Improving access to education through income share agreements

Income Share Agreement are a potential solution for addressing the obstacles associated with financing education. But can they truly revolutionize the way education is funded?

Education is key to unlocking better livelihoods. As numerous studies highlight, education impacts such factors as the ability to get a job and income level. But equal access to education remains a pressing issue, even in developed economies.

A large number of factors can explain the differences of education levels among social classes or regions. Yet, financing seems to be a cross-cutting issue. Current philanthropic, government and bank instruments are not sufficient, and too often students are left with a high debt burden, forcing them to quickly find jobs that might not fit their aspirations. In this context, a new financing solution based on private capital has come to light – income share agreements. But will they revolutionize the way education is funded?

Income share agreements

An income share agreement (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. ISAs come with several advantages, especially in comparison with traditional loans:

• They offer flexibility. The student must only reimburse a set percentage of his or her income, when he/she has one. Payments stop when students are not earning an income, or when they reach a maximum indebtment rate.
• Generally speaking, 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 appear as a way to help solve 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. 

Ethical and legal risks

While ISAs are attractive, it is important to note that the concept is still widely unregulated with many ethical ramifications.

Legally, ISAs bring about 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. Creating a legal framework around ISAs is needed to unlock the full scale of this opportunity.

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? ISAs are substantially more complex to handle than traditional loans. For instance, there is not always a clear visibility on workers’ revenues (borrowers moving abroad, starting an entrepreneurial journey, etc.).
• Are risks adequately managed by the fund team? Generally speaking they are, 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.

Ethically, ISAs pose many questions which 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 one-on-one relationships, 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. Ensuring the freedom of the students will be key to the ethical success of ISAs.

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. In both cases, the underlying wager can be ethically questionable. However, both tools serve to solve a pressing societal issue: providing seniors with added revenue streams for one, financing education for the other. Additionally, through the use of funds financing large numbers of life annuity sales or ISAs, one can consider that 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 as well as enforcing tight governance and setting clear impact goals; only then will ISAs be able to unlock the full scale of this opportunity. To that end, bringing together a mix of institutional, private and philanthropic capital can ensure the right terms are set up and applied at scale. And this is where blended finance can play a role. 

Blended finance

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 noted 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, universities already play a role by partnering with ISA funds. Asking them to share a part of the risk is an interesting path to follow. After all, aren’t they the ones selling a bright future to their students?

Concessional investors and/or philanthropic donors could also be useful:

• They could fund the part of the pool of students considered to be “riskier”. In this case, they would accept to potentially lose 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 member of the funds, they could ensure that the fund has the proper team and governance framework in place to maximize the impact.

Such ideas, along with proper regulation, could help make ISAs a truly impact-driven model. They have a great potential to alleviate the current financing hurdles faced by students in developed, but also in developing countries. They could also serve to finance students in emerging economies wanting to study in developed countries, thus reducing a perceived obstacle in reaching access to education for all. 

ISAs can bring private capital into a social impact sector and open new investment opportunities for investors. However, one needs to be cautious when structuring such a tool – if wrongly designed, they can easily become discriminatory and/or unjust. In this context, we believe blended finance could make ISAs a truly human-driven impact solution. As fund managers, will we be able to find the appropriate balance?

Ladislas de Guerre is a Manager at KOIS Paris and Colin Godbarge is a Principal at KOIS Paris.

This opinion piece was originally published by KOIS.