A proposal to reform the current Winter Fuel Payment (WFP)

This was a paper that I wrote from my Energy and Resource Economics class, built on previous work attempting to show the efficiency savings from reforming the Winter Fuel Payment.

 

Abstract

Currently the UK government offers a Winter Fuel Payment (WFP) for those born before January 5th 1953 (Age 63), receiving a state pension, housing benefit, council tax reduction, or child benefit. This can range from £100 – £300 and is not means tested. Statistics show that only 41% (Beatty et al. 2011) of this benefit is actually spent on its purpose, to heat homes sufficiently throughout winter. This paper will suggest a reform of the policy through a method called ‘Energy Credits’. The reform not only seeks to drive the full use of this benefit, but at the same time potentially reducing the Government’s expenditure and possibly increasing the demand from Energy Suppliers.


Introduction

In 2014/15 the UK government spent £2.177 billion on WFP’s, representing 1.27% of the Gross Benefit Expenditure within the same financial year. Nonetheless, a clear market failure is implied due to the actual implementation of the policy measure. Despite the tax-free annual cash payment significantly reducing excess Winter Deaths (EWD) by 50% in England in Wales since its introduction (Iparraguirre et al. 2014), the WFP is paid in an inefficient manor which is hindering the policies effectiveness at reducing EWD’s. This paper will be focussing solely on reforming the WFP for the purposes of improving the efficiency of the public purse; however, it should be recognised that this isn’t the only policy measure that is aimed at tackling EWD’s in the UK.

The current situation

Attempts have been made to make sure that the WFP is used as intended. One measure that has been put in place to try and boost the use of the payment is the ‘labelling effect’, a behavioural nudge that pushes citizens into socially desirable behaviours (Lange et al. 2015). By simply naming the cash transfer as the “Winter Fuel Payment”, it is estimated that this raises the use of the benefit by 38% (Beatty et al. 2011).

Nonetheless, this is still not an efficient use of the public purse. Making the payment in November and December is another attempt at ensuring recipients get the hint to use the payment on heating their homes for the Winter. Working against this on the other hand, is the issue that the benefit is paid before Christmas, creating a nice windfall for those looking to buy some extra presents.

 

Data

This section will look at the data collected on pensioner income for the financial year of 2014/2015, with a specific focus on the top 5th percentile. Currently in the UK, there are 8.7million pensioners, that will qualify for the Winter Fuel Payment in some shape or form. With a near 50/50 split on the number of couples and singles, essentially households.

The following tables breakdown the income of the two categories to better understand what the lowest and also the highest income percentiles are. It is important to grasp what the income gap is amongst pensioners, so that whatever policy reforms are made, we know how the income of those ‘worse’ off are affected. However, in the case of this report, we want to understand what the effect would be on a reduction in the number of higher earners, claiming the WFP.

Table 2

Pensioner Couples (Weekly)
Quantiles 1st 2nd 3rd 4th 5th Mean
Net income before housing costs 255 358 456 592 912 563
Pensioner couples’ net income before housing costs distribution
Recently retired 17% 18% 19% 22% 24% 100%
Head aged under 75 17% 18% 19% 21% 25% 100%
Head aged 75 and over 26% 24% 22% 18% 10% 100%

(ONS 2015)

Table 3

Single Pensioners (Weekly)
Quantiles 1st 2nd 3rd 4th 5th Mean
Net income before housing costs 137 197 244 305 436 280
Single pensioners’ net income before housing costs distribution
All single pensioners 20% 20% 20% 20% 20% 100%
Recently retired 16% 17% 20% 21% 26% 100%
Aged under 75 18% 19% 21% 20% 23% 100%
Aged 75 and over 22% 21% 19% 20% 18% 100%

(ONS 2015)

As we can see from Table 2, there is a significant gap in income, from the lowest to the highest 5th percentile of 72%. Similarly, the gap in single pensioner income (Table 3) is 69%. Understanding the difference in ‘Net income before housing costs’ is vital to recognizing the disparity in what these two groups are likely to spend on their energy bills. The ONS in 2014, estimated that the average pensioner’s expenditure on energy bills is roughly £97 per household per month. By this estimate, the lowest income single pensioner will be paying 17.7% on energy bills per month, whilst in comparison to the higher incomes at 5.6%. A somewhat similar story is being told amongst the couple’s category, with the lowest percentile paying 9.5% of their income on energy bills and the highest percentile paying 2.6%.

