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Higher education accountability has climbed toward the top of the federal policy agenda. The federal government shells out more than $150 billion in grants and loans to colleges and universities annually, but asks comparatively little in return regarding student outcomes. In the face of sharp tuition increases, stagnant student completion rates, and delinquency rates on student loans that rival those on subprime mortgages in 2008, policymakers are under pressure to demand more of our nation’s colleges and universities.
Existing federal policies designed to hold institutions accountable—cohort default rates, the 90/10 rule, and financial responsibility scores—fall short of ensuring that taxpayer dollars are well spent. Colleges rarely lose federal aid (Title IV) eligibility for any reason, and access to grants and loans props up schools that would not pass a market test if students had to pay on their own.
How should federal policymakers reform accountability in postsecondary education? The key is to find an approach that is simple, transparent, difficult to game, and that applies to all institutions. One idea gaining bipartisan traction is “risk-sharing,” or “risk retention,” the notion that institutions should bear some fraction of the financial risk when their students fail to repay their loans after school.23 Risk retention is common in other areas of lending, and research suggests that lenders behave differently when they have “skin in the game.”
Why would a risk retention policy be an improvement on the status quo? How might policymakers design such a system? And how can they protect against potential unintended consequences?
The Status Quo in Quality Assurance
Federal policies designed to hold colleges accountable for the quality and cost of their programs do a poor job. The primary federal lever—the cohort default rate—measures the proportion of students who default on their federal loans within three years of entering repayment. Schools with 30 percent or more student borrowers in default over three consecutive years (or 40 percent in one year) are subject to sanction. Introduced in the early 1990s, the rule curbed the worst abuses and drove default rates down.
But the policy doesn’t work so well at ensuring a basic level of accountability. First, it is easily gamed. So long as students default outside of the three-year window, colleges are held harmless. This creates an incentive to nudge students into deferment or forbearance, which avoids default for a time but leaves balances to grow with accruing interest. When the Department of Education shifted from two-year to three-year default rates, the average jumped 4.6 percentage points.24 Though the official three-year default rate is just under 14 percent, a recent study found that the five-year cohort default rate for the 2009 cohort was double that.25
Second, the rule is binary: Colleges whose default rates are just below the federal standard retain access to federal aid programs. Those institutions that are close to the threshold likely have incentive to improve in order to avoid sanction in the future. But the set of schools with relatively high default rates that remain below the thresholds are held harmless when students are unable to repay. These thresholds are not magical, yet policy treats colleges on either side of them completely differently.
Third, the binary measure is extremely high-stakes; losing access to Title IV aid is essentially a death sentence for colleges. Institutions have a host of opportunities to challenge and appeal the Department of Education’s ruling, and policymakers have been reticent to sanction schools under the policy. According to the Congressional Research Service, just 11 of the 7,000 institutions that receive federal aid lost eligibility on the basis of their default rates between 1999 and 2014.26 In 2014, the Department of Education revised the default rates of a subset of institutions based on concerns about inadequate loan servicing, effectively saving them from sanction.27
In short, under current policy, institutions encourage their students to take on federal student loans but bear only a small fraction of the risk of default. Whether or not tuition is affordable and students are successful, colleges are paid in full. The result: Federal loan programs create incentive to enroll students but less incentive to worry about keeping tuition low or promoting student success.
To be clear, student success is a shared responsibility between students and institutions, and students should bear the bulk of the risk. At the same time, rigorous evidence indicates that colleges do have an effect on student success and that they can adopt interventions to improve retention and completion rates.28
Risk Retention
How would colleges respond if they retained some of the risk on the loans their students take on? The idea here is to give colleges—not just those with the highest default rates— stronger incentive to focus on keeping tuition affordable and promoting the success of their students. To be sure, many colleges already promote these goals as part of their mission. For those that charge high tuition for programs of dubious value, a risk-sharing policy would give them a reason to consider changes to institutional practice, resource allocation, and tuition pricing. Importantly, that policy would not dictate the remedies that colleges would have to adopt, but leave those details up to them. Institutions might respond by adjusting their admissions standards; working to contain costs and lower tuition; rethinking practices, programs, and policies; or some combination.
