Just PENSIONS

Appraising the community interest in a pension plan upon dissolution of marriage is not a well-defined process. It is necessary to know what series of benefits is being valued. Is it the series of monthly benefits expected to be paid starting at the earliest retirement age on the assumption the employee terminated service now? Is it the monthly benefit expected if the employee continues in service and does not receive any salary or benefit level increases? Or is it the monthly benefit expected if the employee continues in service and receives salary and benefit increases? What age is assumed for retirement? If the plan has a provision for a post-retirement cost-of-living adjustment, has this benefit been valued? Has the valuation been made as of the date of separation without apportionment between separate and community property, or as of the date of trial with the community interest apportioned between separate and community property? What technique was used to make the apportionment? What assumptions were used? Are the assumptions consistent? If the life expectancy method has been used, be careful! Use of the life expectancy method suggests that a quasi-actuary has made the calculations. The method has been widely condemned by both actuaries and courts. Properly used, the life expectancy method can sometimes produce valid approximations; however, a review of reports made by quasi-actuaries using this technique more often than not discloses mistakes. For example, in several cases the actuarial present value developed has been the value at retirement, not the value now (the actuarial present value). In other cases, the technique has been applied in a manner that assumes all the monthly pension payments are held back and paid at the time of death.

It is popularly believed that the expectation of life is widely used in actuarial calculations. In reality, it is of interest to actuaries as an index for comparing different mortality tables. The life expectancy method is unnecessary, improper, and indefensible, but unfortunately too firmly entrenched in legal and judicial publications for removal and obliteration. Inadequate data and benefit documentation can seriously impair the validity of an actuarial valuation. The available booklets describing pension plan provisions are occasionally incomplete, ambiguous, or out of date. The actuary is dependent on his attorney-client to obtain current plan information and accurate statistical data on which to base a valuation.

A. Actuarial Value of What Benefits?

1. Introduction

a. Community Property Defined

Community property is property acquired by either spouse during marriage as a result of community property labor or purchase with community property funds. Benefits resulting from service under a pension plan during marriage qualify as community property. Property acquired after separation is separate property — Civil Code #5118 (now Family Law Code #771).

b. “Community” times “Separate” — Character ?

What is the character of property whose value is dependent upon the product of community property and separate property? Part of the benefits under a final pay defined benefit pension plan are a function of service, which is community property, and salary above the salary at the time of marriage separation which is separate property. Typically, if employment continues after marriage separation, benefits for all years of service will be based upon a salary earned postseparation that is greater than the salary at the time of marriage dissolution. The excess salary is, by definition, separate property. The service for the community period is, by definition, community property. Considered alone, neither the excess salary nor the community service has any value for pension purposes. However, taken together, a value is created. What is the character of a hybrid asset that requires both separate property (service) and separate property (postseparation salary increase) to have value? The purpose of this section is to show that many of the determinations necessary for a conclusive answer to this question have not been answered and to argue that this hybrid benefit is community property and should be valued for community property purposes.

c. Equal Division Requirement

The court is required to make an equal disposition of community property between the spouses. For pension benefits, the court can select between the approaches of retained jurisdiction and actuarial cash-out. If, in practice, these different approaches are allowed to produce results of differing values, can both remain valid given the requirement of an equal disposition?

(1) Under Retained Jurisdiction

If the court decides to distribute the community interest in the benefits as each pension payment is made (retained jurisdiction) and if employment continues, the law is clear that the community shares in benefit increases resulting from postseparation salary/benefit increases.

(2) Under Cash-Out

Should the dissolution actuary, in making a valuation for cash-out purposes, value the benefit stream expected to be received if the court selects the alternative retained jurisdiction method of disposition? In other words, should the dissolution actuary develop an equivalence in value between the approaches? Or is the assumption (that the actuarial cash-out approach should value the same stream of benefits expected if the court elects to retain jurisdiction) simply arbitrary and without foundation? Is the valuation for cash-out purposes to be limited to a consideration of what is available if the employee spouse terminates employment now? Is the cash-out an alternative that the non-employee spouse can choose in lieu of receiving an equal share of the community property asset?

