Just PENSIONS

Before-the-Fact v. After-the-Fact

If the court retains jurisdiction and supervises the disposition of the future payments, then it is operating after-the-fact with actual, known facts. The person is either alive to receive the payment or not, and the amount of the payment is known. On the other hand, in the actuarial present value, or cash-out method, the actuary does not know in advance the amount of the payment or whether the person will be alive to receive the payment. The actuary must substitute after-the-fact known facts with before-the-fact estimates. A condition necessary for a retirement plan to pay benefits is that the person be alive. After-the-fact this is either a “yes” or “no” situation; before-the-fact this is a contingency. Dealing with the consequences of contingent events is a hallmark of the actuarial profession. An actuary treats a contingency as a probability and weights the consequence of the contingency by its probability. For example, if the probability that a $100 payment will be made is one in four, the expected, or actuarial value of the payment is $25. This expected value is discounted from the time of payment back to the date of appraisal, and the result is known as the actuarial present value.

The actuarial present value process replaces after-the-fact knowns with before-the-fact estimates. Each factor that is involved after-the-fact has its before-the-fact counterpart. If after-the-fact, the magnitude of the pension payment is based upon a compensation period that occurs after marriage separation, then the actuarial present value process replaces this after-the-fact compensation period with its before-the-fact estimate.

The Actuarial Present Value Approach is Fair

Two realistic choices are available for disposing of the community interest in a pension plan: assign the entire interest in the pension plan to the employee and give the spouse other assets of equivalent value, or wait until the employee retires and divide each retirement payment as it is paid.

Despite the extensive discussion of this question, apparently the courts and attorneys do not always understand the nature of an actuarial present value of future retirement payments. An actuarial present value is one form of mathematical expectation. Let us consider an analogous, but simple case. (Mr. Murray Projector, a dissolution actuary in Claremont, California, first used this analogy.)

Suppose that tickets are sold as entitlements to the outcomes of each of a succession of coin tosses; in each case, heads pays $1,000 and tails pays nothing. The mathematical expectation is thus $500 for each toss, since half the time $1,000 will be paid and half the time nothing will be paid.

There often seems to be an instinctive, or gut, feeling that reserved jurisdiction is inherently fairer that the actuarial present value is an unrealistic product of imagination.

Most people would agree that $500 is the fair value of a ticket. This value seems reasonable, whether applied to one ticket or to hundreds of tickets for hundreds of coin tossings in hundreds of locations.

Suppose a review of the actual outcomes of these heads-or-tails happenings is made, and a comparison made, ticket by ticket, with the actual results. How does the fair price of $500 compare with the effect of each toss on each ticket holder? Sometimes, the fair price is $500 more than the amount realized; sometimes it is $500 less. When a sufficiently large number of tosses have been made, the average amount realized is very nearly equal to $500.

In no single case, however, does the accepted appraised price prove equal to the actual value determined by later events. Thus we have a fair price which is always wrong when rightness and wrongness are determined by future events.

At this point, some of those who originally agreed with the $500 appraisal become uneasy. A fair price that is always contradicted by future events is hard for many to accept. For others, this apparent conflict presents no difficulty. The latter group makes and maintains the distinction between a fair value and predicted outcome. The $500 is a fair value; it is not a prediction of future events.

An analogy with actuarial present values of defined benefit pension plans is possible. An actuarial present value for the community interest in pension plan benefits is neither a prediction of the value nor a prediction of how long the employee spouse will live. It is a fair value now, based on probabilities of future events. If actuarial present values are calculated properly, then future realized values will exceed fair values about half the time, and fall short the other half.

The relationship between later realization and actuarial present values should be disassociated from what is equitable now. Later events, such as length of life, are chance events unrelated to need or merit. To measure the community interest at trial by the outcome of fortuitous events, as is done by reserving jurisdiction, is using the wrong criterion for fair value.

The actuarial present value approach determines the value of a community asset at time of trial. It is like the value now of a ticket to a coin tossing, and the rightness of that value will not be better determined by waiting for events to unfold.

Understanding actuarial present values leads to the following conclusions:

• Actuarial present value replaces an all-or-nothing gamble with assurance of a fair division of community property. Makes it possible for both spouses to plan for the future.

• Assuming sufficient other assets, the courts in most cases, if not all, should prefer immediate cash-outs.

• The legitimacy of the actuarial present value approach is unquestioned. Despite its apparent individual inequity, the use of mathematical expectation is accepted not only in all jurisdictions but also in everyday life.

• The attorney who advises a client to accept a proposed settlement in lieu of litigating the matter is mathematically weighing the expectation of the potential outcome of the trial against the value of the settlement.

• While history can be used as a basis for the assumptions selected, predicting the future is still difficult. Some assumptions of future events, such as mortality, can be predicted quite accurately; others, such as future investment return, cannot.

• The dissolution actuary must select assumptions carefully. They must be defensible.