This NYT piece on an alternative to student loans just blows my mind. Instead of making student loans essentially great big unsecured debts to unemployed adults in which the government guarantees the lender (such a backward financial transaction it baffles my mind that it exists), they become insurance pools that encourage employment and have the potential to depress runaway tuitions.
In exchange for $8,530 in financing, Sneider agreed to repay 14 percent of his salary for 118 months after he graduated. At that point, regardless of how much he has paid, his obligation terminates. Although this might sound similar to a loan, an “income contingent” repayment plan like this is far less risky for a low-income student like Sneider. If he has trouble finding a job or switches careers and earns a lower salary than expected — very distinct possibilities — his payments will drop automatically. The terms are, in fact, determined based on his expected earnings. If he ends up earning the average salary for nurses in Colombia, he will end up paying the equivalent of an interest rate of 17 percent, which is the average rate in the country for a student loan. And if he ends up doing better, he will pay more, and Lumni will share in his success.
So how do we finance something that is extremely valuable both for individuals and for society — something that, in most cases, should happen, but often won’t happen because the risks are too high?
The best way is to spread the risk. That’s how insurance works. In Lumni’s case, students share the risk with investors, who make more or less based on how well the students do. But they also share it with one another. Lumni pools its investments into funds to balance out the risks. They know that some students will run into difficulties, some will achieve average success, and some will do very well — but they don’t know in advance how any individual student will fare. And students don’t know this themselves. Through diversification, however, their funds can achieve stable returns.
Imagine Lumni and companies like it become the default financing option for college applicants. These companies could deny funding for certain colleges and universities based on poor actuarial outcomes; if the University of Southwest Alaska has a poor track record of graduating employable adults, Lumni won't subsidized its tuition rates, and students will have a choice between traditional Faustian loan bargains or, crucially, other schools that Lumni determines do a good job of creating jobs.
This would accomplish two goals -- increasing higher education outcomes in relation to graduate job prospects, and reducing financing as the primary determination of college choice -- while still allowing young and inexperienced adults to spread the costs and risks of attending college out over time.
It remains to be seen if this model scales up with its remarkable 3 percent default rate (and that's servicing exclusively low-income and first-generation college applicants!) but I can emphatically say I wish this type of financing was a choice when I was going to school.