(3) Some Viewpoints

Some commentators, in discussing the considerations supporting the actuarial approach from the viewpoint of the employed spouse, state that using the actuarial approach precludes the non-employee spouse from sharing higher pensions resulting from increases in pay. For example, in the Treatment of Retirement Benefits from the syllabus of the Annual Los Angeles Bar Association Family Law Section Symposium, Judge Richard E. Denner states that there is no authority statute or case for the use of projected salary in the calculation of the actuarial present value of retirement benefits. This interpretation means that the determination of the actuarial present value of retirement benefits (cash-out value) is independent of what is expected to occur if jurisdiction is retained. In other words, the actuarial or cash-out approach calls for the valuation of a different stream of benefits from those involved under the alternative approach to disposition of retained jurisdiction. Under retained jurisdiction, the law is well established that the community shares in benefit enhancements due to future salary/benefit increases. If the court can select among different approaches to valuation, how can it be possible for these different approaches to produce results of different value? On the other hand, if the actuarial or cash-out approach is supposed to develop the best estimate of the present value of the future benefit stream expected if the court retains jurisdiction, then all factors, including future salary or benefit increases, should be considered in the calculations. The effect of future salary or benefit increases on an anticipated basis should be part of the actuarial present value calculation, and the community should receive consideration for benefits resulting from these anticipated increases.

2. Footnote 9

Gillmore [1981] The purpose of this note is to provide some actuarial background that may result in a better understanding of both footnote 9 of Gillmore [1981] and the actuarial valuation process. Footnote 9 reads as follows: “The non-employee spouse, of course, cannot have it both ways. The decision to ask for distribution of the retirement benefits before the employee spouse actually retires constitutes an irrevocable election to give up increased payments in the future which might accrue due to increased age, longer service, and a higher salary”. (In re Marriage of Luciano supra 104 Cal App.3d at p.961, citation omitted.) Thus, if Vera chooses to receive her share of the retirement benefits immediately, she will forfeit her right to share in the increased value of those benefits in the future. 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 benefit payment or is not alive. Both the amount and occurrence of the benefit payment is known. On the other hand, in the cash-out, or actuarial present value process, 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 assumptions. For a retirement plan to pay benefits, it is necessary that certain conditions be met. Typically, for payments of basic retirement benefits, it is necessary for the person to be alive. After-the-fact, this event is either a “yes” or “no” situation; before-the-fact, this is a contingent event. Dealing with the consequences of contingent events is a hallmark of the actuarial profession. An actuary treats a contingent event as a probability and weights the consequence of the event by the probability of its occurrence. For example, if the payment of $100 is contingent on an event that has one chance in four of happening, the probability is 25% and the expected, or actuarial value, of the payment is 25% of $100, or $25. This expected value is then discounted from the time of payment back to the date of appraisal, and the result is known as the actuarial present value for that particular benefit payment. The actuarial present value process replaces after-the-fact knowns with before-the-fact estimates. Each factor involved after-the-fact has its before-the-fact counterpart. If, after-the-fact, the magnitude of a pension payment is based upon a compensation period that occurs after the Gillmore election, then the actuarial present value process replaces this after-the-fact compensation period with its before-the-fact estimate. If the implied “actual” is added, Footnote 9 would read: “The non-employee spouse, of course, cannot have it both ways. The decision to ask for distribution of the retirement benefits before the employee spouse actually retires constitutes and irrevocable election to give up increased payments in the future which might accrue due to actual increased age, actual longer service, and an actual higher salary”. (In re Marriage of Luciano supra 104 Cal App.3d at p.961, citation omitted.) Thus if Vera chooses to receive her share of the retirement benefits immediately, she will forfeit her right to share in the increased value of those benefits in the future. With the implied “actual” added, the intent of the footnote becomes clear. If the non-employee spouse elects to receive a stream of benefits now (and this stream of benefits is reduced to an actuarial present value), the non-employee spouse in the actuarial present value process already has received benefit due to assumed increased age, assumed longer service, and assumed higher salary. The non-employee spouse cannot have “it” both ways and receive additional increases based on actual events; however, the non-employee spouse should have “it” one way or the other–either after the fact (retained jurisdiction( or before the fact (actuarial cash-out). It is clear that if the retained jurisdiction approach is used, the community receives consideration for benefits resulting from actual future salary or benefit increases. Obviously, the community should not receive benefit from both assumed and actual future salary increases. To do so would give the community two bites of the same apple. However, if the apple is there to bite, and it is clear that it may be there, the community should get a bite regardless of the approach used for disposition. Under retained jurisdiction, the bite comes from the result of actual salary or benefit increases. Under the actuarial or cash-out approach, the bite comes from the results of assumed future salary or benefit increases.

