Education is key to unlocking better livelihoods. As recent studies highlight, your education impacts factors such as your ability to get a job, your income-level, and even that of your grand-children:
Just last year, European unemployment rates were 46% lower for those with a higher education compared to those with only a secondary school diploma
In the same year, Americans with a masters’ degree earned on average three times more than their high-school educated counterparts.
A 2018 OECD study demonstrated that it takes on average 4 to 5 generations for children from families earning in the bottom decile to attain average earnings
Equal access to education remains a pressing issue, even in developed economies. A large number of factors can explain the differences of education levels among social classes or regions. Yet, financing seems to be a cross-cutting issue. Current philanthropic, government and bank instruments are not sufficient. Too often, students are left with a high debt burden, forcing them to quickly find jobs that might not fit their aspirations.
In this context, a new financing solution based on private capital has come to light: Income Sharing Agreements (ISAs). Will they revolutionize the way we fund education?
Income Sharing Agreements: an attractive concept
An ISA is a contract between a student and an investor (or a school). The investor covers the tuition fees and the student promises to pay back a percentage of his future income for a fixed number of years.
In 2017, Mr Hoyler, a graduate from the university of Purdue, received $16,000 through an ISA. He is now repaying 5.9% of his monthly income as a regional pilot, for the next 8,5 years. To quote Hoyler, the ISA has been “more streamlined and easy to understand’. He can also enjoy peace of mind, knowing his pilot entry-level wage allows him to afford the ISA payments.
Indeed, such contracts offer a real response to the education financing needs. They come with several advantages, especially in comparison with traditional loans:
- ISAs offer flexibility. The student must only reimburse a set percentage of his or her income, when he/she has one. Payments stop when students are not earning an income, or when they reach a maximum indebtment rate.
- Generally speaking, no collateral is required when the student enters the contract.
- The fixed percentage, regardless of salary variations, offers the student more freedom in choosing the job he/she wants, rather than the one he/she needs in order to pay back a loan.
- In case of market or career failure, the student experiences less pressure to pay back a loan.
For private investors, ISAs appear as a way to contribute in solving a pressing issue, while making a return and entering a new market. With such advantages, it is no surprise that many ISA contracts have already been set up, notably in the US where the student debt issue is gaining heat.
A student as a financial asset? An unregulated domain? ISAs still come with many ethical & legal risks.
While this solution is very attractive, we must note that the concept is still widely unregulated and implies many ethical ramifications.
Legally, ISAs bring about several risks for students, including a lack of borrower protection. Some investors may not have a student’s best interest at heart and could impose inacceptable clauses, or charge usury fees. Creating a legal framework around ISAs is needed to unlock the full scale of this opportunity.
Financially, before investing in such schemes, private funders must consider the many inherent risks and the potential mitigants put in place, of which:
- How is the risk of adverse selection alleviated? Students wanting to enter lower-income or riskier sectors might tend to bend more towards ISAs than students aiming for high-earning jobs.
- How much will the management of the ISAs cost over time? ISAs are substantially more complex to handle than traditional loans. For instance, there is not always a clear visibility on workers’ revenues (borrowers moving abroad, starting an entrepreneurial journey, …).
- Generally speaking, are risks adequately managed by the fund team? Notably thanks to the use of relevant statistical data estimating students’ capacity to pay back, and through a pooled fund targeting a large enough number of universities and students.
Ethically, Income-Sharing Agreements also pose many questions which need to be tackled with, to ensure a human-driven model:
- ISAs could conjure many biases. Such contracts can lead to a situation where the rich only lend to the rich, to lower the default risk. Investors could also “cherry-pick” their students, based on discriminatory criteria such as studies, gender or background.
- In such one-on-one relationship, impartiality could be an issue. Investors may feel they should have a say in their borrower’s future and try to influence students in making certain career choices. Some lenders already offer career coaching to the financed students. Ensuring the freedom of the students will be key to the ethical success of ISAs.
- A more global ethical issue is that of considering a physical person as a financial asset. Interestingly, such ethical issues already exist in the form of life annuity sales. While one bets on someone’s death, the other bets on someone’s success. In both cases, the underlying wager can be ethically questionable. However, both tools serve to solve a pressing societal issue: providing seniors with added revenue streams for one, financing education for the other. Additionally, through the use of funds financing large numbers of life annuity sales or ISAs, one can consider that investors are investing in statistical trends representative of a population’s behaviour rather than betting on someone’s death or career.
All this points to a strong need for creating a legal framework but also enforcing tight governance and setting clear impact goals. Only so will ISAs be able to unlock the full scale of this opportunity. To that end, bringing together a mix of institutional, private and philanthropic capital can ensure the right terms are set-up and applied at scale. And this is where blended finance can play a role.
Blended finance to the rescue: some first ideas to resolve financial and ethical risks
Blended finance aims to strategically use public or philanthropic funds to mobilise additional finance towards solving societal issues. In the case of Income Sharing Agreements, mixing different sources of funding would help find the right governance and balance.
As mentioned above, pooling private capital into a fund financing hundreds of beneficiaries could enable risk diversification. However, the temptation of selecting students depending on biased criteria is high. Forcing fund managers to adopt non-discriminatory policies and diversity measures would mechanically imply an increase in the risk of the ISAs portfolio. This, in turn, could raise the expected returns, bringing a higher average cost for the beneficiaries. Blended finance can help avoid this pitfall.
In the case of Income Sharing Agreements, universities already play a role by partnering with ISA funds. Asking them to share a part of the risk is an interesting path to follow. After all, aren’t they the ones selling a bright future to their students?
Concessional investors and/or philanthropic donors could also be useful:
- They could fund the part of the pool of students considered to be “riskier”. In this case, they would accept to potentially lose part of their capital;
- These investors could also specifically fund students deciding to go for lower-income jobs. In fact, students pursuing jobs with high societal value but low income could find it difficult to pay back part of the investment;
- They could act as capital guarantors if specific diversity thresholds are reached;
- As board member of the funds, they could ensure that the fund has the proper team and governance framework in place to maximize the impact.
Such ideas, along with proper regulation, could help make ISAs a truly impact-driven model.
Income Sharing Agreements: a potentially very impactful tool, if well designed
In conclusion, ISAs have a great potential to alleviate the current financing hurdles faced by students in developed, but also in developing countries. In fact, Income Sharing Agreements could also serve to finance students in emerging economies wanting to study in developed countries. Thereby, they can reduce a perceived obstacle in reaching access to education for all.
ISAs allow to bring private capital into a social impact sector and open new investment opportunities for investors. However, one needs to be very cautious when structuring such a tool: if wrongly designed ISAs can easily become discriminatory and/or unjust. In this context, we believe blended finance could make Income Sharing Agreements a truly human-driven impact solution. As fund managers, will we be able to find the appropriate balance?