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Pensions and less than perfect health: A guide for the family lawyer

Nigel Bradshaw, of Bradshaw Dixon Moore, spotlights the pension planning and negotiation issues arising when a divorce involves a party in ill health

Nigel Bradshaw, Actuary, Bradshaw Dixon Moore

1 in 5 of us are obese. 1 in 4 of us smoke. 1 in 6 of us have an adverse family history. All these factors mean that a lot of us are in less than perfect health. Less than perfect health may mean a shorter working life and earlier death.

This article explores the effect of less than perfect health on both the valuation of pension assets, and how they might be distributed to maximise the overall value of assets shared out in the final settlement. Practical next steps conclude the article.

Extreme ill-health
The extreme ill-health of one party in a divorce or dissolution has many implications which are generally recognised. In addition to the greater emotional issues the needs of the ill person might be very high, albeit for possibly a limited time. This may impact on the shape of the final settlement.

Where the person cannot carry on working an ill-health, early-retirement pension may have been, or imminently will be, paid. This may be for an enhanced income compared to the normal pension accrued to date. This pension may be payable for a shorter period, for example in the event of cancer, or for nearer to a normal life expectancy, for example on leaving work due to a mental problem.

Careful actuarial consideration of the value of the pension assets is needed in this situation. Such advice could also cover insurance policies which are now more likely to be paid out.

Less than perfect health
Less well understood is the implication of one or both parties being in less than perfect health. Obesity, smoking and an adverse family history are potential issues, as are other illnesses and injuries.

A certain amount of wear and tear is to be expected as we get older, as is an inevitable tendency to fill-out a little. Therefore we should not worry about every ache and pain of our clients, nor feel the need to quiz them on intimate medical details.

A rule of thumb to judge if a client's health may be an issue.

or

An adverse family history can be taken as a natural parent or sibling having had a life-threatening illness before the age of 60. Travel of less than 3 months abroad a year can be ignored. Judge obesity by eye with tact.

In the rest of this article those people who meet the above conditions will be termed as being in ill-health.

The impact of ill-health on pensions
Ill-health lowers life expectancy and hence the time over which a pension will be paid. Therefore the value of a pension of someone in ill-health is less then an equivalent pension for someone in average or better health.

For example someone in ill-health as defined above might be expected to experience twice the rate of mortality of the average. The value of a pension of £20,000 per annum to them at retirement to them might only be £375,000, compared to a value of £450,000 for someone in good health.

The treatment of ill-health in practice
It is a major complication, but also a major opportunity, that most pension schemes ignore the actual health of a member or their spouse in calculating CETVs and in pension sharing calculations. This will over-value the pension asset if either is in ill-health. The effect will be greater if it is the member in ill-health rather than the spouse or partner.

If the pension scheme does not ask for information on the health of the member or their spouse, then it is making simplifying assumptions which ignore the true state of the individual's health.

More appropriate valuations of pensions for use in divorces and dissolutions should provide the option to allow for the health of an individual in calculating the value of the pension asset and inform the decisions made on pension sharing proportions and offsetting.

Ill-health pension values
If a client is classified as in ill-health, the value of their assets is reduced. Usually a CETV does not account for this factor. It is unlikely that a pension scheme will alter its policy on this matter due to an individual case.

If the spouse is in ill-health then the value of their assets will be lowered by allowing for their state of health. Put another way a CETV that does not factor in ill health will produce a higher value for the spouse's pension assets than is realistic. An independent actuarial valuation that does not take the option to allow for the spouse's state of health will normally produce an even higher value.

Offsetting
In the normal course of events the impetus for using appropriate actuarial valuations for final salary (defined benefit) pensions will come from the party with the smaller pension assets, as appropriate valuations are invariable higher than CETVs.

However where the party with the larger pension assets is in ill-health their pension values will be reduced and it might be for their benefit to provide the impetus for appropriate actuarial valuations allowing for their health.

