Projected Benefit Obligation (PBO)

Definition

A projected benefit obligation (PBO) is an actuarial estimate of the present value of a company’s future pension liabilities. It reflects the benefits employees have earned to date, adjusted for expected future salary increases and other assumptions about future events.

Key points

• PBO assumes the pension plan will continue and incorporates future salary growth.
• Actuaries calculate the PBO using assumptions about service, salary increases, mortality, discount rates, and other factors.
• Comparing PBO to the fair value of plan assets indicates whether a pension plan is underfunded.

How PBO is measured

Companies must measure and disclose pension obligations at the end of each reporting period. The PBO is one method for valuing defined benefit pensions and is computed as the present value of projected future benefits attributable to employee service to date.

Factors used in the calculation include:
* Remaining service life of employees
* Expected salary increases
* Mortality and other demographic assumptions
* Discount rate (used to determine present value)

Components that change the PBO

Actuarial calculations break movements in pension obligations into distinct components:
* Service cost — increase in PBO from employees earning another year of service.
* Interest cost — growth in the PBO due to the passage of time (discounting).
* Actuarial gains or losses — differences between assumed and actual experience (e.g., changes in assumptions, investment returns, mortality).
* A gain occurs when actual outcomes are more favorable than assumed.
* A loss occurs when outcomes are less favorable than assumed.
* Benefits paid — reductions in the PBO when pensions are paid out.

Determining underfunding

A pension plan is underfunded when the fair value of plan assets is less than the PBO. Companies disclose funding status—typically in footnotes to financial statements—so stakeholders can assess pension risk.

Other common pension measures

• Accumulated Benefit Obligation (ABO) — present value of benefits earned to date using current compensation levels (does not reflect future salary increases).
• Vested Benefit Obligation (VBO) — portion of the ABO that employees are entitled to receive even if they leave the plan.

Example

Example data from large corporate pension plans illustrate funding comparisons:
* General Motors’ U.S. plan had a PBO larger than its plan assets, indicating a funding shortfall.
* Ford’s U.S. plan showed a similar pattern but with a slightly higher funded percentage.

(These examples show how PBO and plan assets are used to calculate funded status; specific amounts vary by company and reporting period.)

Special considerations

• Classification as a liability: Although PBO is reported as a liability, some debate whether it meets all formal criteria for a liability because payments occur in the future and depend on ongoing plan existence.
• Accounting and tax treatment: Actuarial gains and losses and other pension accounting items can be treated differently under accounting standards and tax rules, so pension expense and funding requirements may diverge depending on the framework applied.

Summary

PBO is a forward-looking, actuarial measure of a pension plan’s obligations that accounts for future salary growth. It is central to assessing pension funding status and relies on key assumptions set by actuaries. Comparing PBO to plan assets reveals whether a pension plan is underfunded and requires disclosure in financial statements.