Annual Required Contribution (ARC)

Definition

The Annual Required Contribution (ARC) is the amount that an employer must contribute each year to fund its other post-employment benefits (OPEB) obligations, such as retiree health insurance. This contribution is calculated based on actuarial assumptions and represents a necessary funding strategy to meet future benefit payouts. Understanding ARC is vital for employers to ensure they adequately set aside funds to cover their long-term liabilities associated with OPEB commitments.

5 Must Know Facts For Your Next Test

1. The ARC is calculated using actuarial methods that take into account factors like life expectancy, healthcare costs, and employee demographics.
2. Failing to meet the ARC can lead to increased unfunded liabilities, which can create financial strain on the employer over time.
3. The Governmental Accounting Standards Board (GASB) requires public sector employers to report their ARC and related OPEB liabilities in their financial statements.
4. ARC is not a fixed amount and can fluctuate based on changes in actuarial assumptions, such as changes in healthcare trends or demographic shifts among retirees.
5. Employers often face challenges in budgeting for ARC due to the unpredictability of future healthcare costs and legislative changes affecting OPEB.

Review Questions

• How does the calculation of the Annual Required Contribution (ARC) incorporate actuarial assumptions?
  • The calculation of the ARC incorporates various actuarial assumptions, such as estimated future healthcare costs, employee turnover rates, mortality rates, and the projected lifespan of retirees. By using these assumptions, actuaries can estimate how much money needs to be set aside annually to meet future OPEB obligations. This process helps employers understand their funding requirements and plan accordingly.
• Discuss the implications for employers who do not adequately fund their Annual Required Contribution (ARC).
  • When employers do not adequately fund their ARC, they risk accumulating significant unfunded liabilities that can lead to financial instability. This shortfall can result in budgetary pressures in future years as employers may need to make larger contributions to catch up on past deficits. Additionally, failing to meet OPEB funding requirements may impact the employer's credit rating and result in higher borrowing costs.
• Evaluate how changes in healthcare trends might affect the Annual Required Contribution (ARC) over time.
  • Changes in healthcare trends can significantly impact the ARC by altering the underlying assumptions used in its calculation. For instance, if medical costs increase at a faster rate than anticipated, this will likely raise the expected future liabilities associated with OPEB. Consequently, actuaries may revise the ARC upward to ensure that sufficient funds are allocated for these rising costs. This dynamic nature highlights the importance of ongoing monitoring and adjustments in funding strategies as healthcare trends evolve.

Related terms

Other Post-Employment Benefits (OPEB): Benefits provided to employees after they retire, which can include health care, life insurance, and other forms of compensation beyond pensions.

Actuarial Valuation: A process that evaluates the financial status of a pension plan or OPEB, using statistical methods and assumptions about future events to estimate liabilities and required contributions.

Pre-Funding: Setting aside money in advance to pay for future obligations, such as OPEB costs, which helps ensure that funds are available when needed.