Smoothing mechanism could save govt £15bn on state pensions - PPI

Changing the triple lock on state pensions to a ‘smoothing mechanism’ could save the government £15bn in 2022/23, according to the Pensions Policy Institute (PPI).

A briefing note from the institute said that the temporary mechanism, which could require a change in legislation, which would track inflation and earnings growth over a two year period, and could mitigate the effect of an anticipated spike in earnings inflation in 2021.

The current triple lock system ensures that the state pension rises by whichever is higher, earnings growth, inflation or 2.5 per cent.

PPI's briefing note also claimed that dropping the triple lock in favour of a double lock will not necessarily save money on state pension costs in the short term.

The note stated that a high inflation scenario could see the cost of the state pension rising to 5.2 per cent of GDP (£111bn) in 2022/23 under both the double and triple lock, while the smoothing mechanism could limit this rise to 4.6 per cent (£96bn).

Under a triple lock, and different scenarios of inflation, the state pension could cost between 5.8 per cent and 6.6 per cent of GDP in 2040, between 5.8 per cent and 6.3 per cent under a double lock, and between 5.5 per cent and 6 per cent if a smoothing mechanism was used for one year, and then the triple lock was returned to.

However, the note cautioned that installing this smoothing mechanism would require legislative changes as “the government is currently required by law to increase the basic and new state pensions by a minimum of the increase in average weekly earnings”.

The briefing also warned that the smoothing mechanism would cause future pensioners’ income to inflate more slowly, while moving to a double lock would not necessarily save much over the short term, but would reduce costs in the long term.

“Policy-makers considering changing the way in which state pensions are inflated will need to take these factors into account, alongside the inherent uncertainties around the economy and health, in order to ensure that changes are properly targeted to achieve the desired effect, and that potential negative effects on both pensioners and government spending are taken into account,” said the report.

PPI head of policy, Daniela Silcock, said: “The government is reportedly considering replacing the state pension inflationary mechanism, the triple lock in order to reduce government expenditure and make the Covid-19 bill more affordable. News reports originally indicated that the government was considering replacing the triple lock with a double lock.

“However, it has become increasingly clear to economists that changes in employment, arising from Covid are likely to result in spikes in earnings inflation in 2021, which would mean that a double lock would not save any money on the state pension bill in that year.”

Analysis from Willis Towers Watson showed that triple locked state pensions could rise by as much as 21.3 per cent over a two-year period if there is a V-shaped economic recovery from the coronavirus crisis.

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