Aligning Higher Education’s Cost to its Value: Policy Appendix

FREOPP’s report Aligning Higher Education’s Cost and Value describes a comprehensive set of reforms that aim to ensure students and taxpayers receive a return on their investment in higher education. This policy appendix contains additional details of the reform agenda that were excluded from the main report in the interests of brevity. The details in this appendix are organized according to the component of the accountability plan to which they pertain: student loan risk-sharing, the financial guarantee, or the Pell Grant bonus.

Student loan risk-sharing: additional policy details

Defining programs. Programs are defined at the 4-digit CIP code level. If a student earns two credentials in different fields at the same time and at the same institution (e.g., a double major), his loans are split evenly between the cohorts for the two programs. If a student earns two credentials at the same institution at two different times (e.g., a student who first earns an associate degree and then a bachelor’s degree), all loans disbursed before the first credential was granted are included in the first credential’s cohort, while loans disbursed between the earning of the first and second credentials are included in the second credential’s cohort. Note that loans are assigned to the cohort corresponding to the year in which the borrower enters repayment, not the year in which he earns the credential.

Transfer students and consolidation loans. If a student entering repayment has loans from multiple institutions (e.g., a transfer student), the loans originated at each institution remain in the appropriate cohort for that institution. Payments are applied proportionately to each loan. If a student entering or currently in repayment consolidates loans from different institutions or programs, the consolidation loan is divided proportionately across the applicable cohorts.

For example, consider a student who borrows $10,000 to attend a community college, where he earns an A.A. in liberal arts. He then transfers to a four-year college where he borrows an additional $20,000 to earn a B.A. in psychology. When he enters repayment, the $10,000 is assigned to the cohort entering repayment that year for liberal arts at his community college; the $20,000 is assigned to the cohort entering repayment that year for psychology at his four-year college. If he does not earn a credential at the community college before transferring, his loans are assigned to the undergraduate non-completers cohort for that school. Functionally, none of this changes if he consolidates his loans.

Deferment and forbearance. Colleges should not be allowed to avoid risk-sharing liabilities simply by encouraging students to place their loans into deferment or forbearance. Any loan in deferment or forbearance will end up in a risk-sharing repayment cohort at some point. However, the timing depends on whether the deferment or forbearance is undertaken for “good” reasons or “bad” reasons.

“Good” reasons for a deferment or forbearance include in-school deferment, graduate fellowship deferment, military deferment, cancer treatment deferment, rehabilitation training deferment, and forbearance for medical and dental residency. If a borrower enters one of these statuses within five years of entering repayment, his loans are reassigned to the repayment cohort corresponding to the fiscal year in which the deferment or forbearance expires. Therefore, interest that accrues during the deferment or forbearance does not count against the school when calculating cohort repayment rates.

“Bad” reasons for a deferment or forbearance include economic hardship deferment, unemployment deferment, Parent PLUS borrower deferment, student loan debt burden forbearance, and general or discretionary forbearance. If a borrower enters one of these statuses, his loans are treated as if they were in repayment. Interest that accrues during the deferment or forbearance does count against the school when calculating cohort repayment rates. This is because “bad” deferments and forbearances are usually undertaken for reasons of financial hardship, and that reflects on the quality of the school’s education.

Phase-in. Only loans associated with students who enroll at an institution for the first time after the accountability system is enacted are subject to risk-sharing liabilities. Students enrolled at the time the accountability system is enacted may continue to use federal loans no matter what, and those loans are not subject to risk-sharing penalties.

Small cohorts. The Education Department (ED) may still assess risk-sharing penalties for programs with a small number of students in their graduating cohort. ED may suppress publicly-available data on borrower counts, balances, repayment rates, and assessed penalties for cohorts with fewer than ten students, if necessary. However, an institution still has the right to review, challenge, and appeal the data for small cohorts even if it is not released publicly.

Notification and appeals. The Secretary of Education must notify the institution of its risk-sharing liabilities at the cohort level. An institution may appeal a risk-sharing penalty within 30 days of notification. In addition, the Secretary must publish “shadow liabilities,” or the risk-sharing liabilities associated with loans issued before the enactment of the accountability system, to the greatest extent possible. Though penalties associated with pre-enactment loans are not charged, they may provide important information for schools seeking to identify and improve programs with low cohort repayment rates.

