A projected benefit obligation (PBO) is an actuarial measurement used to determine the current amount a company must allocate to cover future pension liabilities. By accounting for employees’ earned pension entitlements and adjusting for anticipated future salary increments, the PBO helps companies prepare adequate retirement benefits for their workforce.
Key Points to Remember
- A PBO calculates the present-day financial requirement for future pension liabilities.
- It assumes the continuous operation of the pension plan and adjusts for forthcoming compensation increases.
- Actuaries utilize PBO to assess whether pension plans are adequately funded.
The Mechanism Behind Projected Benefit Obligations (PBO)
Companies offer various retirement benefits, one of which may include a salary scheme for post-retirement. In accordance with the Financial Accounting Standards Board’s guidelines, corporations must evaluate and disclose their pension obligations and the performance of their plans at the conclusion of each accounting period.
A PBO stands as one of three primary methods for assessing the liabilities tied to traditional defined benefit pensions. It bases calculations on employee tenure and salary, projecting future financial needs to sustain pension plans. Factors influencing the PBO include:
- Estimated service duration remaining for employees
- Expected salary advancements
- Employee mortality rate predictions
Actuaries, experts in measuring and managing risk and uncertainties, are pivotal in determining if pension plans have the required funding. They use present value calculations to ascertain the necessary benefits and compare the plan’s liabilities to its assets. They generally classify these into:
- Service costs: Increased value of obligations due to additional service year credits for employees.
- Interest costs: Annual interest on the PBO balance corresponding to accumulated service time.
- Actuarial gains or losses: The disparity between actual and anticipated pension payments. Gains occur when the payouts are less than expected; losses arise when they exceed expectations.
- Benefits paid: Direct reduction of obligations by paid-out benefits.
To identify whether a pension plan is underfunded, companies must compare the fair value of the plan’s assets to the PBO. A shortfall indicates underfunding, which must be disclosed in financial statements.
A Higher Perspective on Pension Obligation Metrics
PBO forms one critical approach for estimating and disclosing pension obligations, alongside:
- Accumulated Benefit Obligations (ABO): Calculates the present value of retirement benefits as per current compensation levels, without future wage increases.
- Vested Benefit Obligations (VBO): Focuses on the portion of ABO guaranteeing benefits, regardless of ongoing participation in the pension plan.
Real-World Illustrations of Projected Benefit Obligations
In December 2018, General Motors’ U.S. pension plan exhibited a PBO of $61.2 billion, while the fair value of its plan assets amounted to $56.1 billion, reflecting 92% funding. Similarly, Ford’s plan displayed a PBO of $42.3 billion against plan assets valued at $39.8 billion, equating to 94% funding.
Special Considerations in PBO Evaluations
Despite being a liability on the company’s balance sheet, the classification of a PBO under traditional liability criteria is often debated. It requires future asset transfer based on past transactions, with exact obligations contingent on retirees’ service histories.
Actuarial losses also encounter differential treatments from the Internal Revenue Service (IRS) and the Financial Accounting Standards Board (FASB).
Related Terms: Accumulated Benefit Obligation (ABO), Vested Benefit Obligation (VBO), Actuarial Gains and Losses, Service Costs, Interest Costs, Underfunded Pension Plan.
