A funded ratio measurement commonly used to describe the funding level of a defined benefit pension plan. The calculation used to determine a funded ratio is simple. It is the value of assets held by the pension fund divided by the calculated cost of benefits promised to employees past and present.
Funded Ratio = Assets / Promised Benefits
A funded ratio effectively measures a public pension plan’s ability to live up to promised benefits. Plans aren’t expected to always be 100% funded, but prolonged periods below full funding should concern taxpayers, retirees and employees. After periods of significant loss—like the 2008 recession—a plan will usually undergo a drop in funded ratio. But, with effective contribution policies, a plan should gradually improve their funded ratio over time back to 100% funded.
A funded ratio is an adequate measurement for evaluating a plan’s general ability to pay pension promises, but there are limitations to this metric. A funded ratio depends on a wide range of market and demographic assumptions. It is not uncommon for plans to adjust these assumptions, which may significantly change the final calculation. A change in funded ratio from new actuarial assumptions may appear as a significant shift in a plan’s overall fiscal health, but what is actually occurring is a more realistic and accurate evaluation of assets on hand or future pension costs.
Additionally, these assumptions vary from plan to plan, which can sometimes make it difficult to compare one pension plan’s funded ratio to another’s. When viewing multiple plans side by side, it is important to remember that the figures used for funded ratios aren’t evaluated on the same baseline assumptions.
A funded ratio can use two different types of valuations to calculate assets, and most plans will report two separate funded ratios using each method. One can use either the market value or the actuarial value of assets. The former (market value of assets, or MVA) is a straightforward accounting of the actual amount currently held in a fund. The latter (actuarial value of assets, or AVA) uses smoothing methods to mute volatile year-to-year returns on a plan’s assets. There is no standardized way to calculate the AVA, so methods vary from plan to plan. Since the AVA is less volatile and a better reflection of long-term funding goals, it is more commonly used in a pension plan’s primary funded ratio.
All funded ratios use what is called the actuarially accrued liability to represent the cost of benefits promised to members of the plan. This number uses the plan’s discount rate, as well as several retirement and mortality assumptions, to price the promises made to public workers to date.
State Pension Funded Ratios
|State||Funded Ratio in 2001||Funded Ration in 2019||% Change|
Stay in Touch with Our Pension Experts
Reason Foundation’s Pension Integrity Project has helped policymakers in states like Arizona, Colorado, Michigan, and Montana implement substantive pension reforms. Our monthly newsletter highlights the latest actuarial analysis and policy insights from our team.