Financial guarantee: additional policy details

Mechanics of financial guarantees. Financial guarantees are determined at the time a loan is disbursed. However, the cohort to which a loan is assigned depends on the year in which that loan enters repayment. ED should therefore treat financial guarantees as associated with individual loans, not cohorts. Once a repayment cohort is constructed, ED adds up all the individual financial guarantees associated with the individual loans in that cohort to calculate the cohort financial guarantee.

Financial guarantees are siloed at the cohort level; the financial guarantee from one cohort may not be used to pay off the risk-sharing liabilities of another cohort, even if both cohorts are associated with the same institution. If the risk-sharing liability for an institution’s art school exceeds the financial guarantee for the art school, ED does not use a surplus financial guarantee from the engineering school to pay off the art school’s uncovered liability. This will sharpen the incentive for institutions to withdraw poorly-performing programs from federal loans while maintaining well-performing programs.

Waiver reversals. Institutions may waive a program’s uncovered risk-sharing liability if it withdraws that program from federal student loans for ten years from the date that the penalty is assessed. If the school later wishes to change its decision, it must pay all outstanding uncovered penalties associated with that program, plus interest (charged at contemporary student loan interest rates). Once those liabilities are cleared, the school may enroll new students using federal loans in that program before the ten-year window has expired.

Regulation of insurance companies. Schools may purchase insurance from a third-party financial institution in order to satisfy the financial guarantee requirement. The financial institution must be approved to offer insurance by the appropriate state insurance commissioner; ED and other federal agencies should be barred from directly regulating insurance companies to encourage market entry.

Note that insurance companies must directly guarantee the risk-sharing payments for which the school is liable. Financial products that guarantee student outcomes, such as degree insurance and loan repayment assistance programs, do not qualify. However, the institution might certainly consider investing in products such as these in order to improve students’ economic prospects and avoid risk-sharing liabilities.

Pell Grant bonus: additional policy details

Exclusions from median earnings. When calculating median earnings three years after completion, ED uses only students who are not enrolled in school and are not in a “good” deferment or forbearance as defined in the previous section. Only students who received Title IV aid are included in the earnings median. Earnings data in the College Scorecard should be modified to align with this definition. However, for the initial years of the Pell Grant bonus, ED can simply use median three-year earnings for non-enrolled students as they are calculated today, in order to allow Pell Grant bonuses to take effect immediately.

Institutional failsafe earnings. To calculate institution-level median earnings for both completers and non-completers, as required to implement the institutional failsafe, ED uses data on earnings for students who were separated from an institution in a given academic year; earnings are measured three calendar years later. Only students who received Title IV aid are included in the earnings median. Before this data becomes available, ED may use median earnings for working and non-enrolled students six years after first enrolling in an institution, which is currently available in the College Scorecard, as a substitute.

Small programs. There must be a minimum of ten students in the earnings cohort to calculate median earnings and Pell Grant bonuses. ED may use up to three consecutive years’ worth of completers to construct the earnings cohort.

Phase-in. Congress should direct ED to provide 33 percent of the applicable Pell Grant bonus in the first academic year that bonuses take effect. ED should increase this to 67 percent in the second academic year and 100 percent for all years thereafter.

Disbursement and disclosure. Pell Grant bonuses should be calculated twice yearly. The school should certify the program in which a student is enrolled before federal aid is disbursed so that ED can calculate the appropriate Pell Grant bonus for that student. Institutions participating in Pell Grant bonuses should adopt a standardized financial aid disclosure form, designed by ED, that clearly specifies the Pell Grant bonus and the fact that it is conditional on enrolling in a particular program.

Enforcement. Congress must give ED authority to monitor schools to ensure they do not game the Pell Grant bonus, for instance by nominally enrolling students in high-value programs to capture the bonus but giving them a credential in a separate, lower-value program. Congress should direct the Secretary of Education to issue a regulation that empowers ED to make an institution ineligible for Pell Grant bonuses if a large proportion of its students are using Pell Grant bonuses for programs in which they do not eventually earn a credential.

Additional policy recommendations

Administration. Congress should modestly increase funding for the Office of Federal Student Aid so it has the resources to administer the risk-sharing system and the Pell Grant bonus.