A. Present Value
To produce a figure that can appropriately be attached to a defined benefit pension for equalization purposes requires that its “present value” (sometimes called “present-day capitalized value”) be determined. The present value of a stream of payments that are to begin at some point in the future may be thought of as the amount that one would have to invest today so that as of the date the payments begin the original investment plus accumulated earnings would be exactly sufficient to cover all of the payments as they come due. In the particular context of marriage breakdown and defined benefit pensions, the present value as of the valuation date is the amount that would have to have been invested on that date in order for the original investment and accumulated earnings to be just adequate to fund the monthly benefits when the pension comes into pay. Of course, this figure is necessarily the product of conjecture. The person performing the valuation does not know on the valuation date when the pension payments will begin (given that the date of retirement is unknown on that date) or even whether they ever will begin (given the possibility that the employee will die first) or if they do begin, how long they will last (given that the date of death is unknown), nor does he or she know how much any given investment will ultimately earn (given that tomorrow’s interest rates and inflation levels are unknown); lacking omniscience concerning the future, the valuator must make assumptions about all of these variables. As the Supreme Court of Canada has noted, ascertaining a present value is “a matter of educated guesswork, undertaken by actuaries”.
B. Methods of Valuation
Although there seems to be little doubt today that the present value approach is to be preferred over the contributions approach in valuing rights under a defined benefit pension plan, at least some uncertainty regarding the methodology used to calculate a present value continues to exist. Neither the FLA nor the Pension Benefits Act (PBA) provides any guidance as to how pension rights should be valued for purposes of calculating net family property; therefore, the question of how it should be done has been left to be answered by the parties, their lawyers and pension valuators (and ultimately, the courts). Debate on the issue has typically been framed as a matter of whether to use the “retirement method” or the “termination method”. However, there is some considerable ambiguity in these terms, and it is not always clear what a court means when it declares that one or the other method is being utilized. Indeed, it has been suggested that in many cases in which the termination method was ostensibly used, the method that was actually being employed was the “real interest retirement method” (also known as the “hybrid termination-retirement method”).
C. Retirement Method v. Termination Method
The retirement method assumes that the employee will continue in his or her employment with the plan sponsor until reaching some specified retirement age selected by the valuator; accordingly, the basis on which the value is calculated includes projections as to future salary increases, both those that are rooted in inflation and those that are based on promotion or productivity increases, as well as future service credit accruals and possible pension plan enhancements. In contrast, under the termination method, the amount of the future pension entitlement is said to be assessed as if the pension plan member had terminated his or her employment on the valuation date. This means that only those service credits accrued to the valuation date are taken into account; it would also seem to imply that no consideration is given to the possibility of salary increases that may occur after that date.
If one goes strictly by the labels employed by Ontario courts to describe their preferences in valuation methodology, the termination method seems generally to have found much more favour than the retirement method, although the view that it represents the better approach is by no means universal. (Indeed, the Supreme Court of Canada has raised the possibility that the retirement method might provide an appropriate result in at least some circumstances.)
Two main arguments have been advanced in support of the termination method over the retirement method. The first is that by projecting salary levels and service credits that will be earned after separation, the retirement method gives the non-member spouse the “fruits” of the member spouse’s post-separation labours and is therefore in conflict with the FLA requirement that value be determined as of the valuation date. How valid an objection this is can be debated. While the retirement method undeniably looks to post-separation events (or, rather, assumptions about post-separation events), the “years of service” multiplier used in a defined benefit plan formula does not assign any greater weight to the final years of the member’s time with the plan sponsor than to the early years (although the dollar multiplicand employed in the formula obviously would be based on projected post-separation salary levels).