3. Benefit Stream to Reduce to Present Value

What monthly benefit stream should the dissolution actuary reduce to present value? Brown [1976] held that all pension benefits, whether vested or nonvested, earned during the community period are community property. Vesting, as used in a marriage dissolution proceeding, occurs when the employee is certain to receive benefits, whether employment is continued, although survivorship to a particular age may be a further requirement before actual payment. Brown directed the trial court to consider the possibility that . . . termination of employment may destroy (pension) rights before they mature. In our hypothetical case, the Gillmore [1981] situation would occur at employee’s age 50 (benefits matured), when the employee could either retire with a monthly benefit stream of $400 or continue employment until age 55, when a monthly benefit stream of $825 would be available to the community. In this situation, should the analysis be limited to the monthly benefit stream of the $400 available and conclude that (since the non-employee spouse has an immediate right to the actuarial present value of this benefit stream) no consideration should be given to the monthly benefit stream of $825 available to the community at age 55 if employment continues? The court does not have the discretion to defer the start of distribution of the community interest until the employee spouse reaches age 55, if the non-employee spouse exercises Gillmore rights at the time of the dissolution. However, if the non-employee spouse does not exercise this right, and the court is left with the discretion to dispose of the pension benefits, should the court limit its consideration to the actuarial present value of the matured benefit available? At employee’s age 50, even though the Case II benefit is mature, the Case III situation remains as a nonvested benefit. Should this Case III benefit be considered by the court per Brown [1976]?

a. Hypothetical 1

(1) Disposition 1 If employment ends at age 40, the community divides a monthly benefit stream of $200.00 starting at age 50, the earliest possible retirement age; each payment is contingent upon the survival of the employee spouse.

(2) Disposition 2 If employment continues to age 50, the community divides a monthly benefit stream of $400.00 starting at age 50, with each payment contingent upon the survival of the employee spouse.

(3) Disposition 3 If employment continues to age 55, the community divides a monthly benefit stream of $825.00 starting at age 55, with each payment contingent upon survival of the employee spouse.

b. Hypothetical 2

Consider an employee, now age 54, who has 29 years of service, all during the community period, covered by a plan with a monthly benefit formula of 2% per year of service times high-3 salary (the highest average monthly salary over a three year period) with deferred retirement at age 62, or longevity retirement at age 55 with 30 years of service. The monthly benefit available now is a deferred benefit, starting at employee age 62, of 58.00% of high-3 salary. The benefit is vested but not matured.

If the non-employee spouse wants his/her share now, should the actuarial analysis be limited to the benefit available now here, a monthly benefit stream of 58.00% of salary starting at employee’s age 62? Or should the nonvested longevity benefit that starts at age 55 be valued with discounting to reflect the possibility that 30 years of service will not be completed?

Under retained jurisdiction, if employment continues the one additional year, the community will have a 29/30ths interest in a monthly benefit of 60.00% of the member’s high-3 salary starting at employee’s age 55. If the non-employee spouse wants his/her share now, is the community value limited to what is available now, in this case, the monthly benefit stream starting at employee’s age 62?

Or should the court follow the direction of Brown and consider the actuarial present value of the community benefit stream starting at age 55, with some reduction for the possibility that the additional year of service may not occur? Since benefits in this hypothetical case are based on high-3 salary, if employment continues an additional year, how should the high-3 salary on which the benefits are based be estimated? Should the high-3 salary be calculated on the assumption that the next year’s salary will be the same as the current salary? Or should an estimate be made of the salary that is expected to be paid, if the additional year of service is worked? Or should the average salary at the time of trial, an assumption that generally implies a decrease in future salary, be used?

c. Hypothetical 3

Ask your actuary or pension plan appraiser for an opinion on the following hypothetical case:

“I have a client, age 40, who has been covered under the 2.0% at 50 California Highway Patrol formula for the past 20 years. My client is earning $2,500 per month. If employment of my client continues until age 50, my client expects to receive salary increases of 5.0% per year. My client has an offer to change employment. The retirement formula of the potential employer is the same as the retirement formula for the CHP. Should my client give any consideration to the economic consequences of changing employment with respect to the 20 years of service already invested in the retirement program?”

