UK - Public sector defined benefit (DB) schemes should be closed and replaced with defined contribution (DC) schemes by the end of the decade, a report on the sustainability of the UK's pension system has urged.

Published by the Centre for Policy Studies, a think tank closely aligned with the ruling Conservative party, Self-sufficiency is the key - Addressing the public sector pensions challenge also suggests that all public sector workers over the £10,000 per annum earnings threshold should be encouraged to enroll in the National Employment Savings Trust (NEST).

In the report, Michael Johnson, a former JP Morgan investment banker and consultant at Towers Watson, argues that public sector pensions are unaffordable, unsustainable and unfair, likening the current situation to a Madoff-style pyramid, collapsing under the pressures of underfunding and demographic change.

He goes on to suggest two approaches for how any reforms should attempt to tackle the issues.

The first, highlighted as the 'brave' option, suggests that all currently unfunded schemes, such as the National Health Service's pension scheme, should be closed by 2020 and replaced with nominal DC schemes.

He argues that the government should take advantage of the imminent retirement of baby boomers, phasing in new DC retirement offerings as replacements for the ageing workforce are hired.

The report says: "Moving to a DC basis would have to be on an unfunded basis, i.e. notional DC. There would be no underlying assets, and contributions would continue to flow to the Treasury to be available to pay pensions in payment."

The report continues to say that to address the lack of underlying assets, a system of indexation should be developed.

"In the interests of simplicity and transparency, the government should seed the accounts with index-linked gilts (issued on a cashless basis) in an amount that reflects the annual increase in the state's liability," it says.

However, the report stresses that the scheme would not be linked to longevity expectations, allowing the government to avoid additional longevity risk. Members wishing to pursue an investment strategy outside of simple gilt exposure would be allowed to do so, but at their own risk, with the government's sole obligation being the servicing of the gilts.

The cautious option put forward by Johnson would see a shift to career-average pensions, with a salary cap in place. NEST and the notional DC scheme suggested in the 'brave' option would serve as as the additional source of retirement income.

Reform suggestions for local government pension schemes are also made, with their separate situation as funded schemes acknowledged.

Johnson proposes that a similar path as with the unfunded schemes should be taken, with the exception that due to its funded nature members would not have to be enrolled in NEST when the shift to DC occurs.

However, Johnson concedes that reforms should not be forced on any of the LGPS, with those currently funded to 90% or more able to continue as at present as long as a recovery plan can be completed within 10 years.

Additionally, he urges a reform of reporting standards, bringing them in line with best practice in the private sector.