Nicky Hunter, Partner at Stowe Family Law, explains in this analysis for IFA Magazine how and why lawyers and experts are calling for a review of the Duxbury formula. This is the process which is used to calculate payouts based on the receiving parties’ ages, required annual income need and their estimated life expectancy, in order to ensure fairer settlements for divorcing high net worth couples especially where large financial portfolios are at stake.
A ‘Duxbury calculation’ is a formula which originates from the 1990 divorce case of Duxbury v Duxbury in which the wife relied on a set of financial projections in seeking a discounted upfront cash fund as a ‘clean break’ instead of monthly maintenance.
Although referred to by judges as ‘a tool and not a rule’, and despite recognition over the years that the formula is an inexact science which does not always achieve the intended outcome, Duxbury calculations are still widely relied on by family lawyers and judges to calculate the value of a capitalised maintenance award in divorce cases where the paying party has the wealth to be able to pay the lump sum necessary to achieve the clean break. The calculation process involves using a set of a tables based on actuarial assumptions in respect of future life expectancy and financial returns to work out the capital lump sum that the wife needs which, when invested will fund the annual income that the court would otherwise order her husband to pay her.
It tends to be that the husband pays the wife so I have used this example for ease, although, of course, it can, and occasionally does work the other way around.
The Court’s approach is to start by assessing the wife’s annual need for financial support and the number of years that the maintenance should be paid for – often this will be for the rest of her life, but in some cases, for a fixed number of years that the court has decided the wife needs to be financially supported for until she can support herself from her own resources.
Even this starting point of calculating annual maintenance ‘needs’ builds in an element of guesswork, as it requires the wife to provide the court with a fixed budget listing all her future income needs, which of course may change significantly for one reason or another in the future. The courts have been clear that needs should be ‘generously interpreted’ with reference to the standard of living during the marriage but if the budget is inaccurate, then this can result in an inadequate fund.
The main assumptions behind Duxbury calculations are that, over a period of time, the capital fund, when invested will achieve uniform gross returns of 6.75% each year, based on a 3% income yield and 3.75% capital growth. It also assumes that the beneficiary of the investment will suffer inflation of 3%, resulting in an overall net rate of return on the investment of 3.75%.
Duxbury also works on the assumption that the lump sum will be entirely used up after being drawn down and spent by the same amount each year by the end of the time period that the court has ordered for the ongoing financial support, so as to ensure it does not accidentally award the wife extra capital beyond that which in most cases it will have divided up separately.
Recent examples have seen a 36-year old wife found to have an income need of £600,000 a year until her 50th birthday, then £400,000 until the end of her life, resulting in a Duxbury fund of £4.44 million, and a 47 year old wife awarded a capital fund of £21,720,767 to provide her with an assessed income of £1,110,316 per year over a 40-year period.
As Duxbury calculations have now been operating for over 30 years, there is an increasing amount of evidence that the capital fund is in many cases exhausted before the end of the recipient’s lifetime. In some cases, this may be because people are simply living longer than expected. But it is also clear that the uniform assumptions in relation to investment performance and inflation which underpin a Duxbury calculation have not remained fixed and inevitably years of poor growth and higher inflation will have an impact on performance.
Sometimes the fund is calculated to allow for a reduced amount of annual maintenance once the beneficiary reaches retirement age and can draw on pension benefits, and again this involves assumptions that pension funds will perform as anticipated.
It is clear from a review of reported Duxbury cases that in many of those cases, the capital fund does not perform as well, or last as long as the calculations supposed. This would suggest that the formula favours the paying spouse over the receiving spouse. However, where there is sufficient wealth to capitalise maintenance and achieve a clean break, and despite acknowledgement of some the limitations of the Duxbury formula in achieving its intended outcome it is still the recommended approach, not least because maintenance payments will end on the death of either spouse, and receiving a capitalised fund removes the risk of losing the maintenance payments entirely in the event of the early death of the paying spouse or their own loss of income.
In stripping out the risk of losing the maintenance payments, the recipient of a Duxbury fund takes on investment risk instead. It is therefore recommended that the cost of ongoing investment advice, and investment management fees are built into the needs budget to assist with maximising the future performance of the fund.
Nicky Hunter is a Partner at Stowe Family Law.
