Greece, Spain, the Euro and your Divorce Settlement

on Thursday, 14 June 2012. Posted in General News

To start with you have to consider how your defined benefit pension is valued, in valuing an accrued pension the expected future payments are projected and then probability of surviving each year is applied.  These expected cash flows are then “discounted” at a rate of interest and summed to provide what is known as a Present Value, it’s a bit like projecting forward your savings applying interest each year, only in reverse.

As payments can be expected to be made many years into the future, the value placed on the pension benefits is extremely sensitive to changes in the rate of interest used; a 0.5% reduction in the rate of interest would increase the value of pension benefits by around 15% - 20% for someone aged around 45.

To value pension benefits, the actuary has to decide upon a rate of interest to use as part of the overall assumptions.  The starting point is to consider what rate of interest is available on investments with minimal risk and similar duration to the pension in question, this means starting from the yield (rate of interest) on longer term UK Government or high quality corporate bonds.

Now, back to the issue of the crisis in the Euro zone, as concerns have increased in relation to a breakup of the Euro and the risk of default by the PIGS, funds have flooded out of these countries to  what are considered safer havens, Germany, Switzerland and the UK amongst those considered relatively safe.  Funds coming into the UK increases the demand for UK Government bonds, as with any product, an increase in demand results in an increase in price unless supply in increased.  An increase in the price of bonds means that investors are paying a higher price for the same interest and redemption proceeds therefor the yield on those bonds decreases.

The yield on 20 year government bonds now sits at around 2.6% in June 2012, in June 2011 the yield was around 4.1%, a reduction of around 1.5% in 12 months.  For the 45 year old referred to above, that equates to an increase in the value placed pension benefits in excess of 50%. 

 

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