Can Britain afford the Triple Lock?

It's expensive, controversial, and very popular

March 23, 2016
Britain's basic state pension was, and remains, below average song OECD nations ©Stuart Clarke/Rex/Shutterstock
Britain's basic state pension was, and remains, below average song OECD nations ©Stuart Clarke/Rex/Shutterstock
Read more from Prospect's recent pensions supplement

David Cameron’s vow to increase the purchasing power of the nation’s retirees was not on the agenda on Budget Day. But there is a rising debate about intergenerational fairness in Britain, which the government cannot ignore.

The central promise to British retirees is known as the “Triple Lock,” and it was first set in place back in 2010 by the Coalition government. On sweeping to victory last year, David Cameron vowed to keep it in place until 2020, the end of the current Parliament. This formula guarantees that every year the basic state pension will rise at a rate equal to the annual rise in whichever is the highest of average wages, consumer prices or 2.5 percentage points. At that rate, the value of retirees’ benefits is guaranteed to rise faster than wages of the average worker, barring an unexpected rise in the rate of wage gains.

If the Triple Lock becomes permanent policy, it will increase spending on old age pensions alone­—not including any other old-age related costs—by 1.3 per cent of GDP by 2064-65, according to forecasts from the Office for Budget Responsibility. The retirement age is rising meaning that pensions payments will start later for both men and women, but by 2060, the triple lock will have more than offset the savings made from this.

Moreover, by 2021, pensioners will receive government benefits that are 13 per cent greater per person than they were before the 2008 financial crisis. By contrast, benefits for children and working-age adults will have fallen by 15 per cent and 9 per cent respectively, according to new research from the Resolution Foundation.

In 2015, households headed by a person aged 65 to 74 held roughly 19 per cent of the nation’s wealth. Households headed by a person below the age of 45 held 16 per cent. For the first time, pensioners hold a larger share of wealth than younger households.

Already in the six years that the policy has been in place, older adults have been net gainers. According to a report prepared by the Government Actuary’s Department in 2015, since 2010, the triple lock has caused the rate of the basic state pension to increase by about £10 a week more than if it had been linked to earnings. The difference has cost the Treasury around £6bn a year.

If the Triple Lock is kept in place until 2040, 22 per cent of pension costs will have to come from somewhere other than the contributions of the National Insurance Fund, the government fund from which the state pension is paid. The choice will be either higher taxes or spending cuts. And under “low inflation, low wage growth” economic conditions, similar to those of recent years, that figure will rise to 28 per cent of pension costs. For comparison, in 2015/16, state pensions accounted for only 73 per cent of the National Insurance Fund.

Paul Johnson, director of the independent Institute for Fiscal Studies, has called for the scrapping of the Triple Lock on grounds of cost, equity and logic. The IFS estimates that it will add £15bn more to the costs of state pensions than would otherwise be incurred by simply allowing pensions to rise in line with earnings. And that expenditure comes at a time when the incomes of retirees are already rising more quickly than those of workers, thanks largely to the huge numbers now enjoying relatively generous occupational pensions. Johnson also says that there is no logic to a minimum annual state pension rise of 2.5 per cent, because it bears no relation to any other benchmark of earnings or prices.

It was not ever thus. In 1970, roughly 40 per cent of the nation’s elderly lived in poverty, according to IFS analysis. The Social Security Act of 1973, enacted at a time of raging inflation, required pensions to be uprated annually by the higher of earnings or prices. But the Thatcher government in 1979 pronounced these rises as unsustainable and ordered indexation to be linked to prices, not earnings. However, wages typically rose by 1 to 2 per cent faster than prices as workers demanded rising real incomes.

As replacement income, the basic state pension became increasingly inadequate. By 1989, the percentage of retirees in poverty was as high as it had been nearly two decades earlier. The advent of a Labour government in 1997 did little to change that; policy was concentrated on improving incomes only for the worst-off through a complex formula called Pension Credit.

But in 1999, prices rose so modestly that the annual increase to pensions totalled a miserable 75p, causing a political furore. “The 75p pension rise politically had very great resonance,” recalled Gregg McClymont, now head of retirement at Aberdeen Asset Management and shadow pensions minister in the former coalition government. The decision to target resources on the poorest pensioners, via Pension Credit, was designed to address the immediate emergency. But it did little to address the broader issue, which was that relative to other industrialised nations, Britain’s basic state pension was and remains below average among Organisation for Economic Cooperation and Development (OECD) nations. In 1999, McClymont said, the analysis of poverty rates of various age groups tended to support the case for a much more generous increase to pensions. But that is no longer the case. As McClymont remarked: “The arguments for the Triple Lock have now become weaker.”

By 2012, the percentage in poverty had fallen by two-thirds to roughly 13 per cent of older adults. In contrast, the percentage of adults living in poverty with children had risen from around 10 per cent in 1970 to roughly 25 per cent in 2012, according to the Resolution Foundation.

David Willetts, executive chairman of Resolution and a former Conservative MP, said that there are some good reasons why the Triple Lock should remain in place until 2020, as promised in the Conservative manifesto in 2015. “I respect the disciplines of democratic government,” he said. Politicians who make promises should be expected to keep them. Also, retirees who had been augmenting their pension income by earning interest on savings had lost out badly in the recession with rates near zero. The danger, he said, is that Triple Lock becomes entrenched policy. “In its current form, it is unaffordable on a continuing basis,” he said.

James Lloyd, director of the Strategic Society Centre, points out that due to the rising percentage of older adults in the population, there will be many competing demands for expenditure on that demographic, including those of health and social care costs. “Ultimately, the level of state pension is a political choice,” he observes, noting that retired voters attach greater significance to the additional pounds in their monthly pension payment than they do to, say, a general increase in health spending. The risk, he said, is that the longer the Triple Lock remains in place, the more retirees expect to go on receiving it. “If you had five or ten years of retirement, you would notice if it stopped.”

But for all the discomfort with the Triple Lock, no one suggests that the purchasing power of pensions should be allowed to fall far behind other incomes. Indeed, some see the current planned rises in state pension age (SPA)—and the recently launched review into whether to continue raising it in line with increases in longevity—as evidence that Britain is already cutting benefits. “It’s just a question of how much redistribution you want to do through the SPA,” Paul Johnson of the IFS said.

In its pensions analysis, the Government Actuary’s Department noted that in 2001 when the Labour government made its Double Lock promise (a rise in line with inflation or 2.5 per cent), the Bank of England’s inflation target was 2.5 per cent, which provides a context for why that figure was chosen. Also, the 2001 Pre-Budget report called for a rise in annual pension payouts of at least £100, at the time roughly equal to 2.5 per cent of benefits. (GAD’s suggested solution to the rising costs was to reduce the annual Triple Lock underpin to 1.5 per cent.)

Ultimately, adjusting state retirement benefits to reflect the right mix of affordability and fairness is a political, not an economic question, Lloyd said. The Triple Lock is much more of a political question than the public, and the media, fully appreciate.