The year 2022 experienced unprecedented levels of global market volatility. In particular, because of political instability and a controversial “mini-budget”, in September 2022 the British pound fell over 16% against the US dollar and 7% on a trade weighted index. This resulted in greater than anticipated increases to the cost of living, as the cost of exports rose. The turbulence of 2022, which included the economic impact of the ongoing conflict in Ukraine, has caused huge ruptures in the markets and many economists fear that the worst is yet to come. The Bank of England responded to the crisis and raised interest rates by 50 basis points in an attempt to balance inflation. In 2022, the UK has experienced interest rates rise from 0.1% to 3.5% and it is expected that they are to continue to rise well into 2023. These changes will have a significant impact on most households and families across the UK, but what does this mean for couples getting divorced and their financial settlements?
Valuing assets
A financial agreement following a divorce is centred around financial disclosure – this means agreeing the value of domestic and offshore assets including investments, shares, digital assets such as crypto currencies, and pensions. If you are in the process of negotiating the terms of a financial settlement it is vital that updated values are produced regularly to ensure any assets schedules, which form the basis of negotiations, provide an accurate reflection of what your assets are worth in the current market. Given the volatile markets, it may be more appropriate to divide assets rather than agree offsetting lump sums to share the risk across a portfolio and avoid a gamble on the market.
For international families with investment and property portfolios across several different jurisdictions, the fall in the pound creates difficulties when considering the relative values of domestic and international assets. This may lead to couples revisiting financial settlements to recalculate how assets have been allocated and divided. This is particularly the case with individuals who may have assets held in the US, or funds held in US dollars, given the weakness of the pound.
If expert valuations have been prepared during negations or financial proceedings, you should consider asking the expert to update their findings based on current market conditions. Many companies will find that their export costs have rocketed which may have a significant impact on its profitability, the value of shareholdings and the income that will be drawn from shareholders as dividends. Therefore, reliance on previous performance and last year’s accounts / returns may not be a reliable indication of how a company will perform.
The courts made it clear in case law following the 2008 financial crash that financial agreements that had already been approved by the court could not be revisited due to unpredicted economic change and that market fluctuations do not justify reopening and re-drawing capital orders. However, there may be scope for agreements made by consent and orders that have been approved but not yet implemented, to adjust orders where market volatility has resulted in an unfair outcome that is not in line with what the parties (or the court) had intended.
Mortgage rates and the housing market
Another factor that may have a huge impact on the terms of a financial settlement in a divorce is the impact of increasing mortgage rates, and in turn the effects on the housing market. The ability to purchase a home and the reasonable housing needs of the family can be a turning point and crucial factor in negotiations for the court. My colleague, real estate partner Lee Greaves, who frequently acts for clients purchasing and selling high value property and estates, summed it up like this:
“The increase in mortgage interest rates affects affordability and will start to put the housing market under stress. When the costs of borrowing increase dramatically, the ability to purchase a property which meets the needs of the family becomes more difficult. The recent changes to Stamp Duty Land Tax will do little to change that picture. The availability of affordable finance on a re-mortgage can also affect the ability of parties to raise funds on property that forms part of the settlement.”
Mortgage borrowing capacity can be influential in agreeing the terms of a settlement, therefore it is important that any deal is based on current market possibilities and is also realistic when considering affordability and monthly mortgage payments when budgeting.
Income and tax
The changes implemented to taxation under the government will also need to be considered and reviewed when agreeing the terms of a financial settlement. Any projections based on historic rates of income tax and corporation tax will need to be updated to reflect the Autumn Statement announced in November 2022, due to be implemented from April 2023. Another colleague, tax expert Adrian Moss, summarized the situation:
“The autumn statement followed a rather chaotic political period in respect of the public finances and, whether you agree or not with what appears to be the outcome, the proposed tax changes will need to be factored in to considering the terms of a financial settlement. In general, taxes are increasing in relative terms. Corporation Tax will be rising to 25% from 1 April 2023, with the previous proposal to shelve the tax increase having been withdrawn. For income tax, the personal allowance and higher rate tax thresholds have been frozen, while from 2023 the dividend allowance will be halved from £2,000 to £1,000, and then halved again next year to £500. The capital gains tax exemption will follow a similar path – being more than halved from £12,300 to £6,000 in 2023 and then halved again in 2024 to £3,000. Rates of income and capital gains tax have not changed, but the reduction in allowances and freezing of tax bands represent a considerable relative increase in taxation over the next two years. It will be a case of watching for further developments in the Budget on 15 March 2023, where the political mood may have shifted again as we move towards a general election.”
Pension sharing
Pensions are also a key consideration within a financial divorce settlement. The court has powers to make pension sharing orders and these are often calculated by actuaries, based on economic assumptions and market trends. The recent rise in Bank of England rates may have a major impact on the Cash Equivalent Value of pensions which is the figure that most divorce settlements rely on. A change in the CEV may have a dramatic impact on a pension sharing order that is being calculated but has not yet been implemented. This is because a pension sharing order takes a percentage of the transferor’s schemes based on the valuation at the time the calculation was made. If there is a change in the value of the pension before it is implemented, this means the transferee will receive a much lower pension credit than expected.
For couples who are agreeing to offset the value of their pensions against other assets such as cash or property, they must consider that there is now more risk than ever that the CEV will not be a reliable or realistic indication of the asset’s market value.
This risk should be considered when agreeing the terms of a financial settlement, and you may wish to consider instructing a pension actuary to advise on mitigating it when preparing pension sharing calculations. I consulted Alison Hills, our head of pensions, who advised:
“The manner in which pension sharing orders are implemented can give rise – particularly in uncertain times like these – to unexpected results, with the % share awarded to the spouse representing a wildly different % of the total fund by the time it is implemented (which can be up to four months after the pension sharing order takes effect once the scheme administrator has all the information needed to give effect to the order).”
Income needs and maintenance
If you are in the process of negotiating the rate of spousal maintenance within your financial settlement, it is essential that monthly budgets are reviewed and updated. The family court in England and Wales quantifies the appropriate rate of spousal maintenance by assessing needs of both the recipient and the payer. It is therefore imperative that income needs schedules accurately account for any increase in the cost of living to ensure that the terms of any agreement reach is affordable now, and in the future. If your budgets are not up to date, it is likely that the agreed rate of maintenance will not meet your needs, and this may lead to a flurry of applications to vary maintenance rates. Variation applications may be inevitable for those who have already reached an agreement but could be avoided if you have not yet finalised a deal.
What about settlements that have already been agreed?
You may have already negotiated the terms of a financial settlement and be concerned that the values used to agree the terms have now changed significantly due to the current economic climate and further volatility that may following in 2023. Generally, the courts are clear that fluctuation in economic markets does not automatically allow couples to reopen financial settlements. However, in limited circumstances it is possible to delay the payment of lump sums or restructure a deal if the impact is significant, or if the change was significant and unforeseen.
It is important to remember that ongoing spousal and child maintenance orders are variable where there is a change of circumstance. Therefore, there may be scope to revisit income orders if there has been a significant change to the payer’s income, or if a recipient can no longer meet their own, or any child’s needs, from the sum being paid.
If you are in receipt of maintenance and it is index linked to inflation, check the terms of the order and ensure that the rate of maintenance is increased if appropriate. Often, this is provided for automatically in a spousal maintenance order.
It is important to seek advice from a specialist family lawyer if you are concerned that your financial agreement may have been impacted by volatile markets.