The second principal objection to the retirement method concerns its highly speculative nature, resulting from the fact that it requires the making of assumptions as to what the member spouse’s salary and service credits will be when he or she does retire. These assumptions will virtually never have a perfect correspondence with future facts as they unfold and they may not even be close. Still, the termination method also involves the making of many assumptions. In order to produce a present value, the termination method, like the retirement method, must employ assumptions about when (and if) the member spouse will retire and about how long he or she will collect the pension; assumptions are also made about future rates of interest and taxation. Any of these assumptions could turn out to be “incorrect”, in the sense that events might unfold differently than was assumed; and, in fact, they will almost certainly prove to be so in any individual case, notwithstanding their validity from an actuarial point of view. And, if the assumptions made do turn out to be wrong, the actual value of the pension benefit and the value it had been considered to have had for equalization purposes could deviate quite dramatically, to the great disadvantage of one or the other spouse. For example, if the member spouse ends up collecting the pension for a longer period than that on which the valuation was based, the actual value of the pension rights may end up exceeding, perhaps by a quite considerable amount, that which was attributed to them as net family property.
D. Do the Courts Really Favour the Termination Method?
In Bascello v. Bascello, the court reviewed a number of previous decisions of Ontario courts purporting to apply the termination method and concluded that most of those courts were not in fact using a true termination method but the “real interest retirement method” (often labeled the “hybrid termination-retirement method”). Under this approach, while the valuation is based on the pension entitlement accrued to the valuation date, allowance is made for inflation (at least in the case of fully-indexed plans, as most public sector plans are); it is only non-inflationary increases in salary, such as those stemming from promotions and productivity improvements, that are not taken into account.
Another respect in which the method that is typically employed by Ontario courts is not a pure termination method lies in the treatment of rights that an employee may have under the pension plan to take early retirement without any reduction in the defined benefit. While courts that purport to apply the termination method do not take into account any actual or assumed post-valuation date employment for purposes of calculating the amount of the pension, in the majority of cases that have dealt with pension plans having an unreduced early retirement option the courts did assume that the employee’s employment would continue for the purpose of eligibility to exercise such an option.
This distinction can be illustrated with the example of an employee who has twenty-one years of service, who is 45 years old as of the valuation date and whose pension plan establishes a normal retirement date of age 65, but also accords a right to take early retirement without penalty if the employee meets a “factor ninety” qualification (i.e., the employee’s age plus his or her years of service add up to ninety). A valuation based on a pure termination method would ignore the unreduced early retirement possibility, as the stated premise of the termination method is that the future pension entitlement is assessed as if the pension plan member had terminated his or her employment on the valuation date, and the employee in our example would reach the normal retirement date without having achieved the factor ninety threshold. Nevertheless, although the amount of her pension entitlement will be based on her years of service as of the valuation date, most courts will posit continued employment after the valuation date and eventual qualification for an unreduced early retirement pension (in the case of the employee in this example, at age 57) for the purpose of selecting the date on which the employee is most likely to retire. (Objections that the member spouse’s employment may terminate prior to retirement because of lay-off or other reasons are typically addressed by using a discount for that possibility.) This can have a very substantial impact on the valuation, because if the employee retires before the normal retirement date, the pension is likely to be in pay for a longer period than it otherwise would, thereby increasing the value.
Despite Bascello and a number of other cases that seem to reject, in substance if not in name, the termination method (at least in its pure form), this area of the law cannot be regarded as entirely settled. In Salib v. Cross, decided after Bascello, the Ontario Court of Appeal approved the trial court’s use of a quite stringent termination approach in which the member spouse’s pension was valued on the basis that she would retire on a reduced pension, even though the retirement date was assumed to be the day on which she would first qualify for an unreduced pension; approaches that would have resulted in a higher valuation were rejected on the basis that they were too speculative, given that on the facts before the court considerable post-valuation date service would have to be assumed. On the other hand, the Supreme Court of Canada has suggested that the retirement method might be appropriate in some circumstances. Thus, it appears to be that while the hybrid termination-retirement method (or, using the terminology preferred by the Bascello court, real interest retirement method) is the most frequently used, a court has discretion to employ the termination method or the retirement method if it thinks that that method produces the fairest result in a particular case. However, this means that at least some uncertainty about how a defined benefit pension should be valued for family law purposes continues.