scheme until the date of divorce) should be assigned to the
ex-spouse. The clock should then be re-started for the purpose
of establishing survivor's benefits, and, in the event of a second
divorce the whole of the accumulated survivors' benefit between
the two divorces should be assigned to the second ex-spouse, and
so on.
7. RE -BUILDING
PENSION RIGHTS
7.1 Paragraph 27 of chapter 3 of the consultation
document is unclear to us. If we understand the paragraph correctly,
the Inland Revenue Rules will apply as if no pension sharing had
taken place. That is, the ex-spouse could accumulate a pension
of two-thirds of her final salary plus any pension share obtained
in a divorce settlement. The scheme member, however, would be
subject to the Inland Revenue limit on the sum of his actual pension
and the shared portion. If this interpretation is correct, the
proposal does not seem to be fair.
8. NEGOTIATION
8.1 The proposed legislation does not require
pension splitting, but envisages that pension rights may be traded
off against other assets. From the purely private point of view,
other things being equal, it is desirable that the law should
not place constraints on freely negotiated settlements. The possibility
of negotiation, however, reveals a drawback of treating pensions
like other assets. From the point of view of the public purse,
one of the consequences of divorce is the reliance of large (and
growing) numbers of divorced women on means-tested benefits in
old age. The objective (set out in paragraph 7 of the consultation
document) of narrowing the pension gap between men and women is
not only a question of equity, but also has implications for public
expenditure. If, however, a woman can trade off her claim on her
ex-husband's pension rights for an asset with more immediate benefit
(cash, or the marital home), this asset might be used up before
she reaches pension age. It may not, therefore, be available to
finance her old age -or to offset against the need for means-tested
benefits in old age. The extent to which a woman may be inclined
to sacrifice future pension for a currently disposable asset or
current services (such as housing) will depend on a variety of
factors. In particular, it is likely to depend on the circumstances
in which she finds herself in the years immediately following
the divorce. Recent research shows that women (and their dependent
children) are likely to suffer quite a sharp fall in their standard
of living in the first few years after divorce.[20]
Women with dependent children (especially those of pre-school
or primary-school age) are particularly likely to find it find
it difficult to earn after divorce, and may reasonably decide
to put the immediate consumption needs of their family ahead of
their own need for old-age security. Giving women a more explicit
right to share in their husband's pension assets will benefit
these women, as it will improve their bargaining position in negotiating
a financial settlement. It will not necessarily, however, make
them much better off in old age. The extent to which a woman will
want to trade off the prospect of pension for herself as against
current income will depend on a number of factors, apart from
her personal preferences:
— Her age: the nearer she is to pension
age, the more highly is she likely to value an increased pension.
— Her current family needs, in particular
whether she has dependent children: the greater the family needs,
the more likely is she to value liquid assets or housing services
rather than future pension.
— The extent and security of child-support
payments: the more confident is she that child support payments
will be adequate and will be regularly forthcoming, the more likely
is she to value future pension rather than currently liquid assets.
— Constraints on her labour market
participation: if responsibility for childcare limits her ability
to earn, she is more likely to sacrifice future pension for current
income.
— Her own earning power. It is not
clear in which direction this will work: a woman with high earning
power is more likely to be able to finance her family's current
needs from her earnings, but is also likely to accumulate substantial
pension rights of her own.
— How the tax and benefit system treats
assets and asset income of people of working age. To the extent
that having non-pension assets reduces entitlement to benefit,
a woman is more likely to want deferred benefits (i.e. pension
rights).
— What expectations she has of how
the State will treat her in old age. To the extent that a woman
expects that acquiring extra pension rights will reduce her entitlement
to benefit in old age, rather than increase her income in retirement,
she might choose assets with immediate benefit over pension rights.
8.2 The effect of enabling pension sharing will
therefore depend on a number of other government policies which
have themselves recently changed or may soon change—in particular
policies designed to enable lone parents to spend more time in
the labour market, and the overall reform of pensions provision.
8.3 Although the pension sharing option enabled
by the draft bill is a welcome addition to the range of instruments
which are available to reach a financial settlement on divorce,
it will not by any means eliminate the prospect that large numbers
of elderly divorced women may be reliant on means-tested benefits,
because:
— The amounts available to be split
are often likely to be fairly small, especially given the valuation
methods proposed.
— The women who are most at risk of
having low income in old age are those who have had low labour
market participation or have spent a high proportion of their
time in the labour market in poorly paid jobs (perhaps mostly
as part-timers). These women are increasingly likely to have been
married to men who are themselves low earners, and are therefore
also likely to be badly-pensioned.
4 August 1998
18 H B Davies and H E Joshi, Pensions in Divorce: Illiquids
Assets in Dissolving Unions, Family Law, January 1992, 21-24. Back
19
D Blake and M Orszag, Portability and Preservation of Pension
Rights in the United Kingdom, in Vol. 3 of Report of the Director
General's Inquiry into Pensions, Office of Fair Trading, 1997. Back
20
See S Jarvis and S Jenkins, Marital Splits and Income Changes:
Evidence for Britain. Innocenti Occasional Papers, Economic
and Social Policy Series. No. 60, UNICEF, International Child
Development Centre, Florence, 1997. Back
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