What is the difference between the PBO and Total Future Liability? The descriptions in CFA curriculum (book 2, pg. 399) make them seem to be the same.
Total Future liability has the accumulated component in it , while the PBO does not . In other words , the ABO shows the accumulated benefit , the PBO shows the future accumulation including wage increases , while the total shows the effect of both
I thought PBO showed both? I guess i need to review
Actually forget what I wrote. I don’t think what I wrote is correct.
I think I need to revise , not you !
Maybe PBO uses a different ( CFAI calls it reasonable ) measure of future wage increases than the total future liability does. The total liability has some component of actual increase possible , and is an internal planning number , while the PBO ties down the final average pay based on current circumstances of the employee. Probably ( my guess ) the PBO is smaller , just to satisfy a regulator such as ERISA , but for a conservative organization , they may plan a arger number .
For example an employree is a boiler mechanic now , and if he works as a boiler mechanic for the rest of his career in the company he may retire with a salary of X , which may be used in PBO calculation.
The total future liability may be factoring that his role may change or his job description may become very different and he is paid much more in the future
Pure conjecture on my part.
No clue to the actual numbers possible , no solved example in CFAI text.
to jankisri’s point - when looking at using asset classes to hedge against specific risks in pension obligations, my impression is that total pension liability encapsulates those factors which compaies cannot easily model nor hedge against - like workforce volatility, future changes in productivity, or other so called sources of “liability noise” as CFAi puts it.
PBO = ABO + Future Liability
And if they cannot model it, how do they count it in total liabilities? Pull it from a cloud?
shouldn’t have said “cannot” - more like cannot do it accurately, hence it’s not hedged - so yeah it’s kind of a cloud number
ABO accounts for already accumulated benefits (i.e i’ve worked here 10 years making x, I’m entitled to Y). it’s the liability for a plan in run off (i.e. dead)
PBO accounts for accumulated plus future (ABO+ assumed increased due to years works and wage increase)
Total Pension accounts for things like changes in workforce, etc. which are not effectively modeled (you don’t know how many people will be in your plan in 10 years).
I had one post earlier. Can anybody confirm/modify my understanding about it…
Decomposing the pension obligation
1) Inactive. Two parts here. a) Retirees - retired & currently receiving benefits b) Deferreds - Not retired, but not working in the company anymore. Company is owing their future benefits. Benefits are fixed then nominal bond portfolio.
2) Active - working with the company. Obligation can be decomposed into two parts. a) For past services. Known so Part B (deffereds) + this part = Accrued benefits. Accrued but not yet started paying off.
b) Future services (this is where the problem of understanding is) - are the benefits attributed to (i) future wages to be earned, (ii) future services to be rendered, and (iii) future entrants into the plan.
(i) Futures wages to be earned - this is current wages plus _ X% growth. _ If X% is known (assumed-provided by actuary) future benefits could be ascertained. PV of this future wage liability + Accrued benefits = Projected benefit Obligations (PBO)
(ii) Future entrants into the plan - Not known hence not modeled
(iii) Future services to be rendered - number of years in futures current - active employees will continue to work. IMO, here the company would pay benefits to these employes when they retire based on two things - a)length of service b) salary history at the time retirement. Say the formula company adopted is
- X % multiplied to No of years of services of their avg of final last 3 year’s salary
- Say 2% X 10 years x Average pay = 20% of the final salary as benefit every year
Since we neither know with certainity the year of services nor the final pay withdrawn by these employee, its difficult to model them. Also future services of future entrants is not known.
Here is the answer:
3 liability concepts for pension plans
Accumulated Benefit Obligation (ABO) – This is the PV of the obligation owed to employees that is already “earned”. It’s what you would owe if the employees were all to be terminated immediately. So if I have been working for 15 years and will likely work another 10, the ABO is the PV of what I am owed for the 15 years I have already done (accumulated service), not the additional 10 I am expected to do.
Projected Benefit Obligation (PBO) – This is the PV of the obligation for work that has been done so far with the added wrinkle that it increases the liability by some factor to anticipate expected compensation increases until retirement (relates to the idea that your total pension benefit will be based on your average compensation of the course of your career at the company). So again, if I have 10 years left to work in my career and have worked 15 already, PBO = ABO × compensation factor for 10 more years of work
Total future liability – this one is the PV of all 25 years of work; the 15 I have already done and the 10 I am expected to do. As with the PBO, it assumes increases in compensation.
For calculating the funding status, the PBO is the one that is generally used.
Resurrected from the dead by magicskyfairy. Page in the 2014 curriculum is 437.
Simple answer:
-
ABO - benefit calculated at the valuation date using service and pay to date.
-
PBO - benefit calculated at the valuation date using service to date, but pay projected to retirement.
3)Total future liability - benefit calculated at the valuation date using service and pay projected to retirement.
While PBO is generally the liability measure that is used, that is because its use was mandated by the accounting standards boards. In the US, the funding rules used by the government require that the ABO be used. On a theoretical basis, the ABO is preferrable, because it doesn’t anticipate pay increases that have not yet been earned.
Very well explained - Thankyou!.
Just wanted to add that Projected benefit obligation (PBO) is a terminology used by US GAAP while IFRS calls it present value of defined benefit obligation (PVDBO).