Ms Jasmina Behan:

I thank the committee for the invitation to speak with members on the issue of benchmarking and indexation. My colleague from the Department of Social Protection has already outlined the background to benchmarking and indexation in relation to the State pension. The report of the Commission on Pensions from October 2021 and the accompanying technical working paper on benchmarking and indexation set out an overview of the proposed policy recommendations and the key considerations relating to these recommendations. Previously, officials in the Department of Public Expenditure and Reform worked closely with officials in the Department of Social Protection on possible approaches to applying benchmarking and indexation to the State pension in advance of the publication of the Roadmap for Social Inclusion 2020-2025, which was published in January 2020.

One approach discussed in the roadmap was referred to as the smoothed earnings approach. This approach was endorsed by the Commission on Pensions in its report, which was published in October last year. I will talk through the mechanism of the smoothed earnings approach in more detail and highlight some important considerations of potential changes to determining the State pension rate from a public expenditure management perspective. Broadly, the smoothed earnings approach is based on two parameters: growth in wages and growth in prices.

Using wage growth as the benchmark, the State pension is calculated as a percentage of average earnings. This percentage has frequently been assumed to be set at 34% based on an analysis from the Economic and Social Research Institute, ESRI, dating back to 1996. By benchmarking the State pension rate to 34% of average earnings each year, changes in earnings are reflected in the basic State pension rate.

The second component of the smoothed earnings approach applies price inflation to the calculation. Here, the pension rate is adjusted using the harmonised indices of consumer prices, HICP. Both the consumer price index, CPI, and the HICP are designed to measure the change in the average level of prices paid for consumer goods and services. The HICP has gained prominence in recent years as it enables comparison across EU member states. Its main difference from the CPI is that it excludes items such as mortgage interest, motor tax, house and car insurance and trade union subscriptions. The HICP and CPI are typically very close in their measure but the HICP has marginally been the higher indicator of the two in recent months.

Once the pension rates are calculated, the smoothed earnings approach uses the higher of the 34% earnings benchmark or HICP growth over the period to determine the increase in the rate. The smoothed earnings approach is designed to preserve the real value of pensions over time and to keep pace with both inflation and earnings, whichever is growing faster. Linking pension payments to developments in earnings and prices in this way can provide greater certainty to individuals and to public expenditure planning. If implemented, it could bring Ireland’s approach to determining the appropriate pension rates more in line with other countries.

However, benchmarking and indexation would be a fundamental policy change which also gives rise to important considerations in relation to managing the public finances. Future pressures on the public finances due to an ageing population are well documented. Expenditure on the State pension is due to increase considerably as a proportion of modified gross national income, GNI, over the coming decades. Department of Finance calculations included in the pensions commission's report estimate that expenditure on social welfare pensions will increase from around 3.8% of modified GNI in 2019 to 5% by 2030, assuming that the pension age is retained at 66. By 2050, this estimate increases to 7.9%.

A change in policy such as implementing the smoothed earnings approach would impact on the current budgetary discretion available to the Government, which allows for consideration of the overall prevailing economic conditions. Periods in which both earnings and prices are both falling, and periods in which the public finances are under pressure due to economic conditions, could represent problematic scenarios for the application of the smoothed earnings approach. The Government is currently considering the recommendation of the pensions commission to establish a pension rate commission. While the presence of such a commission may help with the deliberation process for applying a benchmarking and indexation approach, there is also the consideration of the administrative complexity and cost that may arise. The Government is due to deliberate on the pensions commission's recommendations by the end of March this year.

I hope that gives this committee an insight into the high level detail of the benchmarking and indexation approach under consideration for pensions and the key considerations in relation to the public finances. My colleagues and I will be happy to take any questions committee members may have.