Since 2010, the policy of successive governments has been to uprate the basic state pension each April by the highest of three numbers:
- The percentage increase in (CPI) inflation in the year to September
- The percentage increase in average earnings in the year to Jul-Sep compared with the same quarter a year earlier
- A floor of 2.5%
For the first nine times the triple lock was applied, each element came top three times. In other words, the first element was needed three times to ensure that pensioners never suffered a real-terms cut in the value of the pension, the second element was needed three times to ensure that pensioners never fell back relative to earners and the third element was needed to avoid an embarrassingly low cash increase figure (and to provide an upward ‘ratchet’ to the real value of the pension).
More recently, the Pandemic has led to wild swings in the economy with knock-on effects on prices and earnings. In particular:
- As demand in the economy dropped, price inflation fell, and the CPI figure used in the last state pension uprating was just 0.5%; but there is now much talk of resurgent inflation with headline consumer price inflation in the US now at 5%;
- As the economy went into ‘lockdown’ some workers lost their jobs altogether but millions more were ‘furloughed’ on reduced wages; this resulted in a temporarily negative figure for average earnings growth for the last state pension uprating; but average earnings are now surging;
In April 2021, the Chancellor chose to apply the triple lock formula, which led to an above-inflation increase of 2.5% in the basic (and new) state pension rate.
For April 2022, it will be some months before we know the final figures that will feed into the triple lock calculation, but there are early indications that the Chancellor could again face a tough decision.
Inflation
The May inflation figures (published in June 2021) showed a jump in CPI inflation over two months from 0.7% in March to 2.1% in May. However, the latest OBR forecast for inflation (albeit published some weeks ago in May 2021) suggests a rise to around 2% by Q3 2021 which is roughly the relevant period for the triple lock calculation. But even if inflation is at or slightly above this level then it will be irrelevant because either earnings or the 2.5% floor would be higher. We should therefore turn our attention to average earnings.
Earnings
New average earnings figures published on 15th June 2021 showed a startling year on year increase of 5.6% in the 3 months to April 2021, but the ONS says that these figures may be misleading for two reasons:
a) ‘base effects’ – a year ago wages were depressed by furlough and other factors and are now simply returning to more ‘normal’ levels; so we are not necessarily seeing big underlying pay rises but the removal of a temporary drop; ONS estimates that without this effect, the figure would have been 4.3%-4.8%;
b) ‘composition effects’ – average earnings figures obviously only include the earnings of people in work; in the last year job losses have been concentrated amongst the lower paid; if lower paid people drop out of the figures, the average wage will increase even if no-one had had a pay rise; ONS estimate that this could account for around 1.5% of the 5.6% figure.
Stripping out both ‘base’ effects and ‘compositional’ effects, ONS estimate that wage growth would be around 3%, though they stress the uncertainty around this figure.
The key earnings number for the triple lock will be the three months to July rather than the three months to April. But if the figures were to stay at current levels, the Chancellor would face a difficult challenge. Simple application of the triple lock formula could imply a pension increase of 5.6%, which could look extraordinarily generous to pensioners at a time when inflation might be half that level or less.
An increase of 5.6% might also look relatively expensive to a Chancellor looking to cut borrowing and find money for extra spending on the NHS, social care and other priorities.
The triple lock policy applies to the (old) basic state pension and the new (flat rate) state pension. In 2021/22, these two elements cost around £85 billion, so a 5.6% increase would add around £4.8bn to the state pension bill. By contrast, if the Treasury chose to define earnings in terms of the underlying wage growth of 3%, the uprating would ‘only’ cost around £2.5bn, a saving of over £2bn. Such an adjustment to the earnings measure would be hugely tempting.
Another alternative (as set out in our earlier ‘On Point’ paper ) would be to find a way of averaging this year’s earnings jump with last year’s earnings dip and come up with a ‘two-year’ triple lock approach.
The latest earnings figures also provide a hint that the crucial earnings figure for later this year could be even higher. Although headline earnings growth in the three months to April was 5.6% compared to the equivalent period a year earlier, the figure for April alone was 8.3% up on April a year earlier. If the final figure turned out to be in this area, a crude earnings link could add £7 billion to state pension costs, which it is hard to see being the government’s priority. We can therefore expect that Treasury civil servants are beavering away on the justification for using an ‘adjusted’ earnings figure when the next uprating decision is announced.
Steve Webb is a partner at LCP