Risk retention is common in other lending markets, and having even a small stake (e.g., three percent) in loan performance seems to affect lender behavior.29 In the lone simulation of risk sharing in higher education, Temple University economist Douglas Webber found that a policy where colleges had to pay back 20 percent or 50 percent of defaulted loans would “bring about a sizable reduction in student loan debt,” though at the cost of “modestly higher tuition rates.”30 Webber shows that if colleges were able to reduce their default rates 10 percent, the reduction in loan debt would be considerable.
How might policymakers think about implementing risk sharing in the real world? The simplest approach would be to charge institutions a percentage of the outstanding balance on non-performing loans in a given cohort, perhaps targeting institutions whose repayment rates fall below a certain threshold. Charging on a sliding scale, where the percentage charged increases as repayment rates worsen, would ensure that schools just below any standard receive a lighter penalty while poor performers are subject to stronger sanctions. Either way, the formula should be continuous, not riddled with sharp cliffs.
The two key design questions are: How should the percentage be calculated, and to what outstanding loan balance should that percentage be applied? On both questions, policymakers should move away from relying exclusively on default rates, data which are increasingly noisy due to a heavier reliance on Income-Based Repayment (IBR). Instead they should consider relying on repayment rates—the percentage of students who have paid down at least a dollar of principal over a set period of time (at least five years).
On the percentage, a norm-referenced formula that reflects both overall sector performance and national economic trends would ensure that colleges are judged fairly. For example, policymakers could take the difference between a school’s five-year repayment rate and the national average for the sector (two-year or four-year colleges). That difference could be adjusted uniformly for all schools (i.e., by dividing it by 10) to keep the percentage within reason. The point isn’t to put colleges out of business overnight, so the penalty need not be enormous.
The policy could then apply that percentage to the outstanding balances of the students in a given cohort who, after five years, either fail the repayment rate test or are in default.31 To allow for economic trends, the formula could adjust that sum based on the national unemployment rate for workers between the ages of 25 and 34. Colleges would be on the hook for the resulting amount.
When it comes to implementing those sanctions, there are a few options. The federal government could withhold the amount from subsequent aid disbursements. Alternatively, institutions could be required to place a portion of their tuition revenues that is proportional to the risk of non-repayment into an escrow account or student aid insurance fund that would cover the cost of sanctions. Or institutions could simply remit a payment to the federal government.32
Caveats
The most obvious criticism is that risk sharing will reduce access for low-income students. In some cases, encouraging institutions to think twice about enrolling students who are unlikely to be successful is not necessarily a bad thing. Policy should encourage students to enroll in institutions where they are likely to be successful, not any institution that will take them.
However, to provide institutions with continued incentive to enroll qualified low-income students, policymakers should offer institutions a bonus for every Pell Grant recipient they graduate. Such a reward could be financed via risk-sharing payments and would help balance the potential financial risk of enrolling low-income students. In addition, schools that improve their outcomes over time should be eligible for “safe harbors” that protect them from sanction.
Colleges have also raised concerns that risk retention would hold them accountable for behaviors they do not control. For instance, the Department of Education has discouraged colleges from limiting how much students are allowed to borrow for living expenses, which gives the colleges little control over borrowing beyond the cost of tuition. Students are allowed—and perhaps encouraged—to borrow in excess of tuition.33
There are two options here. One is to adjust the formula to reflect the ratio between tuition and the total cost of attendance—thereby holding colleges accountable for tuition. The other is to allow colleges more power to limit borrowing for particular types of students (those in online programs, attending part-time, or living with family).
Risk sharing will be controversial with colleges and universities, as all accountability ideas are. Unlike other plans (i.e., the college ratings), though, it has the advantage of being simple, transparent, and non-binary.
Notes
23 Alex Pollock, “Fixing Student Loans: Let’s Give Colleges Some ‘Skin in the Game,’” The American, January 26, 2012, https://www.aei.org/publication/fixing-student-loans-lets-give-colleges-some-skin-in-the-game/; Jordan Weissmann, “Elizabeth Warren Wants Colleges to Pay a Price When Students Can’t Pay Their Loans. Great Idea,” Slate, June 12, 2015; Office of Senator Jeanne Shaheen, “Senators Shaheen, Hatch Introduce Bipartisan Bill to Improve Quality of College Education,” August 5, 2015, https://www.shaheen.senate.gov/ news/press/release/?id=b581bd4b-2ceb-435d-b62a-7d761b07639a.
