Incentives and the New Title IV Servicing Contract

My apologies for my "Title IV Servicing Contract of the brain" recently.  In case you missed any of the earlier posts, here goes:

• Department of Education Names 6 Finalists Vying for the Big Enchilada, the Direct Loan Servicing Contract
  
• And Now For Your Final, Final Bids...Due By Tomorrow (June 11, 2009)
• And the Winners Are...Department of Education Awards Servicing Contract To...(June 17, 2009)
• Department of Education Posts Contracts For Four Companies Awarded Title IV Servicing Business (June 26, 2009)
  
• SLA Values DL Servicing Contract at $1.3 to $1.5 Billion Over Initial Five Years (June 28, 2009)
• So, What Exactly Did Happen To ACS Anyway? (June 29, 2009)

I thought it was worth taking a look at the pricing structure to see the incentives that this long-term contract creates for the four servicers that have been awarded the contract.  As a refresher, here is the standard unit pricing for the contract with borrowers being the unit measured: 

Status	Volume Low	Volume High	Unit Price
Borrowers In In-School Status	N/A	N/A	$1.05
Borrowers in Grace or Current Repayment Status	1	3,000,000	$2.11
	3,000,001	Up	$1.90
Borrowers in Deferment or Forbearance	1	1,600,000	$2.07
	1,600,001	UP	$1.73
Borrowers 31-90 Days Delinquent	N/A	N/A	$1.62
Borrowers 91-150 Days Delinquent	N/A	N/A	$1.50
Borrowers 151-270 Days Delinquent	N/A	N/A	$1.37
Borrowers 270+ Days Delinquent	N/A	N/A	$0.50

Here are the performance criteria that will be measured to determine future allocations of loans: 

The allocation of ongoing volume will be determined based on the following factors:
1. Percentage of “In Repayment” Portfolio Dollars that go into default (as transferred to DMCS – 360+ days) – Measured as a percentage of the servicer’s current Federally held portfolio

a. Percentage at Public Schools
b. Percentage at Private Schools
c. Percentage at Proprietary Schools

2. Percentage of unique “In Repayment” Portfolio borrowers that go into default (as transferred to DMCS – 360+ days) – Measured as a percentage of the servicer’s current Federally held portfolio

a. Percentage at Public Schools
b. Percentage at Private Schools
c. Percentage at Proprietary Schools

3. Borrower Surveys

a. In School Borrowers
b. In Grace Borrowers
c. In Repayment Borrowers

4. School Surveys

a. Public Schools
b. Private Schools
c. Proprietary Schools

5. Survey of FSA personnel

First the disclaimer that I don't pretend to be as smart as those companies who have teams of people looking for ways to maximize revenue (as good capitalists do) from such government contracts.  Mulling the price sheet and the performance criteria, however, leads to some basic concerns:

• The incentives seem to be set up for servicers to provide any borrowers, at threat of defaulting, with the forbearance or deferment option.  While that may be the appropriate decision in certain instances, it is not in all instances, as interest continues to accrue on the loan while the borrower gets a breather on payments.  Meanwhile, the servicer receives a unit price of $2.07 almost equivalent to the grace or repayment status unit price of $2.11. 

This practice of granting forbearance and deferment will also allow minimize servicer defaults which represent #1 and #2 of the 5 criteria used to determine future allocations.  In case you were wondering about what controls exist to limit forbearance, this is straight from the contract (bold is mine):

"There is authority in the DL for unlimited discretionary forbearances. DL servicers must be able to offer borrowers additional administrative forbearance after the 3-year limit and upon receipt of additional documentation from the borrowers."

Hmm...has a taxpayer ever seen more frightening terms than "unlimited" and "discretionary" used in the same sentence.  In case this story about forbearances sounds familiar to you, it may be because it is.  This from a complaint brought against Sallie Mae by its shareholders for this very issue as it applies to private loans:

"Based on information provided by former employees of SLM that worked in collection centers...during the Class period SLM collection policy was consistent in encouraging PEL (private education loans) collection employees to move past-due loans into forbearance whenever it appeared that payment was not forthcoming."

• The second concern regards how surveys of borrowers, school and FSA will be used to measure servicer performance. 
  
  • I would hope that the FSA surveys are quantitatively driven to ensure that objective standards are used to compare servicers.  Certainly a servicer's activities lend themselves to measurement and should require minimal subjective evaluation.  There should be no time wasted by the Department having servicers seek to influence these survey results.  Please let the numbers speak for themselves.
  • Second, the survey results from borrowers should be weighted more heavily (50%) than both the school and FSA (which should be 25% each).  Borrowers' opinions should matter more since they are the ones actually experiencing and living with the service levels provided by the servicers.  Most financial aid staff would agree that their opinion of servicers  is driven more by anecdotes than by a wealth of data.  As a generalization, most also have less exposure to the relationship between servicers and students that develops after the in-school period. 

My purpose of this post is not to prejudge any servicer or their performance under this contract.  Rather it is to point out concerns regarding the incentive structure of the new contract. 

Any other ideas about how this contract might be improved?