funding ratio and unfunded liability
/ UAL = "U-A-L" /
Once you know how much a pension has promised (its accrued liability) and how much money it actually holds (its assets), the most important health check is simple: is there enough? The funding ratio answers this. It is just the plan's assets divided by its accrued liability, usually written as a percentage.
A funding ratio of 100% means the plan holds exactly enough to cover the benefits earned so far; above 100% it is in surplus; below 100% it is underfunded. The shortfall — accrued liability minus assets — is the unfunded liability (unfunded actuarial liability, UAL), often called a deficit. For example, a plan with 80 million in assets and a 100 million accrued liability has a funding ratio of 80% and an unfunded liability of 20 million; the employer typically must contribute extra over time, on top of the normal cost, to close that gap (this catch-up is sometimes called the supplemental cost or amortization of the unfunded liability).
Funding ratios are the headline number in pension finance, watched by regulators, sponsors, and members, and they directly drive how much extra a sponsor must pay. The honest caveat — and it is a big one: the funding ratio is only as meaningful as the assumptions behind the accrued liability, especially the discount rate. A plan can swing from 'fully funded' to 'in deficit' purely because the discount rate changed, with not a single benefit altered. Comparing funded ratios across plans (or across countries) without checking the discount basis can be deeply misleading.
A pension fund holds 800 million in assets against an accrued liability of 1,000 million, so its funding ratio is 80% and its unfunded liability is 200 million. The regulator requires the deficit be paid off over, say, 10 years, so the employer must contribute extra each year on top of the normal cost. The next year, a fall in long-term interest rates raises the liability to 1,100 million — the deficit grows to 300 million even though no benefit changed.
Funding ratio = assets / liability; the shortfall below 100% is the unfunded liability.
A funding ratio is only as honest as its discount rate. A plan can look 'fully funded' or 'in crisis' purely from the rate chosen, so never compare ratios without checking the assumptions underneath.