Income-contingent loan with personal insurance policy: an empirical assessment using Spanish data

ABSTRACT

We propose an Income Contingent Loan that defers the payment of university fees and charges a fixed proportion of gross income for 30 years or until the debt is written off. Under these conditions, some participants in the scheme will have insufficient income to fully repay their loan balances. The deficit will be covered by the taxpayer, who ultimately bears the risk of investing in higher education. We then propose to transfer this risk to the student by adding a mandatory personal insurance policy to the individual loan. We calculate the premium required for the system to break even in Spain when everybody pays the insurance cost. Alternatively, the payment of the premium can be deferred, adding it to total debt. Then, some participants in the scheme will have insufficient income to even pay the insurance cost, and the premium needs to be increased to maintain the sustainability of the program. Although these mechanisms imply redistribution towards borrowers who end up being low earners, we show that middle-income individuals contribute a higher proportion of their incomes to covering for those unable to repay. To provide the system with more internal progressivity, we propose to impose a minimum period of repayment.

KEYWORDS:

• Student loans
• insurance
• repayment burdens
• higher education financing
• returns to education
• government policy

JEL CLASSIFICATION:

• I22
• 26
• 28

Acknowledgments

We gratefully acknowledge the comments and suggestions of an anonymous referee of this journal. This work was supported by the Spanish Ministry of Science [grant numbers ECO2016-76255-P, ECO2017-86305-C4-2-R] and the Regional Government of Aragón, and FEDER [grant number S52_17R: Compete Research Group].

Disclosure statement

No potential conflict of interest was reported by the authors.

Data sources

The Survey of Household Finances (EFF), 2011 wave. Bank of Spain.

Notes

¹ This contrasts with mortgage type loans that impose predetermined fixed monthly payments.

² Like other insurance mechanisms, income contingent loans can lead to adverse selection. The reason is that they can be more attractive to those who expect to be low earners, who will not pay back in full. To avoid this, in all the universal schemes (Australia, England, New Zealand), participation in the scheme is compulsory.

³ The literature also refers to this kind of schemes as graduate taxes (e.g. García-Peñalosa and Wälde 2000).

⁴ Note that early repayment cannot be allowed in this case.

⁵ Other papers, like Azmat and Simion (2017), focus on the effects of financing reforms on educational attainment and labour market outcomes.

⁶ Chapman and Lounkaew (2015) argue in contrast that unconditional quantile regression analysis is more adequate in this case. We have used both methodologies and results do not change much. They are available upon request.

⁷ It is common to assume that the distribution of income is constant (e.g. Chapman and Lounkaew (2015)). Our interpretation of this assumption is less stringent than assuming zero earnings mobility across percentiles.

⁸ European Commission, EACEA, Eurydice (2014). National Student Fee and Support Systems in European Higher Education: 2014/15: Eurydice: Facts and Figures.

⁹ Calculations are made for the average 10-year interest rate on government funds for the last three years: 1.6%.

¹⁰ The term progressivity is usually understood to be with respect to the whole population. Here we refer to progressivity within the subset of graduates in the population.

¹¹ It is important in this case that early repayment is not allowed.

Additional information

Funding

This work was supported by the Spanish Ministry of Science [grant numbers ECO2016-76255-P, ECO2017-86305-C4-2-R] and the Regional Government of Aragón, and FEDER [grant number S52_17R: Compete Research Group].