Originally published: Forbes | By Michael B. Horn | Jun 15, 2017
Intrigue with new models of student financial aid that encourage innovation in postsecondary education and align the incentives of institutions with the interests of students is growing.
In particular, Income Share Agreements (ISAs), which collect a set percentage of a student’s future income as opposed to putting a student into debt, are attracting considerable attention.
But ISAs are a nascent vehicle. Although their potential to address the issues of access, risk sharing, program quality, and education innovation is significant, there is considerable uncertainty around them. As a nascent and fast-evolving category, documentation and categorization of the players in this new ecosystem have been hard to come by.
This current state of ISAs is what spurred a new report, “The Future of Student Aid: Advancing New Models to Expand Access, Improve Quality, and Spur Innovation in Education.”
The report fills in a, to this point, missing picture of the state of the ISA market. The picture includes descriptions of the emerging players, as well as a clear-sighted view and market map
of how ISAs fit into a larger ecosystem of student aid options and private borrowing models. Included in the depiction of the larger ecosystem of student aid options is a detailed listing of the players, what they offer, and how their offerings compare to each other, including what interest rates and terms private loan providers offer and how all the different financing vehicles stack up against each other.
Among our conclusions, it appears that ISAs have the potential to:
• Factor in program quality in financing decisions;
• Consider nonfinancial factors in deciding credit eligibility;
• Share in the risk of financing a student’s education;
• Provide data and insights to help students make better decisions;
• Offer solid payment protections to students during times of hardship;
• Create incentives to offer students support during school and after graduation;
• Allow students to carry no principal balance;
• Fund innovative, nontraditional programs that do not qualify for financial aid.
There are also key questions to answer around ISAs that, in some cases may require Congressional action.
One exciting feature of ISAs is that to this point they are only considering forward-looking data — such as a student’s major and which school they are attending — in deciding what terms to offer a student, as opposed to backward-looking data like a student’s parents’ credit score. But there is no reason an ISA has to consider only forward-looking data per se. To improve returns for investors, an ISA provider could theoretically use both forward-looking and backward-looking data. As legislation emerges in the years ahead to clarify treatment of these loan alternatives, is it a good idea to lock in which criteria an ISA can and cannot consider?
Similarly, we write that Congressional action is likely important to clarify the terms and conditions of ISA contracts to specify the percentage of future income the individual will be expected to pay, the annual and aggregate limitations on the obligation, the time limit of the agreement, and early termination details. Considering capping the maximum payments that may be made out of an ISA may be important, as is clarifying that ISAs are not a debt instrument.
We also need more research on ISAs. ISAs have the potential to make sure that institutions don’t accept students they are ill-equipped to serve well — which would be a welcome thing in the wake of many for-profit and community colleges serving students unlikely to succeed — but there is a question in some people’s minds if this could cause institutions to roll back access too far. Another question to follow will be if access to ISAs in some way harms low-income students because by not taking out debt they don’t build a credit history, which may restrict access to the middle class over the longer term.
That said, one of the most intriguing things about ISAs is that they are often not competing today directly against most loan instruments but instead filling a gap in the portfolio of ways students pay for college. They are often competing against nonconsumption — where the alternative for a student is no financial aid. Today ISAs are often best suited for students who can’t easily get a private loan — often low-income and minority students without credit history or eligible cosigner — or to help students complete the “last mile” of their education when financial aid options have run out — for example when they are in the fifth or sixth year of a postsecondary program they are trying to complete. In at least this respect, ISAs resemble a disruptive innovation.
A key question is how will ISAs go up-market over time to serve more students in more circumstances and eliminate student reliance on private loans? Lessons from disruptive innovation would say to continue to compete against nonconsumption. For example, ISAs could dive in harder to serve students who have maxed out federal loan options but still need more time to complete their degrees.
Another possibility is a novel idea we float in the paper: reframe ISAs as insurance products. For example, one potential problem with the transition to an ISA market in which the university, not a third-party investor, is fronting the costs for students to attend, is that those universities are accustomed to receiving their money upfront. In this new scenario, the university will lose money for at least four years. This makes the transition difficult and not ideal for many existing institutions. As an alternative to an investor-led model that may make some universities and student advocates uncomfortable, if a third-party comes into the equation as an ISA insurance agent, students receive funding upfront and pay universities immediately, just as they do today. If a student does not finish school, then she is not responsible for the payment — the insurance agent becomes responsible. If the student completes the program, then she pays a percentage of her salary for a defined period of time, as outlined in the ISA contract. Students would have to pay a premium for ISA insurance, but they would be protected from any downsides. The pressure for institutions to maintain high-quality programs and prove outcomes remains, as ISA providers will only invest in high-quality programs.
Either way, after several months of research, we leave excited about the wave of innovation in student financial aid options, and intrigued by the potential of ISAs to serve low-income students well without sending them into crushing debt.