Vested Benefit Obligation (VBO)

Definition

The vested benefit obligation (VBO) is the actuarial present value of the portion of a pension plan’s benefits that employees have earned and are entitled to receive even if they leave the employer. It represents only the benefits that have vested, not benefits that depend on continued service.

How it works

• VBO is one of three common measures used to quantify a pension plan’s liability at each accounting period end. The others are:
• Accumulated Benefit Obligation (ABO) — present value of benefits earned to date, whether vested or not.
• Projected Benefit Obligation (PBO) — present value of future benefits using projected salary increases and service.
• Companies calculate VBO using actuarial assumptions (discount rates, mortality, etc.) to determine the present value of vested benefits.
• Financial accounting standards require firms to measure and disclose pension obligations so users can assess plan performance and the firm’s financial condition.

Vesting rules (ERISA)

Under the Employee Retirement Income Security Act (ERISA), employers must follow one of two minimum vesting schedules:
– Cliff vesting: benefits fully vest within 5 years of service (or less).
– Graded vesting: at least 20% of benefits vest by the third year (or earlier), with an additional 20% vesting each year thereafter until 100% vested after seven years of service.

Because minimum vesting is commonly five years, VBO and ABO values are often very close in practice.

Reporting and disclosure

• Companies are required to disclose pension obligations at fiscal year end. When VBO and ABO values are not materially different, firms frequently present the ABO and note that the VBO is substantially the same.
• VBO provides a conservative measure of the firm’s guaranteed pension liabilities because it excludes benefits that are contingent on future service.

Example (conceptual)

If an employee has earned a future pension benefit, the VBO equals the actuarial present value of the portion of that future benefit that has already vested. Actuarial assumptions determine how future payments are discounted to today’s value.

Key takeaways

• VBO measures the present value of vested pension benefits — the amount employees are entitled to regardless of continued employment.
• It differs from ABO (includes nonvested earned benefits) and PBO (includes projected future salary-based increases).
• ERISA sets minimum vesting schedules; these rules often make VBO and ABO similar in value.
• VBO is used in accounting disclosures to help users evaluate a company’s pension liabilities.