24 Texas Guaranteed Student Loan Corporation, “The Difference a Year Makes: Comparing Two-Year and Three-Year FY 2009 CDRs,” October 1, 2012, www.tgslc.org/blog/post.cfm/the-difference-a-year-makescomparing-two-year-and-three-year-fy-2009-cdrs.
25 Adam Looney and Constantine Yannelis, “A Crisis in Student Loans? How Changes in the Characteristics of Borrowers and in the Institutions They Attended Contributed to Rising Loan Defaults,” Brookings Institution, September 2015, http://www.brookings.edu/~/media/projects/bpea/fall-2015_embargoed/conferencedraft_ looneyyannelis_studentloandefaults.pdf.
26 Senate Committee on Health, Education, Labor & Pensions, “Risk-Sharing/Skin-in-the-Game Concepts and Proposals,” http://www.help.senate.gov/imo/media/Risk_Sharing.pdf.
27 Jeff Baker, “Adjustment of Calculation of Official Three Year Cohort Default Rates for Institutions Subject to Potential Loss of Eligibility,” Information for Financial Aid Professionals, Federal Student Aid, September 23, 2014, www.ifap.ed.gov/ eannouncements/092314AdjustmentofCalculationofOfc3YrCDRforInstitutSubtoPotentialLossofElig.html.
28 Robert K. Toutkoushian and John C. Smart, “Do Institutional Characteristics Affect Student Gains from College?” The Review of Higher Education 25, no. 1 (2001): 39-61, https://muse.jhu.edu/ login?auth=0&type=summary&url=/journals/review_of_higher_education/v025/25.1toutkoushian.html Thomas Bailey et al., The Effects of Institutional Factors on the Success of Community College Students (New York: Community College Research Center, Teachers College, Columbia University, January 2005), http://ccrc. tc.columbia.edu/media/k2/attachments/effects-institutional-factors-success.pdf Eric P. Bettinger and Rachel B. Baker, “The Effects of Student Coaching: An Evaluation of a Randomized Experiment in Student Advising,” Educational Evaluation and Policy Analysis 42, no. 7 (October 2013): 1-17 Nicole M. Stephens, MarYam G. Hamedani, and Mesmin Destin, “Closing the Social-Class Achievement Gap: A Difference-Education Intervention Improves First-Generation Students’ Academic Performance and All Students’ College Transition,” Psychological Science 25, no. 4 (2014), www.psychology.northwestern.edu/ documents/destin-achievement.pdf.
29 Benjamin J. Keys et al., “Did Securitization Lead to Lax Screening? Evidence from Subprime Loans,” Quarterly Journal of Economics 125, no. 1 (2010): 307-362; Cem Demiroglu and Christopher James, “How Important is Having Skin in the Game? Originator-Sponsor Affiliation and Losses on Mortgage-backed Securities,” The Review of Financial Studies (September 2012); see also Pollock, “Fixing Student Loans: Let’s Give Colleges Some ‘Skin in the Game,’” 2012.
30 Douglas A. Webber, Risk-Sharing and Student Loan Policy: Consequences for Students and Institutions (Bonn, Germany: The Institute for the Study of Labor, February 2015), p. 3, http://ftp.iza.org/dp8871.pdf.
31 This is the approach that Senators Jeanne Shaheen (D-NH) and Orrin Hatch (R-UT) took in their Student Protection and Success Act. See: http://www.shaheen.senate.gov/imo/media/doc/Student%20 Protection%20and%20Sucess%20Act.pdf.
32 For more on different options, see Senate Committee on Health, Education, Labor & Pensions, “Risk-Sharing/ Skin-in-the-Game Concepts and Proposals,” http://www.help.senate.gov/imo/media/Risk_Sharing.pdf.
33 Mark Kantrowitz, “Borrowing in Excess of Institutional Charges,” Finaid.org, April 28, 2011, http://www. finaid.org/educators/20110428debtbeyondtuition.pdf. |
