Vested Benefit Obligation - VBO
Categories: Careers, Company Management
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.
Related or Semi-related Video
Finance: What Does It Mean to Be Vested?227 Views
finance a la shmoop. what does it mean to be vested ?well here's what I mean
invested but vested in a financial sense has almost nothing to do with Cashmere. in [man in sweater vest smiles and waves]
most applications the term vested refers to stock option grants. and if you don't
know what a stock option is to stop watching now and go watch the stock
option video first. all right well these things are complex in the way they work
because they're more or less the modern-day equivalent of golden
handcuffs ,and no not the Fifty Shades kind .when an employee joins a typical
private small Silicon Valley technology company they're granted say twenty
thousand stock options in the company. the standard structure of an esop or
employee stock option plan. not the guy who wrote fables. the normal structure is
that the options vest over four years with a one-year cliff. what does all this
mean? well the one year cliff means that an employee vests or owns zero of the
options she has been granted until she hits her one-year anniversary at you
know whatever dot-com. it kind of sort of works like this. [ people celebrate]
your parents have decided to give you 20 bucks a month on your 14th birthday but
you don't get to start collecting the money until your 15th birthday and on
your 15th birthday you get a big fat check for $240. at 12 months times 20
bucks using advanced calculus there. now that you're 15 you get 20 bucks a month
for three more years or thirty six more months until you turn 18 and then you're
on your own no more allowance for you. so now let's
take this structure and apply it to a stock option grant. well the employee has
granted 20,000 options she gets none for the first 12 months but then after 12
months she vests or wears 1/4 of the options she was granted. she now legally
has title ownership of those granted options. even if the company fires her
the next day she still keeps those options but going forward she'll vest [Donald Trump fires someone]
monthly and be still at the company for another 36 months,
for a total of 48 months to fully vest into ownership of the 20,000 options. why
the one-year cliff well because many employees simply don't work out at
startups and because resources are slim companies have to fire employees who
just aren't cutting it quickly or the companies go bankrupt in everyone's out
of a job. and you know that goes well the one year cliff exists so that companies
can evaluate employees carefully before granting them a meaningful ownership
stake in the company. note that these are just options she's vesting into as
well. she doesn't own the stock. if she wants to buy out the options
she'll pay per share whatever the strike price is and you'll learn that $5.00 word
from watching the stock options video right? so if she has 20,000 options after
four years she's vested in two and then wants to leave with her owned shares
well in the strike price is 25 cents a share well she'll have to write a check
to the company of 25 cents times twenty thousand or five grand [woman wearing 20,000 options sign smiles]
but then own the 20 thousand shares instead of own the twenty thousand
options. if company goes public or is sold for say thirty bucks a share she
sells 20 thousand times 30 bucks or six hundred grand in winnings. yeah nice work
if you can get it. just think of all the fancy vests you could buy yourself with
that kind of cash. yeah all right moving on. [woman wears gold vest]