Select Committee on Work and Pensions Second Special Report



ANNEX B

Letter to the Second Clerk from the

Government Actuary's Department (PC 24A, 5 March)

 

I refer to your letter dated 20 February 2002 to Mr Daykin in connection with the Pension Credit inquiry. Mr Daykin has asked me to reply and I apologise for any delay.

You asked for the parameters of S2P that would be needed for the earnings levels shown in our examples for someone retiring in 2051 with a full basic state pension to achieve a total pension income above the level at which:

(i)   entitlement to the guarantee credit ceases; and

(ii)   entitlement to the savings credit ceases.

I do not think that it is appropriate to envisage different parameters for different levels of earnings; that is we do not want the parameters for a person earning, say, 800 per week to be different from those for someone earning 300 per week. Thus, I believe that the most sensible way to address the issue is to recalculate the S2P parameters in a similar way to that when they were originally set but taking account of the recent changes to the level of the basic state pension and MIG.

The level of the various benefit rates (for a single person) and limits for the year 2002-03, which are relevant to the exercise, are set out in the following table:

 

 

 

Benefit

Lower earnings limit (LEL)

75 per week

Low earnings threshold (LET)

208 per week

Upper earnings threshold (UET)

473 per week

Upper earnings limit (UEL)

585 per week

Basic state pension (BSP)

75 per week

Minimum income guarantee (MIG)

98 per week

S2P accrual on earnings between the LEL and LET

40 per cent

S2P accrual on earnings between the LET and UET

10 per cent

S2P accrual on earnings between the UET and UEL

20 per cent

With these parameters, based on the same assumptions as in our previous letter, in particular the 1.5 per cent pa real earnings growth assumption, a single person retiring in 2051 who earned the LET every week (or, equivalently, 10,800 per annum) of his working life would be entitled to a total pension from the BSP and S2P of 94 per week in constant 2002-03 earnings terms. Thus, their pension would be approximately 4 per week less than the MIG at retirement assuming that the MIG is increased each year in line with earnings. In fact, because of the S2P underpin, anyone earning between the LEL and LET every year would receive this level of pension.

Our understanding is that at the time the S2P parameters were set, it was expected that, for a person as in the paragraph above, the pension at retirement would have been above the level of the MIG and would have remained above it for a number of years. This is not the case now, principally due to the increases that have been made to the level of the MIG in recent years, offset in part by the increases to the BSP.

The following table sets out the accrual factor to replace the 40 per cent factor that would be necessary for a person who earned the LET every week (or 10,800 per annum) of his working life to achieve a total state pension equal to the MIG at award in the year 2051, if the other parameters were left unaltered. The table also shows the factor that would be required if the total state pension were to exceed the MIG for either five years or 10 years after retirement, assuming that the MIG continued to be uprated in line with earnings and the pension was uprated in line with prices.

 

 

 

Pension at award equals the MIG

Pension exceeds the MIG for 5 years after retirement

Pension exceeds the MIG for 10 years after retirement

Change 40 per cent factor to

42.5 per cent

47.7 per cent

53.4 per cent

Alternatively, a similar result could be achieved by increasing the LET and leaving the 40 per cent accrual rate unchanged. The required LET is shown in the table below, again assuming that all other factors are unchanged.

 

 

 

Pension at award equals the MIG

Pension exceeds the MIG for 5 years after retirement

Pension exceeds the MIG for 10 years after retirement

Change LET of 10,800 per annum to

11,200 per annum

12,300 per annum

13,500 per annum

It would, of course, be possible to combine a smaller increase in the 40 per cent accrual rate with a smaller increase in the LET and achieve a similar result.

Given the design of S2P, one would expect that if either the 40 per cent accrual rate or the LET were to be altered then there would be changes to the other parameters of S2P but any changes will not significantly affect the figures above. However, the other changes in the limits or accrual rates would affect the amount of S2P payable to higher earners and consequently would affect the benefit levels for the other examples in our previous letter.

Assuming that the MIG is uprated in line with earnings and that the savings credit threshold is uprated in line with prices, then in 2051, there is no entitlement to any part of the pension credit if income is above 390 per week in constant 2002-03 price terms or, equivalently, 190 per week in constant 2002-03 earnings terms. In order for the total state pension at award in 2051 for our example to be 190 per week in constant earnings terms, the 40 per cent accrual rate would need to be replaced by an accrual rate in excess of 100 per cent. It would not be possible to achieve the same result by keeping the 40 per cent accrual rate but increasing the LET since even if the LET were set to be equal to the UEL the resulting pension would still be less than 190 per week. We have not pursued this scenario further in view of these results.

If the MIG and the savings credit threshold are both uprated in line with earnings, then in 2051, there is no entitlement to any part of the pension credit if income is above 132 per week in constant 2002-03 earnings terms. This figure, as one might expect, is similar to the (illustrative) level of 135 per week under which no pension credit is payable in 2003-04 because all the pension credit factors go up in step in line with earnings in this scenario. In order for the total state pension at award in 2051 for our example to be 132 per week in constant earnings terms, the 40 per cent accrual rate would need to be replaced by an accrual rate of 66 per cent. Alternatively, keeping the 40 per cent accrual rate, the LET would need to be 16,100cper annum instead of 10,800 per annum. Of course, one would need to consider the wider consequences for pension credit if the MIG and the savings credit threshold are both uprated in line with earnings.

Again, if changes were made to the 40 per cent accrual rate or the LET then one would need to consider what changes to make to the other S2P parameters.

In considering these results you might wish to bear in mind the following:

1.    Many claimants reaching pension age will not have a full entitlement to S2P even allowing for the credits available (note that credits are not given in as many circumstances as they are for BSP). On average, only approximately 65 per cent of the working age population are likely to accrue an entitlement to S2P in any one year, which implies that at retirement awards of S2P will only be based on 32 years on average rather than 49, giving much less than a full entitlement.

2.    Whether or not the total state pension will equal the MIG will also be affected by the level of real earnings growth. If one takes the view that an assumption of real earnings growth of 1.5 per cent per annum is slightly conservative then one would need higher accrual rates or LET to target the MIG if real earnings growth is higher. For example, if real earnings growth were to be 2.0 per cent per annum rather than 1.5 per cent per annum then the current S2P parameters will give a total state pension of 89 per week rather than 94 per week in 2051 in constant earnings terms. In this scenario, the 40 per cent accrual rate would need to be replaced by 46.3 per cent (rather than the 42.5 per cent illustrated above) for the total state pension at award to equal the MIG in 2051 for a person who earns between the LEL and the LET for each week of their working life.

3.     2051 is the first year when those retiring will have been in S2P all their working lives but other than that it has no particular significance. In the years before 2051 the position will be different because people will have SERPS for part of their working life rather than S2P. In the years after 2051, the total state pension will continue to reduce relative to the MIG if the MIG continues to go up in line with earnings. For example, under the current S2P parameters, the total state pension at award in 2075 will be 89 per week in constant earnings terms rather than 94 per week in 2051 for the example that we are using.

4.     Where state benefits (such as winter fuel allowances and free television licences) are paid to pensioners other than as a basic pension or SERPS/S2P they fall outside the calculations done above. However, it is not clear that it is appropriate to ignore these payments when looking at the overall position of pensioners.

5.     We have not produced figures for couples but could do so if required.

I hope that the above comments are helpful. Please let me know if I can be of any further assistance.

 

David Lewis

Chief Actuary

Social Security

 

5 March 2002

 

 


 
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