Prepaid Tuition Plans In The News

I noticed a smattering of stories over the past few weeks.  My earlier post "Prepaid College Tuition Plans:  Not Always A Guarantee" highlighted the importance of having a state guarantee to support the plan.  My initial research found that only 40% of plans had some form of a state guarantee although I also noted that should a plan without a state guarantee fail there would be lots of political pressure to compensate the victims (see Alabama PACT program below). 

States are rapidly discovering the problem with how these prepaid tuition programs are structured: 

"When you couple the market's performance with the rising cost of tuition, the states determined that they could no longer continue in the programs and track tuition inflation with their investment gains," said Chris Hunter, associate director with the Lexington, Ky.-based trade association [National Association of State Treasurers]."

Here are some developing stories about these programs:

• The Tennessean headline "Tennessee's Prepaid Tuition Plan May Succumb to Unsteady Economy" highlights the dangers of these plans without a state guarantee:

"State Treasurer David Lillard Jr. could recommend suspending new enrollment in the prepaid tuition plan, among the possibilities, depending on findings from an analysis of assets and liabilities later this year, said Blake Fontenay, his spokesman.

A snapshot taken a year ago found a $12.7 million deficit, although the state's treasury department, which administers the program, said there was enough money to cover at least a decade's worth of tuition expenses.

Keeping enrollment open would bring in more funds to help with short-term obligations, but would also increase long-term liabilities, officials said."

With broad indexes (S&P500) down almost 12% since their last snapshot, it seems difficult to imagine that their deficit would have gone down.  With tuition going up in Tennessee by 6-9% future liabilities would have to seem to have to increase and it would be a herculean task for their investment performance to have been in positive territory. 

• Meanwhile in Pennsylvania, participants in that state's Guaranteed Tuition Program will be paying a premium going forward: 

"A $222.9 million deficit caused by soured investments means investors saving for college through Pennsylvania's Guaranteed Savings Plan will have to pay more than $1 for $1 of tuition.

Effective Sept. 1, the state-run program will charge an 8 percent premium for investors purchasing tuition credits at the University of Pittsburgh and Penn State University. Premiums of 2 percent will be imposed on purchases of credits for Temple University, private colleges and Ivy League schools. There will be no premiums for Slippery Rock University and other schools that are part of the State System of Higher Education or for community colleges."

The premiums are intended to reduce the program's current deficit, which could take 7 years to close:

"However, Wall Street's meltdown last year left the fund with a $328.7 million deficit as of Dec. 31. The market's recovery since March reduced the deficit to $222.9 million by June 30. The plan had assets of $1.1 billion, or 83 percent of the money needed to purchase the $1.3 billion in tuition investors had prepaid for, according to a report by the fund's actuary."

• The Birmingham News is reporting that Alabama is still struggling for a fix to their Prepaid Affordable College Tuition Plan (PACT).  They are going to have to dig themselves out of quite a hole:

"A recent report commissioned by the Retirement Systems of Alabama estimated the state could fix PACT's money woes by giving it $641.8 million in 2011, or by giving PACT as much as $1.006 billion in payments spread over more than a decade."

        Even though the Alabama program does not have an explicit guarantee, clearly this shortfall         has forced the state's politicians to find a solution: 

"The PACT program is part of a state agency administered by the state treasurer, but state law says PACT contracts are not debts or obligations of the state, according to the report. Riley and others say the state has a moral if not a legal obligation to make good on contracts people signed with a state program.  "I think the people of Alabama entered into a good-faith contract with the state of Alabama and have every right ... to see that that contract is honored," Riley said."

As for where the money will come from...

"Riley said he thinks finding money for PACT will involve cutting money from existing programs, but that he, lawmakers and other stakeholders are far from agreeing on how that should be done.  "This comes down to winners and losers," Riley said.  "Do we have the capacity to fix it? Absolutely," he said. "Can we do it without a negative cost to something else? No, you don't." 

Here is the Associated Press story. 

• On the bright side, the Guaranteed Education Tuition (GET) Program in Washington State has recovered due to record enrollments this spring.  This growth in assets was no doubt helped by the fact that the Washington program is guaranteed by state law.

• Meanwhile, the Texas Tomorrow Fund, which closed to new investors in 2007 will be short about $2 billion by 2030, a tab that will be picked up by Texas taxpayers.

So, what is wrong with the design of these programs? 

In one sentence:  As tuition rates have skyrocketed, equity markets have cratered leaving a significant gap between the assets and future liabilities of these programs.  It reminds me of that time-worn cliche:  If a deal (locking in tomorrow's tuition rates today) sounds too good to be true....oh you know the rest.  No amount of financial alchemy could overcome this combination of tuition levels rising at rates consistently above inflation and fickle financial markets which don't grow at a stair step 8% annual rate.  As states are forced to step in and support that guarantee with taxpayer dollars, these plans may become less popular quickly.  One other factor to be aware of is the importance of new contributions in keeping these programs solvent.  If new subscribers pull back, don't be surprised to see more of these plans run into problems. 

Comments

[drtaxsacto]

That is not true of i529 which is the sole Prepaid program that is not state operated.

http://www.independent529plan.org/?utm_source=Google&utm_medium=CPC&utm_term=i529&utm_campaign=GoogleCPC