APPENDIX 20
Letter to the Second Clerk from the Government
Actuary's Department (PC 24A)
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 200203, 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 200203 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 200203
price terms or, equivalently, £190 per week in constant 200203
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 200203 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 200304 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
