Projected Benefit Obligation (PBO) - Breaking Down Finance

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Projected benefit obligation definition

The change in the PBO is the result of the current service cost, the interest cost, past (prior) service cost, changes in the actuarial assumptions and benefits paid to employees. Let’s discuss each of these components in more detail.

  • Current service cost: the present value of the benefits earned by the employees over the fiscal year
  • Interest cost: the increase in the obligation due to the passage of time
  • Past (prior) service cost: retroactive benefits awarded to employees
  • Changes in actuarial assumptions: gains and losses that results from changes in the discount rate, mortality, employee turnover
  • Benefits paid: benefits paid to employees that lower the obligation

Together, these components make up the change in the PBO. Let’s translate this into a formula.

Projected benefit obligation formula

The PBO formula looks as follows:

$$\textrm{} = \textrm{PBO beginning of year} + \textrm{service cost} + \textrm{interest cost} + $$

$$ \textrm{past service cost} +/- \textrm{actuarial gains/losses} - \textrm{benefits paid}$$

We can use the PBO to calculate a plan’s funded status. Using the funded status formula, we obtain

$$ \textrm{funded status} = \textrm{fair value plan assets} - \textrm{PBO}$$

Let’s also have a look at the definition for the total periodic pension cost (TPPC). It is important to keep in mind that this is NOT the same as the change in the PBO. The periodic pension cost formula equals

$$ \textrm{TPPC} = \textrm{employee contributions} - (\textrm{ending funded status}$$

$$ - \textrm{beginning funded status})$$

Finally, let’s have a look at an example.

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