Funding

Study guides: Exam CP-321, Exam GH-101, Exam RET-201, Exam RET-301

Funding is the arrangement by which money is set aside to pay for the benefits a plan promises — how much, when, and who bears the cost if experience differs from expectation. For a pension plan it is the sponsor's contribution policy, which builds assets ahead of benefit payments; for group health and life benefits it is the funding arrangement — fully insured, experience-refund, minimum premium, self-funded with stop-loss, level funded — that decides how much claim risk the employer keeps.

$A_{t+1} = A_t + C_t + I_t - B_t - E_t$

$C_t = NC_t + \frac{AAL_t - A_t}{\ddot{a}_{\overline{n}|}}$

$\text{Refund} = P - \text{Claims} - \text{Retention}$

Pension fund roll-forward: assets $A$ grow by contributions $C$ and investment income $I$ and fall by benefits $B$ and expenses $E$ . Over a plan's life this is the fundamental identity $C + I = B + E$ : every dollar of benefit not earned by investment must come from contributions, so a funding method changes only the timing of contributions, not their total.
Contribution: the normal cost plus a payment amortizing the unfunded actuarial accrued liability over $n$ years. The funded ratio is $A/AAL$ . Canadian plans fund on both a going-concern and a solvency (hypothetical wind-up) basis, and RET-301 is about choosing the assumptions — discount rate, mortality, expenses — for each.
A funding policy (RET-201; CAPSA Guideline No. 7) sets the sponsor's objectives — benefit security, contribution stability, intergenerational equity — and the margins, methods and amortization rules that serve them.
Group insurance arrangements run from most risk with the insurer to most with the employer: fully insured (pooled premium, no refund); experience-refund or retrospective premium (surplus refunded, deficit carried forward); minimum premium (employer funds claims up to a trigger); self-funded or ASO with stop-loss; and level funding, a small-group self-funded plan billed as level monthly payments. Experience rating and credibility sit inside the middle options.

Going-Concern Contribution with Amortization A defined benefit plan has actuarial accrued liability $\$12.0$ M, assets $\$10.5$ M and normal cost $\$400{,}000$ . The unfunded liability is amortized over $15$ years by level payments at the start of each year, at $5.5\%$ . Find the funded ratio and this year's contribution.
Answer
 $\begin{align*} \text{Funded ratio} &= 10.5 / 12.0 \\ &= 87.5\% \\ \text{Unfunded} &= 12{,}000{,}000 - 10{,}500{,}000 \\ &= 1{,}500{,}000 \\ \ddot{a}_{\overline{15}|5.5\%} &= 10.5896 \\ \text{Amortization} &= 1{,}500{,}000 / 10.5896 \\ &= 141{,}648 \\ C &= 400{,}000 + 141{,}648 \\ &= 541{,}648 \end{align*}$ 
The sponsor contributes about $\$541{,}648$ , about $35\%$ above normal cost. Lengthening the period lowers this year's cost and raises total contributions later — the stability-versus-security trade a funding policy has to defend.

Who Pays When Claims Swing: Three Funding Arrangements An employer's group medical plan has expected claims of $\$1{,}000{,}000$ . The options:

Fully insured: premium $\$1{,}150{,}000$ , no refund.

Retrospective premium (experience refund): premium $\$1{,}150{,}000$ , retention $\$130{,}000$ ; any surplus is refunded, any deficit carried forward.

ASO with stop-loss: administration fee $\$100{,}000$ plus stop-loss premium $\$40{,}000$ ; the employer pays claims (no single claim reaches the stop-loss deductible).

Find the employer's cost if actual claims are $\$900{,}000$ , and if they are $\$1{,}250{,}000$ .
Answer Claims of $\$900{,}000$ :
 $\begin{align*} \text{Refund} &= 1{,}150{,}000 - 900{,}000 - 130{,}000 \\ &= 120{,}000 \\ \text{Retro cost} &= 1{,}150{,}000 - 120{,}000 \\ &= 1{,}030{,}000 \\ \text{ASO cost} &= 900{,}000 + 140{,}000 \\ &= 1{,}040{,}000 \end{align*}$ 
Claims of $\$1{,}250{,}000$ :
 $\begin{align*} \text{Balance} &= 1{,}150{,}000 - 1{,}250{,}000 - 130{,}000 \\ &= -230{,}000 \\ \text{ASO cost} &= 1{,}250{,}000 + 140{,}000 \\ &= 1{,}390{,}000 \end{align*}$ 
Claims Fully insured Retro ASO

$900$ K $1{,}150$ K $1{,}030$ K $1{,}040$ K

$1{,}250$ K $1{,}150$ K $1{,}150$ K + $230$ K deficit $1{,}390$ K

Fully insured fixes the cost; the retro arrangement shares the good year and defers the bad one as a deficit to be recovered from future refunds; ASO passes every claim dollar through. The employer's tolerance for that swing — and its cash flow — is what picks the arrangement.

Claims	Fully insured	Retro	ASO
$900$ K	$1{,}150$ K	$1{,}030$ K	$1{,}040$ K
$1{,}250$ K	$1{,}150$ K	$1{,}150$ K + $230$ K deficit	$1{,}390$ K

How it appears on the exam

GH-101 (Underwriting and Funding): a case with expected claims, premium, retention and stop-loss terms, asking for the employer's cost or the insurer's gain under each arrangement — and a written recommendation of the arrangement that fits the group's size, credibility and risk appetite.

RET-201 (Valuations for the Purpose of Funding): written answers describing the funding options open to a sponsor and defending a funding policy for a single-employer, multi-employer or public plan.

RET-301 (Assumptions): selecting and justifying going-concern and solvency funding assumptions, usually written with some calculation of their effect on liability or contribution.

Exam traps

Treating a retrospective deficit as the insurer's loss: it is carried forward against the group's future refunds, so the employer's true cost of the bad year is premium plus the deficit — the insurer absorbs it only if the group leaves before repaying it.

Mixing a level annuity-immediate into an amortization stated as start-of-year payments: the payment comes out about $5.5\%$ too high.

Reading a higher contribution as a higher plan cost: by $C + I = B + E$ , funding faster changes timing and investment income, not the benefits.

Applying going-concern assumptions to a solvency valuation: the solvency basis values a hypothetical wind-up, with settlement-based discount rates.