Vested Benefit Obligation - VBO

See: Vested Benefit.

Figuring out whether a pension plan has enough money presents a complicated problem. Pensions take in contributions over time (both from workers and from the employer). Then they invest those contributed funds in order to turn that money into, well...even more money. Eventually, the pension plan starts paying out from its nest egg as people retire. These distributions support the workers in their golden years.

The money getting collected today might not get paid out for decades. There are a lot of moving parts to determine whether a pension plan has enough money. It's like trying to figure out if a first grader is learning enough to be a doctor someday...it's just hard to project that far into the future.

There are two sides to the equation, both carrying their own complications. You have the amount of money the pension will have, the nest egg out of which it will pay benefits. This figure fundamentally represents a projection of the plan's assets at some point in the future. On the other side of the coin, you have an estimate of what the plan will be expected to pay out in the form of benefits. This figure measures the pension plan's liabilities. The vested benefit obligation deals with the liability side.

There are a few methods people use to measure how much a pension plan will have to pay out. These approaches are important when it comes to tracking the plan's financial health. They help measure how well-financed it is compared to the eventual benefits it will have to pay out. Vested benefit obligation is one of the measuring sticks for liabilities (the other two are called accumulated benefit obligation and projected benefit obligation). The VBO calculates how much future benefits employees in the pension plan have already built up. If the employee quit today, how much pension would they be owed in the future? It tracks the level of benefits already vested.

You belong to a hamster grooming union. Your annual salary is $50,000 a year. At 20 years as a full-time hamster groomer, you are entitled to a pension of half your annual salary ($25,000 a year). You can start collecting the pension at age 65, and it lasts until you die. At 30 years as a hamster groomer, you qualify for a 3/4 pension, or $37,500 a year.

You've been on the job for 27 years. You decide that you've had enough of the job. You're done washing rodents, and want to become a professional skydiver. So you quit. You've passed the 20-year mark, entitling you to a half pension. However, you haven't reached the 30-year mark, so the 3/4 pension isn't on the table.

So, for the VBO calculation, they would use the $25,000-a-year measure. It kicks in when you turn 65. Based on life expectancy charts, they estimate you'll receive the pension for 20 years. The pension plan, therefore, needs $500,000 for your benefits. That figure gets added along with everyone else's estimate to calculate the pension plan's overall VBO.