Present Value of Future Benefits (PVFB)

The Present Value of Future Benefits is the aggregate value of forecasted benefit payments to staff, discounted to the present day. It allows organisations to put away adequate funds to cater for future outlays. Discounting must be undertaken to account for the time value of money, where future outlays have lesser value today.

Projected Benefit Obligation (PBO)

The Projected Benefit Obligation (PBO) calculates the present value of pension liabilities, including anticipated salary growth. Because most benefit plans are tied to final salaries, PBO is a more accurate measure of liabilities than calculations that do not include salary growth. This measure is essential for financial planning and risk management because it reflects both current and future obligations.

Accumulated Benefit Obligation (ABO)

ABO is the same as PBO except that it assumes salaries do not increase in the future but are maintained at their current levels. It does not account for future salary hikes and hence is a conservative estimate of pension obligations. Organisations apply ABO for financial reporting, especially when determining the minimum funding needs of pension plans.

Service Cost

Service cost is the increase in the pension obligation of an employer as a result of employees earning more benefits in the current year. It is one of the fundamental elements of pension expense recognised in financial reports. This measure enables organisations to comprehend the incremental cost of employee service yearly and is a vital component for budgeting future expenses on benefits.

Interest Cost

Interest expense occurs as a result of the passage of time, with future benefit promises nearing their time of payment. It is estimated by applying the discount rate to the PBO at the start of the year. This measure is an indication of the cost of delaying benefit payouts and is a cornerstone of pension accounting.

Discount Rate

The discount rate is an essential assumption of actuarial valuations and is applied to find the present value of future benefits. The discount rate usually reflects yields of high-grade corporate bonds or government obligations. An increase in the discount rate will decrease the present value of liabilities, and a decrease in the rate will make it higher. It is important to select an effective discount rate, as it affects the valuation outcomes and financial reports directly.

Expected Return on Plan Assets

For funded benefit plans, organisations invest assets to earn returns that contribute towards future benefit payments. The expected return on plan assets is an estimated rate of return the assets will provide over time. This measure impacts the employer’s net pension cost since greater expected returns lower the total pension expense. Actual returns, though, may be different, producing actuarial gains or losses. 

Funding Ratio

The funding ratio is the comparison of assets reserved to cover employee benefits to the estimated liabilities. It is an important measure of a benefit plan’s health. A ratio of 100% or more represents a fully funded plan, while anything less than this represents underfunding and needs corrective measures in the form of higher employer contributions or plan changes.

Key Actuarial Metrics – A Summary  

Conclusion

Actuarial valuations are important for evaluating and managing employee benefit liabilities. Actuarial valuations assist organisations with regulatory compliance, financial planning of strategies, and adequacy funding of employee benefits. Mithras Consultants specialises in conducting actuarial valuations, providing businesses with precise calculations and strategic insights to optimise employee benefit management. The team’s expertise ensures that organisations make informed decisions to maintain financial stability while fulfilling employee benefit commitments.