What Is a Projected Benefit Obligation (PBO)?
Let me tell you directly: a projected benefit obligation, or PBO, is an actuarial measure of what a company needs right now to cover its future pension liabilities. You should know that this figure determines how much must be contributed to a defined benefit pension plan to meet all entitlements employees have earned so far, and it's adjusted for expected future salary increases.
Key Takeaways
Understand this: PBO is that actuarial measurement for covering future pension liabilities today. It assumes the plan won't end soon and factors in future compensation expectations. Actuaries handle PBO to check if pension plans are underfunded.
How a Projected Benefit Obligation (PBO) Works
Companies offer benefits like pensions upon retirement, and according to the Financial Accounting Standards Board's Statement No. 87, they must measure and disclose these obligations and plan performance each accounting period. PBO is one of three methods to calculate liabilities for defined benefit pensions, which base benefits on service years and salary.
Here's what you need to grasp: PBO assumes the plan continues indefinitely and adjusts for future pay. It considers factors such as employees' remaining service life, assumed salary increases, and forecasted mortality rates.
Actuaries, experts in risk and uncertainty, calculate the needed benefits via present value. They compare plan liabilities to assets, breaking down elements like service costs (the rise in PBO from another year of service), interest costs (annual interest on unpaid PBO), actuarial gains or losses (differences between expected and actual payments), and benefits paid (which reduce obligations).
To check for underfunding, compare the fair value of plan assets to the PBO. If assets are less, there's a shortfall, and the company must disclose this in its 10-K footnotes.
PBO is one approach; others include accumulated benefit obligations (ABO), which use current pay levels for present value, and vested benefit obligations (VBO), the portion employees get regardless of continued participation.
Example of Projected Benefit Obligations (PBO)
Take General Motors in December 2018: their U.S. pension had a PBO of $61.2 billion against $56.1 billion in plan assets, meaning it was 92% funded. Ford's was $42.3 billion in obligations with $39.8 billion in assets, at 94% funded—slightly better.
Special Considerations
Although PBO appears as a liability on the balance sheet, there's debate on whether it truly qualifies, given criteria like future asset surrender and past transactions. Also, note that the IRS and FASB treat actuarial losses differently.
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