Without exception, any actuary will agree that if employment continues and salary increases are granted, the 20 years of service already worked have additional value. Why then, if the hypothetical case is modified to reflect a family law situation, should the conclusion of the actuary change? If the basic idea is that all benefits that flow from community service are community property and subject to valuation, why then should the benefit based upon community service and future salary increases that result from continued employment be ignored?

B. Valuing the Pension Benefits

After determining the contingent (actuarial), interest (economic) and the monthly benefit amounts, the dissolution actuary combines them to determine the value of the benefits.

1. Valuation Date

Generally, the valuation date should be as close to the date of trial as possible unless an alternate valuation date has been approved. See Civil Code #4800 (now Family Law Code #63), Marsden [1982], and Hayden [1981]. Shattuck [1982] suggests that valuation be made as of the date of marriage separation. However, to be consistent with Gillmore [1981], Civil Code #4800 (now Family Law Code #63) and sound actuarial principals, Shattuck [1982] needs to be interpreted as having the community interest stop at the date of marriage separation. That is, the community interest has to be apportioned out from the total interest.

2. Two Scenarios

As a general practice, the dissolution actuary should consider two scenarios if the participant spouse is currently employed. The first scenario considers that employment may terminate now, and the second that employment may continue until the participant is eligible for retirement. If the participant has terminated employment with a vested right to a deferred pension benefit, is eligible to retire, or has already retired, consideration is limited to one scenario.

a. Employment Termination Now

The first scenario assumes employment will terminate now. The benefit valued is the deferred pension benefit payable at the earliest possible retirement age permitted by the pension plan. As the service on which the benefit is based ceases, no projection of salary or benefit level is made.

b. Employment Continues Until Retirement

The second scenario assumes that employment will continue until the earliest date possible for retirement and values a pension benefit (longevity pension benefit) projected to this date. The pension benefit is based on the assumptions that the participant continues in service and receives increases in either salary or benefit level. The concept supporting the second scenario has been called the momentum concept and is described in Adams [1976], Judd [1977], Anderson [1976], and Andreen [1978].

3. Momentum Concept

Momentum generates an extra community interest which is the difference between the value developed in the second scenario and the value developed in the first scenario after adjustment for nonvested benefits. The difference in value represents the potential increase in the value of the community interest due to postseparation efforts built on the foundation of community effort. It may be reasonable to assume that the community has an interest in this extra value proportional to service already rendered to total career service. Example Actuarial present value of benefits if employment continues to retirement, the longevity or projected benefit $100,000 Actuarial present value of benefits if employment terminates now, the deferred retirement benefit. $70,000 Additional value resulting from continued employment “momentum” $30,000 Years Already Worked 20 Future Years to Retirement 10 Total Years 30 “Time-rule” apportionment of $30,000 additional value to community interest $20,000

4. Justification of Momentum Concept

The momentum of a pension benefit that arises from effort during the community period can be likened to the building of goodwill in a business, particularly in the case where the pension benefit is based on a final-pay formula. The benefits based on the period of employment during the community period are enhanced by the future final salary. Even for non final pay plans, the community interest is enhanced during periods of inflation, because if the employee remains in service to retirement the employer will often increase the benefit level, either directly or indirectly, to offset inflation.

C. Assumptions

1. Economic Assumptions
a. Interest

An interest rate for discounting to present value is required. The trial court need not accept the interest rate used by the expert, but may have the value computed using an interest rate the court finds appropriate — Bergman [1985]. Sheldon [1981] held the trial court determines the interest rate to be used, based on the credibility of experts. (1) PBGC and annuity purchase rates Pension Benefit Guaranty Corporation (PBGC) interest and mortality tables are often used by actuaries outside California and an argument can be made for using current annuity purchase rates, typical California practice is to assume a level interest rate for discounting purposes.

b. Post-Retirement Increases for Cost of Living

Any automatic post-retirement cost-of-living increases provided by the plan will be paid. However, a maximum to the post-retirement cost-of-living needs to be made by the actuary.

c. Pre-Retirement Benefit or Salary Increases

Before retirement, projected benefits are based on an assumption that future salary increases at 3.00% per year. If projected benefits are not based directly on salary, an assumption that the benefit level per year of service will increase at 3.00% per year is made.

