A few ways to hold institutions accountable for student debt defaults

Costs of postsecondary education have skyrocketed while student outcomes have worsened. One potential solution to the problem is something called institutional risk-sharing. This is a skin-in-the-game approach that makes institutions partly financially liable for poor student outcomes.

Currently institutional incentives are misaligned such that schools are largely insulated from the negative impacts they are generating in the underperforming postsecondary education system. Current federal regulations meant to protect students – cohort default rates, gainful employment, and the 90/10 rule – have done nothing to change institutional behavior as most schools will never be impacted by them. Thus, they provide little protection, and have made virtually no impact on the current crisis. By giving institutions a clear and defined financial stake in their students’ success, colleges and universities will be incentivized to ensure more students graduate and attain gainful employment, complete school more expeditiously and with less debt, and accept students that have a likelihood of success, rather than just anyone who can pay or qualify for federal loans. This practice would also discourage excessive borrowing.

Here’s how it works: Currently students are on the hook for their loans (and can’t even discharge them in bankruptcy) unless the loans are never repaid, in which case the American taxpayer bears the burden of the unpaid debt. Who’s not financially responsible? The institutions that promise to provide students a stepping stone to a better and brighter future. Institutional risk-sharing changes the calculus by making schools partly financially responsible when students earn degrees (or fail to earn degrees) that were not worth students’ time or money. It puts in place an accountability mechanism for schools to ensure they are working to improve students’ long term outcomes.

There are a number of different ways such an approach could be implemented. For example:

  • Institutions could be required to pay a flat fee for each student that defaults on a loan or a percentage of total defaulted loans that originate from their school. All fees would be paid to the government to reduce taxpayer responsibility for unpaid debt.
  • Institutions could be required to pay a fee to participate in federal aid programs (basically an insurance premium) either per borrower or as a percentage of the total amount borrowed.
  • A floor could be put in place such that institutions don’t have to pay anything until a certain negative threshold (such as a certain default rate or a debt-to-earnings ratio) has been reached. This would ensure high performing schools are not on the hook for having less than a 100% success rate. After the floor is met, institutions are on the hook for some portion of unpaid student debt.

There are potential drawbacks to a risk-sharing policy. For one, colleges will experience the policy as a tax and may in turn raise tuition even further as both an insurance policy against poor student outcomes and to cover the increased cost they would be required to pay to the federal government. In other words, they would pass the cost on to students and continue to escape financial responsibility. Additionally, while a policy such as this would make it so that colleges and universities shoulder some of the financial burden of poor student outcomes, it won’t actually improve the institutions or help prospective students make better choices about where to attend. Finally, a risk-sharing approach could negatively impact low income students because an obvious solution for colleges and universities is to simply admit fewer students that rely on federal aid.

Institutional risk-sharing isn’t a silver bullet that will magically solve the financial problems associated with postsecondary education, but it has the potential to change the incentive structure so that students, colleges, and taxpayer incentives are better aligned. There are other options that policymakers should explore, because almost any option is better than the status quo.

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