A Path to Financial Aid 'Risk Sharing'

Lumina-funded policy brief calls for separate rewards and penalties for colleges and universities based on the student outcomes of Pell Grant and loan recipients compared to their peers. 

September 9, 2015

The idea that colleges should face penalties when their former students aren’t able to repay their federal loans has caught on in Washington.

Across the political spectrum, policy makers are increasingly calling for colleges to have more “skin in the game” when it comes to federal loans. Institutions, the thinking goes, need to share in the risk of loaning money to students so they’ll be more invested in student outcomes.

But for all that agreement, few politicians have delved into the fraught task of proposing, in detail, a new accountability system based on risk sharing, as the idea is known.

A policy paper released Wednesday by Robert Kelchen, an assistant professor of leadership, management and policy at Seton Hall University, offers one path toward a federal risk-sharing system.

The paper, funded by Lumina Foundation, calls for a system that involves rewards and penalties for colleges based on the academic outcomes of their Pell Grant recipients and, separately, how well their former students are able to repay their loans. On both counts, the government would judge a college’s performance compared to that of its peer institutions.

Kelchen writes in the paper that the goal is to hold colleges accountable for outcomes without harming institutions with few resources or giving colleges an incentive to be more selective in the students they admit.

One distinguishing part of the plan is that it would set up two distinct risk-sharing components: one for Pell Grants and one for federal student loans. Under current law, federal student aid is largely an all-or-nothing proposition. Colleges that have high student loan default rates, for instance, face sanctions that affect all of their student aid programs, including Pell Grants.

Kelchen’s plan calls for decoupling the accountability systems for Pell Grants and federal student loans -- and proposes different carrots and sticks for each component.

First, the plan would reshuffle existing campus-based aid programs like Federal Work Study and Supplemental Educational Opportunity Grants to reward colleges that enroll large proportions of Pell Grant recipients rather than those that have been in the programs for a long time, as is now the case. On the back end, colleges would be held responsible for how well those Pell Grant recipients stay enrolled at the institution, graduate or transfer.

If a college doesn’t meet the performance standards for Pell Grant recipients, the federal government would scale back its contribution and force the institution to chip in with its own money to fund students’ Pell Grant awards at the institution.

For student loans, Kelchen proposes a different set of rewards and penalties. Colleges would be judged based on the share of their former students who default on their loans five years after they become due, the percentage of former students current on repaying their loans, or the percentage of former students making forward progress in paying down their debt.

Colleges that have high loan default rates or low repayment rates would have to pay a penalty based on how far they exceeded the threshold. For example, an institution might have to pay a penalty equal to 5 percent of all loan dollars if its default rate was 5 percent above the sanction threshold.

By contrast, colleges that had default or repayment rates far below that of their peers would be eligible for additional Federal Work Study funds.

Under both parts of Kelchen’s plan, the government would sort colleges into peer groups to make judgments about the performance of their Pell Grant and loan recipients. That’s an approach that the Obama administration proposed in its now-abandoned efforts to hold colleges accountable for outcomes based on a federal ratings system.

Kelchen writes that properly crafted peer groups are important to making fair judgments about performance across institutions serving different populations of students seeking different degrees with varying resources available.

“Current federal accountability systems do not take these differences into account, which contributes to the set of colleges at risk of losing federal financial aid dollars being those with disproportionately large percentages of low-income, minority and first-generation students,” Kelchen writes.

The paper says that peer groups should categorize colleges based first on the type of degree they offer and second based on institutional selectivity and resources using metrics like ACT/SAT scores and per-student endowment values.


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