2. Actuarial Assumptions

a. Mortality Rate

“The mortality basis selected shall be one considered representative of the experience of the pension plan members in general, modified if appropriate to reflect a medically determinable impaired state of health of the particular plan member. Tables commonly referred to as “population” mortality tables normally are not appropriate, whether with respect to a plan member, former plan member or a spouse. The table should be a sex-distinct table. Unisex mortality is not permitted.” — from Standard of Practice for the Computation of the Capitalized Value of Pension Entitlements on Marriage Breakdown for Purposes of Lump-Sum Equalization Payments of the Canadian Institute of Actuaries. Pension mortality tables are more appropriate than general population mortality tables for determining the community interest in pension plans on dissolution of marriage because they reflect the expected mortality rates of employed persons rather than those of the general population. It should be noted that many pension plan appraisers from other, non actuarial professions, usually use the less appropriate population (United States Life) tables. Other pension plan appraisers, also from non actuarial professions, use annuity purchase rates. Such rates include insurance agent commisions, allowance for anti-selection against the company, premium taxes, and insurance company expenses. Pension (annuitant) mortality tables often used for calculations in dissolution of marriage cases are:UP-94 Table

(1) UP-94 Table

The 1994 Unisured Pensioner Mortality Table updated the UP-84 Mortality to reflect the decreased rates of mortality (that is, improved mortality), indicating that the current mortality for uninsured pensioners based on data from 1985 through 1989 was about 14 to 18% less than that expected under the UP-84 Mortality Table. The UP-94 Table is one of the first mortality tables to factor in generational mortality, which recognized the trend of mortality improvement and dynamically projects and incorporates those improvements.

(2) 1983 GAM (Group Annuity Mortality) Table

Developed specifically for use in the valuation of pension plans, the 1983 GAM Table replaces the 1971 GAM table;

(3) UP-1984 Table

The Unisex-Pension 1984 Table was based on the mortality experience of twelve large uninsured pension plans of which female experience representated about 20% of the pensioner death experience. A one-year set forward in age represent the mortality experience of an all male group. Likewise, a five year age setback may be considered appropriate for an all female group. Use of an age setback is an actuarial technique to modify an existing mortality table by using mortality rates for a younger (setback) age than the actual age involved.

(4) CalPERS Table

This mortality table, based upon the experience of the California Public Employees Retirement System, was developed specifically for use in the valuation of the CalPERS plan.

b. Sex

Verlinde [1987] accepted actuarial values based upon sex-distinct mortality rates and held that a wife is not denied equal protection of the law when the court considers her statistically greater longevity.

c. Poor Health of Either Spouse

(1) Modify the Mortality Table

Modification of the mortality table was approved in Bergman [1985] and Shattuck [1982]. If either spouse is in poor health, a special mortality table, a modification of an existing mortality table or a cash-flow analysis is indicated. Shattuck [1982] held that the court will take into account the “inherent uncertainties such as the parties’ probable life expectancies and their health … embrace everything that has reasonable relevancy…”.

(2) Life Underwriter v. Medical Doctor

An insurance company risk underwriter (not an insurance salesperson) is the professional person best qualified to review medical records and advise the actuary on appropriate modifications to an existing mortality table. The typical medical doctor does not have the statistical experience necessary to make a valid assessment of the effect of medical impairments on longevity. Most dissolution actuaries have established a working relationship with a life underwriter for reviewing medical records. Generally, there is no need for the underwriter to testify as it is customary for an actuary’s opinion to based on the advice provided by the underwriter.

(3) Other Considerations

Shattuck [1982] ordered the taking into account the “inherrant uncertanies such as the parties’ probable life expectancies and their health, and the fact that an early death might preclude any pension payments at all. It will embrace everything that has reasonable relevacy to the expectany’s present value.”