The UK looks set on an inevitable course to have the mother of all retirement provision showdowns between the apologists and critics of public sector pensions.

The Confederation of British Business (CBI) has been calling for the unsustainable public sector final salary model to be overhauled if the country is to contain what it sees as a "trillion pound burden" on the taxpayer. But the public sector trade union, UNISON, has vehemently hit back saying that the CBI's arguments are "alarmist and wrong". UNISON claims that the pensions provided to the public sector are both "affordable and sustainable". So do they have a point, or are they merely defending the indefensible?

Research from the CBI published in April, Getting a grip: the route to reform of public sector pensions, appeared to show that because pensions in the public sector include an unpredictable guarantee from employers, and staff contributions are out of sync with payout levels, the financial 'black hole' for unfunded public sector pensions amounts to £10bn every year.

This means that the overall liability for these schemes has swollen to £1trn, or £40,400 for every home in the UK.

John Ball, head of defined benefit pension consulting at Towers Watson, says that the ballooning benefit figures can no longer be ignored.

"The Government has been borrowing off its own employees by promising them pensions in the future in return for work carried out in the past," he says. "Members of public sector pension schemes have a bigger claim on future taxpayers than the investors holding government bonds do.

"The Government has always said that public sector pension liabilities were well below £1trn, but that is no longer the case even on its preferred way of working out the numbers. Like companies preparing their accounts at the start of 2010, the Government will sooner or later have to record a big increase in pension liabilities because interest rates have changed."

The statistics continue to startle: Campaigners claim that through taxes private workers pay more towards public sector pensions than they ever will to their own schemes. This does not seem fair considering that 90 per cent of public sector employees are members of defined benefit (DB) schemes, while the proportion in the private sector had fallen to just 12 per cent - according to The Pensions Apartheid report, written in 2009 by Corin Taylor, a senior policy adviser at the Institute of Directors (IoD). The document points out that while in the past higher pensions in the public sector justified the lower salaries of its workers, this is no longer the case. In fact, the Office of National Statistics (ONS) has calculated that whereas the average public sector salary is £23,660, the average private sector pay packet is now worth only £21,528 per annum.

Compounded by the reality that the state workforce has grown by almost one million in the past decade and that longevity is rising, there does seem strong evidence to suggest that public sector pension reform of some description cannot be staved off for long.

Difficult
"This is a difficult and emotive area, and not one that should be rushed," recognises John Cridland, CBI deputy-general. "Public sector workers deserve a good retirement, but they and their employers should pay their own way. The pensions black hole is over £1trn and rising, and taxpayers cannot be left to make up the difference."

The CBI is calling for the next government to set up an independent commission to fully investigate public sector pension costs. The organisation believes that the public sector should pay for itself and that going forward all public sector staff should be moved off guaranteed DB schemes, although how this happens is likely to depend upon the scheme and the CBI stresses that pension rights and pots already accrued must be protected.

However, the picture is more complicated than this. Public sector pensions vary dramatically in size, and there are those schemes that are unfunded, and those that are funded such as the Local Government Pension Scheme (LGPS).

Counter view
In January this year, the three local government trade unions published ten key facts about the LGPS to set the record straight about the pension plan with over four million members and over £120bn in assets.

It countered claims that local government employees were not paying their way by noting that since April 2008, the average employee contribution to the LGPS is now 6.4 per cent - higher than the UK average of 4.9 per cent. Furthermore, the unions claimed that the current LGPS is not the cause of increases in council tax, or cuts in local services. Actually, money equivalent to less than six per cent of council tax revenue goes towards the LGPS, which is about £70.50 a year for an average council tax payer in England.

"We think all pension schemes are sustainable providing you do something about the three major factors that impinge on cost," says Mike Taylor, chief executive of the London Pensions Fund Authority (LPFA). "One is retirement age, the second is contributions paid by the member, and the third is the contributions paid by the employer, and by varying any of those you can make the scheme sustainable. What we've suggested is possibly some combination of all of those needs to be looked at. But there needs to be proper debate on it rather than forming the opinion that all public sector pensions are too expensive and we should scrap them.

"As for the stories that have been put around about 'fat cat' pensions, there are so few of them it is unbelievable," he continues. "The average local government pension is only £4,000 (annual payout). Now, you could say that is because there are a lot of small pensions in there, but even if you look at the pensions overall, the actual level of pensions is small."

The CBI has identified that not all public sector pensions are the same, but for the unfunded schemes - such as those of the NHS, teachers and civil service - it believes moving staff to provision based on the Swedish model of notional defined contribution (NDC) might be the answer. This would offer a risk-free pension that is more sustainable and secures transparency for employers, staff and taxpayers.

The idea of NDC is that members and employers pay contributions calculated on pensionable earnings, and these are then put in personal accounts. This money is not exposed to financial markets, but ring fenced and drawn upon to provide benefits for current pensioners.

The value of an employee's personal account increases over time in line with selected economic benchmarks.

However, Dave Prentis, general secretary of UNISON, has hit back at the CBI's proposals saying that public sector pension schemes have already been through a comprehensive review.

"The retirement age for most public sector worker is already 65, and far from being gold plated, the average woman working in local government can expect just £2,600 a year, or £40 a week when they retire.

"The Swedish model it draws on is not the answer. Inequalities and extremes of pay are far greater in Britain than Sweden. And giving retired workers a lump sum leaves them vulnerable to mis-selling."

Avoiding the issue?
In response, however, Neil Carberry, head of pensions at the CBI, says that the unions are trying to avoid a debate which is absolutely necessary.

"The unions tend to hide behind quite a misleading figure, which is the average pension in payment. But people need to remember that the average pension in payment includes pensions in payment that were built up over one, or two or even three years in accrual, and that of course drags down the average. But if you look at the pension accrued for the time worked, the schemes are still massively more generous than is affordable in the private sector."

Carberry maintains that private sector workers have "a legitimate interest in this issue as taxpayers" and rejects the suggestion that the country shouldn't be having this discussion.

The IoD's Corin Taylor agrees that the answer comes down to what is "realistically affordable", particularly in light of the fact that everyone is living so much longer. He puts forward a serious of potential reforms, such as increasing the retirement age in the public sector in line with the state pension age and looking at career average arrangements rather than final salary.

"What is pretty incontrovertible in my mind is that there does need to be further reform because of the issues about cost and longevity and fairness to taxpayers."

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