Education is crucial to unlocking better livelihoods. As recent studies highlight, your education impacts your ability to get a job and the income-level of you and even that of your grandchildren.
- Last year, European unemployment rates were 46% lower for those with 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 demonstrates that it takes on average four to five generations for children from families earning in the bottom decile to attain average earnings.
Equal access to education remains a pressing issue, including in developed economies. A large number of factors come into play, yet financing seems to be a pervading issue. Current philanthropic, government and bank instruments are not sufficient.
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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, Andrew Hoyler, a graduate from Purdue University, received $16,000 through an ISA. He is now repaying 5.9% of the monthly income he earns working as a regional pilot. To quote Hoyler, the ISA has been “more streamlined and easy to understand’. He can also enjoy peace of mind, knowing his entry-level wage as a pilot allows him to afford the ISA payments.
Such contracts 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. Payments stop when students are not earning an income or when they reach a maximum indebtment rate;
- Typically, 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 allow them to contribute to 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 and legal risks. While this solution is very attractive, we must note that the concept is still widely unregulated and has many ethical ramifications.
Legally, ISAs bring 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.
Financially, before investing in such schemes, private funders must consider the many inherent risks and the potential mitigants put in place:
- 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? For instance, there is not always a clear visibility on workers’ revenues (borrowers moving abroad or starting an entrepreneurial journey, for example);
- Generally speaking, are risks adequately managed by the fund team? Mainly yes, 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.
ISAs pose many ethical questions that need to be tackled 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 a 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.
- 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. However, both tools serve to solve a pressing societal issue: providing seniors with added revenue streams for one and financing education for the other. Additionally, through the use of funds financing large numbers of life annuity sales or ISAs, 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.
Blended finance to the rescue: ideas to resolve financial and ethical risks
Blended finance aims to strategically use public or philanthropic funds to mobilize additional finance towards solving societal issues. In the case of ISAs, 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 ISAs, concessional investors and/or philanthropic donors could be useful:
- They could fund the part of the pool of students considered to be “riskier”. In this case, they would accept a potential loss of 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 members of the funds, they could ensure that the fund has the proper team and governance framework in place to maximize its impact.
Such ideas, along with proper regulation, could help make ISAs a truly impact-driven model.
Income-sharing agreements: potentially powerful, if well designed
ISAs have great potential to alleviate the current financing hurdles faced by students in developed, but also in developing countries. They could, in fact, serve to finance students in emerging economies wanting to study in developed countries and reduce a perceived obstacle to access to education for all.
ISAs 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 that blended finance could make ISAs a truly human-driven impact solution.