Business issues

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Spending Endowment Income in Today's Climate

As the U.S. economy has derailed, those colleges fortunate enough to have endowments have seen them shrink. Now more than ever, it is critical that they reconsider how they spend the income from those funds, diminished as it is. Colleges that let individual units or departments keep their own endowment revenues risk increasing the gap between their campuses’ “have” and “have-not” programs.

They also make it very difficult to spend their precious dollars effectively on the institutional priorities they deem most important -- something every college or university must do now.

The percentage of the operating budget that is supported by endowment income ranges widely among institutions, from those with no or very small endowments (and thus a negligible impact on operating budgets) to those where they account for 40 percent or more. On average, according to the 2008 Commonfund Benchmarks Study of Educational Endowments, 9 percent of institutional operating budgets are funded by endowment income, while the median percentage is 4.5 percent.

There are two distinct ways of budgeting endowment funds. One is the “allfunds” approach to budgeting, where the goal is to use every available dollar, whatever the source, as a way to support institutional priorities and to ensure equity in the distribution of funds. The other is what I call the “distinct funds” approach, where general funds are allocated “equitably” to all departments to provide base levels of funding, and endowment funds belong to the individual school, department or program to which they are restricted.

In the “all funds” approach, colleges consider restricted funds when allocating unrestricted funds, and use this interplay of endowment funds and general funds to mitigate differences in wealth among activities. Thus, a well-endowed department is likely to receive little, if any, general funding from the institution compared to a department with little or no endowment. This type of practice occurs despite the fact that, at such institutions, more than 75 percent of endowment funds may technically be restricted. Typically, the truly “restricted” spending tends to be used to award prizes, support museums, fund specialized academic endeavors or provide scholarship funds for students with unique skills and talents.

In the "distinct funds” approach, those schools, departments or programs with large endowments operate with substantially greater resources than those that lack endowments. General funds at these institutions are used only at the margin and in small amounts to mitigate serious inequities in resources among departments; departments with little or no endowments of their own tend to receive only slightly more in general funds than do other departments.

To clarify the differences in these two approaches to budgeting, if a department at an all-funds institution were to receive a generous restricted gift, a nearly equivalent amount of the department’s general funds would be taken back and replaced by the funds from the restricted gift. Thus the department would not see much difference in its budget as a result of the new gift. On the other hand, if the gift were given to an institution that uses distinct funds budgeting, the department that received the new gift would experience a significant increase in its funding in future years.

Unavoidably, at some all funds institutions, there are times when endowments have been restricted to activities that are not considered central to the institution’s mission or when the specific fund provides more income annually than the institution would otherwise have chosen to spend on this activity. In these instances, which tend to be relatively few in number, endowment funds do influence institutional priorities. Activities endowed in this manner tend to receive no general funds, and in years when income from the restricted endowment declines, the colleges do not provide general funds to offset the loss in endowment income. Put another way, if these endowments did not exist, general funds would not support these activities.

The significant endowment declines that most institutions are experiencing differ in their impact on individual programs depending on the budget methodology their campuses use. The decline in endowment income has led institutions that take an all funds approach to reevaluate their distribution of all funds across the institution, and to redeploy general funds to ensure that strategic priorities are supported. (For example, if a significant part of an institution's need-based aid comes from endowment funds, a college that uses an all funds budget approach and wants to preserve its commitment to meeting the financial needs of its students will reevaluate the general fund allocations to all programs and make a significant reallocation in favor of financial aid.) These colleges and universities need only to continue to apply their normal budget process, albeit with significantly constrained resources.

At institutions with distinct funds budgeting, the well-endowed areas in this environment will experience significant decreases in resources, which may prove quite disruptive to institutional priorities, while those areas dependent on revenue sources that are not being seriously impacted by the recession will continue to enjoy relative stability in funding. Many of the well-endowed programs have until recently experienced large annual increases in resources and have operated with a level of resources significantly above other programs or departments at their institution that either have no or small endowments. The current situation is a new one for many institutional leaders, as we have not faced this kind of serious downturn in endowments in more than 50 years.

At institutions that use distinct funds budgeting, mission critical programs that have relied primarily on endowment income as their funding source will be sorely underfunded relative to institutional priorities. This will leave the institution with two choices: change its budget practices to look more like those used by all funds schools or operate in a sub-optimal way relative to institutional priorities.

Changing budget practices is difficult in any environment, but it will be especially difficult in this fiscally constrained environment. Now, the “have-nots” will continue to be “have-nots” to preserve those areas of the university that have always benefited from higher levels of funding. Some institutions may not politically be able to make these adjustments, and serious damage may occur to programs that are mission critical.

Institutions that do not use an all funds approach to budgeting should consider reevaluating how they distribute funds so they can better deal with overall institutional priorities in times like these. If colleges change their budget procedures to move toward a more institution-wide approach to fund distribution, irrespective of source of income, they should make clear the ”rules of the game” so they don’t revert to the old way of doing things when endowments recover, once again moving the institution to a situation of “haves” and “have-nots.”

Lucie Lapovsky
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Lucie Lapovsky is an economist who is the former president of Mercy College, in New York. She currently writes and consults on issues related to higher education finance, leadership and planning. This article was adapted from a piece that ran in Trusteeship.

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