What is a projected performance obligation (PBO)?
A projected benefit obligation (PBO) is an actuarial measure of what a business will currently need to cover its future retirement commitments. It is used to determine how much should be paid into a defined benefit pension plan to meet any pension rights that have been earned by employees up to that date, adjusted for the expected future salary increase.
Key points to remember
- A projected benefit obligation (PBO) is an actuarial measure of what a business will currently need to cover its future retirement commitments.
- PBO assumes that the plan will not end in the foreseeable future and is adjusted to reflect the compensation expected in the coming years.
- Actuaries are responsible for calculating whether pension plans are underfunded.
Operation of a projected performance obligation (PBO)
Companies can offer their employees a number of benefits, including wages when they are too old to work. The Financial Accounting Standards Board (FASB) Financial Accounting Standards Statement No. 87 states that companies must measure and disclose their retirement obligations, as well as the performance of their plans, at the end of each accounting period.
The projected benefit obligation (PBO) is one of three ways to calculate the expenses or liabilities of traditional defined benefit pensions – plans that take years of service and employee wages into account when calculating benefits of retirement.
PBO assumes that the pension plan will not end in the foreseeable future and is adjusted to reflect expected compensation in the years to come. As a result, it takes into account a number of factors, including the following:
- The estimated remaining life of the employees
- Assumed salary increase
- A forecast of employee mortality rates
Actuaries are responsible for determining whether pension plans are underfunded. These qualified professionals, specialized in the measurement and management of risks and uncertainties, determine the necessary benefits through a calculation of the current value.
Actuaries are responsible for comparing the liabilities of the pension plan to their assets. In general, they provide a breakdown of the following:
- Service costs: The increase in the present value of the defined benefit obligation resulting from the fact that current employees obtain credit for another year for their services.
- Interest costs: The annual interest accrued on the outstanding PBO balance as an employee’s service time increases.
- Actuarial gains or losses: The difference between the pension payments made by an employer and the expected amount. A Gain occurs if the amount paid is less than expected. A loss occurs if the amount paid is higher than expected.
- Benefits paid: The obligations are reduced when benefits are paid.
It is possible to establish whether a company has an underfunded pension plan by comparing the assets of the pension plan, the investment fund called the fair value of plan assets, to the PBO. If the fair value of plan assets is less than the benefit obligation, there is a pension deficit. The company is required to disclose this information in a footnote in its annual financial statements 10-K.
PBO is one of three approaches used by companies to measure and disclose pension obligations. The other measures are:
Accumulated Benefit Obligations (ABO): Unlike PBO, Accumulated Benefit Obligations (ABO) refer to the present value of pension benefits earned by employees using current compensation levels.
Vested benefits (VBO): The portion of the accrued benefit obligation that employees will receive, regardless of their continued participation in the company’s pension plan.
Real example of projected service obligations (PBO)
Let’s take a look at the funded status of the auto giants Ford Motor Company (F) and General Motors Co. (GM). In December 2020, General Motors’ US pension plan had a PBO of $ 61.2 billion, with a fair value of plan assets of $ 56.1 billion. In other words, it means that his plan was 92% funded.
Meanwhile, Ford’s US benefit obligation at that date was $ 42.3 billion, while its plan assets had a fair value of $ 39.8 billion. This means that Ford’s plan was 94% funded, which is slightly better than its counterpart.
As at December 31, 2020, pension plan assets in the United States totaled $ 56.1 billion, while expected benefit obligations amounted to $ 61.2 billion, giving a ratio of average financing of 91.7%, compared to 91.5% a year earlier.
Criticisms of the planned performance obligations
Although a PBO is classified as a liability on the balance sheet, there are many criticisms as to whether it meets the predefined criteria to be defined as such. These criteria are the responsibility to return an asset from the result of transactions taking place at a specified future date, the obligation for a company to return assets to the liabilities at a future time and that the transaction resulting from the liabilities has already taken place.
Actuarial losses are treated differently by the Internal Revenue Service (IRS) and the FASB.