What is a Projected Benefit Obligation (PBO)
A projected benefit obligation (PBO) is an actuarial measurement of what a company will need at the present time to cover future pension liabilities. A PBO measurement is used to determine how much must be paid into a defined-benefit pension plan to satisfy all pension entitlements that have been earned by employees up to that date, adjusted for expected future salary increase. The projected benefit obligation is calculated by an actuary, who determines the benefits needed through a present value calculation.
Breaking Down Projected Benefit Obligation (PBO)
A projected benefit obligation is a calculation of the total amount due to employees in the pension fund for all of the past service completed up to that date, but it assumes that the plan will not terminate in the foreseeable future and is adjusted to reflect expected future compensation increases. This can be differentiated from accumulated benefit obligation, which lacks the adjustments for expected future increases in salary. PBO is more limited than total future liability, in that total future liability accounts for expected labor that has not yet been rendered.
Projected Benefit Obligation Theory and Calculation
Pension accounting stipulates that these retirement benefits are treated as deferred income that has already been earned. As active participants earn future benefits each year, they incur a corresponding cost known as the normal cost. Additional actuarial gains or losses can be incurred as key assumptions in the PBO calculation change. Some of the assumptions an actuary will use to calculate the PBO include the estimated remaining service life of employees, salary raises and the mortality rates of employees. An unfunded plan exists when the PBO exceeds the pension plan assets.
Consider the funded status of the pension plans for large automakers Ford Motor Company and General Motors. As of December 2015, General Motors had PBO of $71.5 billion, with fair value of plan assets at $61.1 billion, meaning the plan was 85% funded. Ford's benefit obligation at that date was $74.6 billion, while plan assets had fair value of $63.4 billion. Ford's plan was 89% funded, which is slightly better than its peer.
Projected Benefit Obligation Complications
Although a PBO is classified as a liability on the balance sheet, there is considerable criticism about whether it meets the predefined criteria of a liability. These criteria are the responsibility to surrender an asset from the result of the transactions taking place at a specified future date, the obligation for a company to surrender assets for the liability at some future point in time, and that the transaction resulting in the liability has already taken place. Actuarial losses are treated differently by the Internal Revenue Service (IRS) and the Financial Accounting Standards Board (FASB).