Although offsetting is a popular option there may be advantages in considering pension sharing to maximise the value of the settlement to the two parties.

Pension sharing
If all pensions are valued by all parties allowing for the state of health of the individuals then this has a neutral impact on the decision of whether and how to share pensions.

However if a pension scheme is valuing pensions ignoring ill-health, then it will have an artificially high value that can be captured by transferring the pension to the partner in better health through pension sharing.

The value of any benefit would be reduced by the costs of sharing and possible adverse terms offered to shared pensions. Sharing should not be undertaken without due consideration.

For example if Mr. and Mrs. A have total assets quoted in Form E's of £1,200,000, including a pension for Mr. A valued by his scheme for £480,000. However because he is overweight and smokes then his life expectancy is 7 years shorter than the average assumed and allowing for this his pension is only worth £380,000. So the real value of their assets is only £1,100,000 in total.

However if Mr. A shares his pension with Mrs. A so she gets all of it then the pension scheme will set up for Mrs. A a pension worth £480,000, an increase of £100,000. The total real value of the couple's assets to be divided therefore increases from £1,100,000 to £1,200,000 less expenses.

The converse is also true and sharing the pension of someone in good or average health, with someone in ill-health, will normally reduce the actual joint assets.

Other approaches
For clients approaching retirement there may be other ways to capitalise artificially high pension valuations, for example through requesting a transfer to a private scheme and then buying an enhanced annuity from an insurer. Consideration of such options requires financial planning advice.

Perfect Health
Finally you may be thinking, what about someone in perfect, or at least better than average, health? Does the converse apply? Will a CETV undervalue their pension? If they were divorcing would it help to transfer pensions to them to maximise the real value of our joint assets?

There are lots of people in better health than the average, but unfortunately the differential is not as great. Accidents and the cruel hand of fate conspire to put a limit on how much better our health can be compared to the average. Further our ability to identify who those who will be in the best of health when they retire is a lot lower than our ability to identify those in poor health. At the moment any attempt to identify and quantify superior health would be disproportionately expensive compared to the benefit.

So if your client is not in ill-health feel free to say they are looking extremely well and give the benefit of a warm glow inside.

So what?
Applying the above is very straight-forward as the hard work can be left to an actuary.

First check with your actuary how they will assess whether someone is in ill-health. With the help of a life underwriter, who is an expert in evaluating the risks of individuals, they should be able to provide a proportionate solution using a simple form.

Second if you use a financial advisor check they can allow for the health of the individuals in any advice they provide.

On each case as part of your initial fact finding check whether either party is potentially in poor health, you could use the rule of thumb above. If they fit the criteria, ask for the actuary's health form to be completed. It will probably be possible for your client to complete the form for both parties in the initial fact finding process.

When obtaining a value for your client's pensions, or checking that of their partner's, remember their health. Ill-health reduces the value of a pension asset.

The other party may also challenge your client's assessment of the health of the parties or its effect. The use of a systematic, evidenced process involving expert advice should support your valuations or enable you to argue for a joint instruction to settle the case as is proportionate. In the latter case if the two parties cannot agree on the health details provided to the actuary then the instruction should allow for the collection of objective evidence such as a GP report and/or a medical screen.

Similarly remember their health when determining the division of assets. You may at this stage want to apply the rule of thumb again to check whether the health of either party has deteriorated during proceedings.

It may be possible to maximise the value of pension assets by ensuring that the party in better health gets the pensions, because they will benefit from the income for longer. Against this is the cost of pension sharing and the loss in value caused by the way some schemes implement pension sharing orders. Again your actuary will be able to do the numbers on this.

Finally never be afraid to ask your actuary their advice: their's is a dying profession!

Nigel Bradshaw MA FIA is Design Director at Bradshaw Dixon & Moore Ltd
Email:
nbradshaw@bradshawdixonmoore.com
Tel
: 0845 838 2551
Dx: 55103 Rustington