Funding Plans and Accuracy

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Someone who attended one of our recent webinars () asked an interesting follow up question worth sharing. His association manager had recently told him that a Funding Plan based on the “Straight Line” methodology (officially the “Component Method” in National Reserve Study Standard terminology) was more accurate than a Funding Plan based on the “Cash Flow” methodology, and he wanted my opinion on the matter.

It appears that the manager is confused on the matter. In any Funding Plan methodology, the underlying data (the Reserve Component List) is the same. Changing Funding Plans has nothing to do with Reserve Component List accuracy, or Reserve Study accuracy.

Neither Funding Plan methodology is more accurate than the other. Mathematical calculations are mathematical calculations… they all should be accurate (unless one can’t reliably add, subtract, multiply, or divide). The only difference is in how much cash is going into your Reserve Fund (the recommended Reserve contributions). That is an issue of risk management, not accuracy.

Presuming your Funding Objective is identical (to become Fully Funded), computing your contributions using a Cash Flow (pooled) Funding Methodology will typically result in lower contributions, since it can be crafted in a smoother manner that eliminates the jumps and bumps typical with contributions calculated using the Straight Line method.

The Cash Flow Funding Methodology also opens up the possibility of different (lower) Funding Objectives, such as Threshold Funding or Baseline Funding (barely maintaining the Reserves cash-positive). A weak Reserve balance obviously increases the association’s risk of a special assessment, if or when the Reserve Fund is found to be inadequate. Even so, pursuing those lower objectives typically only drops the contributions another 10-15%.

So choosing between funding methods is not an issue of accuracy. It is an issue of contribution smoothness through the years, and how much risk of special assessment the association wishes to take on. If the association wishes to avoid special assessments, they should pursue a Fully Funded objective. Risk of special assessment is measured by Percent Funded. That Percent Funded calculation is the same, no matter which contribution methodology is chosen.

I tend to think of accuracy having to do with the Reserve Component List (is everything included that should be, and are the life and cost estimates on-target), while the Reserve Funding Plan has to do with smoothness, fairness, and risk management.