Table 4

No. of Pensioners – Top Fifth Percentile
Recently retired All under 75 75 or over All
Pensioner couples – £912 PW  336,000  725,000  135,000  850,000
Single pensioners – £436 PW  221,000  471,500  432,000  890,000

(ONS 2015) *To the nearest 50,000

Table 5

Government Cost – Top Fifth
All under 75 75 or over Range
Pensioner couples – £912 PW £72,500,000 £27,000,000 £85,000,000 £170,000,000
Single pensioners – £436 PW £94,300,000 £129,600,000 £178,000,000 £267,000,000
Totals £166,800,000 £156,600,000 £263,000,000 £437,000,000

(ONS 2015) *To the nearest 50,000

In the final analysis, Tables 4 and 5 seek to establish the cost of providing a WFP to the top 5th percentile of both categories. As a result, we can see that under the current payment systems for each age group, the UK government could be saving in the range of £263 and £437 million every winter, if pensioners with the highest incomes chose not to take the WFP. Even if this was in the lower range of the top 5th percentile, there is still a huge saving to be made.

Energy Credits are an efficient benefit allocation method that provides a better return on investment for the UK Government. The method is as follows:

  1. The Department of Works and Pensions provide secure access to a data set of those eligible for the WFP to every energy retailer in the UK.
  2. Included in this data set is the eligible amount of money that is allocated to each individual.
  3. The amount allocated translates into credit held by the energy retailer, that is available for the individual to reduce their energy bill.
  4. Throughout the winter, the individual is able to pick and choose when they use their credits.
  5. At the end of the winter, the energy retailer simply claims the used amount back from the government.

 

Through this method, those over 65 would have to contact their energy retailer in order to use their energy credits when they wanted. This would enable the recipient to spread their benefit over the winter, as and when they needed to.

Herein lies the incentive for the Government. Using the above data analysis, it is then possible to implement the findings of Finn & Goodship 2014. Within their study, analysing the ‘Take up of benefits & Poverty’, they establish that individuals with a higher income are less likely to take up a benefit. This is due to the relative value of the benefit not making a large difference in their welfare, over the absolute amount. Therefore, implying that that those in the higher quartile of pensioner incomes, may not claim the WFP because of the smaller relative welfare increase.

Furthermore, cost-benefit rationale signifies that an individual will not participate in a benefit, if the information costs are higher than the increased welfare from receiving such benefit. Therefore, proactively seeking the WFP, may not be in the interest of the top 5th percentile.

The incentive for the energy retailers, are that the 1st – 4th percentile, are nudged down the route of using the entire benefit on energy consumption. Promotion of the use of the benefit will be to their advantage, as the more credits being used, the more money they can claim back from the UK Government before the end of the financial tax year.

Limitations & Conclusion

One issue that has arisen from the research into this method is the fact that there is still 15% of UK homes off-gas (Greenage). However, this 15% still have access to electricity. The credits would then become available for use on the electricity bills of the person in receipt of the benefit, providing the same level of welfare support.

A potential limitation is that those aged 65+ would have to contact their energy supplier in order to ask for the benefit to be used. This may be more difficult for some older members of society; however, it will be in the interest of the energy retailers to make contact with those that are most vulnerable in society, in order to use up the energy credits.

In 2013, the think tank CentreForum suggested means testing the winter fuel payment in line with receiving pension credit (Telegraph 2013). The likely outcome of this would mean that the top 5th percentile of earners wouldn’t qualify for the WFP. However, this was discredited by the Institute of Fiscal Studies, who highlighted that incorporating the WFP into the pension credit scheme would reduce the impact of the labelling effect, mentioned above. Therefore, they concluded that this would not be the most socially optimal way to provide the benefit. This would also penalise workers for investing into a private pension scheme.

In conclusion, the DWP should reform the WFP through implementing Energy Credits in order to make more efficient use of the public purse.  Energy Credits provide an effective means of delivering a universal benefit without means testing, putting the onus on the Energy industry to ensure that our pensioners homes are heated sufficiently.  The savings potential is massive for the UK Government and this is without mentioning a reduced administration budget from actually delivering the cash to UK pensioners.  It is therefore advised that there is further data analysis into an exact saving that the DWP could make from implementing Energy Credits.

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