By J. FRED GIERTZ
Like zombie banks that have negative net worth but continue to operate, the Illinois prepaid tuition plan has effectively become a zombie, dead but still operating, for the last several years. Prepaid tuition programs provide contracts to parents or grandparents providing locked-in future college tuition costs for an upfront payment made many years in advance of college attendance.
The Illinois prepaid tuition program (established in 1998) has assets of $846 million, but an additional $289 million of unfunded liabilities for a funding ratio of 75 percent. It is now widely known that, contrary to the belief of those buying the contracts, the promised prepaid tuition benefits are not really guaranteed by the state of Illinois.
Because of this predicament, the program has ceased offering new contracts for the last two years, although the structural problems have been clear for many years.
In response to this problem, some members of the Illinois General Assembly are offering plans to make the contract holders whole at the expense of taxpayers in general.
There is also interest in who should be blamed for the problem. Recently, Sen. Scott Bennett, D-Gibson City, suggested that the state universities and especially the University of Illinois are partially to blame because of rapidly rising tuition costs.
Bennett and most other legislators were not around when the program was approved over 20 years ago. I was and testified (at the request of the UI) before a General Assembly committee on the legislation. The members were warned of exactly the scenario that has played out. It is unfair to say that the state has been taken in by the state's public universities.
Prepaid tuition seemed like a good idea at the time to legislators and parents. Tuition costs were rising rapidly and parents were increasingly concerned about the affordability of college for their children. The state of Illinois decided to come to the rescue by establishing a prepaid tuition program. What could go wrong?
Unfortunately, the program was seriously flawed from the very beginning. The program was predicated on a number of highly questionable assumptions that should have been addressed at the onset.
The following is excerpted from an Institute of Government and Public Affairs report that I co-authored March 7, 1997. It was released and presented in testimony to the Illinois General Assembly when the prepaid tuition plan was being drafted:
"Prepaid tuition plans are very similar to defined benefit pension plans. If they are well planned and well administered, there is no particular reason why they should fail. There is one additional complication, however, in comparison to pension plans. Pension plans are based on various actuarial assumptions about future life expectancy, inflation rates, rates of return, etc. With prepaid tuition plans, there is an additional factor in that it is necessary to project future tuition costs. At public institutions, these costs are based on political, as well as economic, factors since the increase in tuition costs results not only from inflation, but also from changing levels of state support. As with public pension plans, there are obviously political incentives that may result in underfunding. It may be attractive politically to offer unreasonably low prices for prepaid tuition knowing that these costs will come due far in the future.
"... Many of the objections to early proposals were based on their wildly optimistic estimates of investment returns and tuition inflation rates that left the state bearing an unreasonable degree of risk which, in turn, might be passed on to the universities."
These cautions raised in the report became a virtual roadmap leading to the current problems. Tuition growth rates were consistently underestimated because of diminishing levels of state support that led to increases that far outpaced inflation. These past underfunding problems cannot be addressed now by raising the costs for new entrants in the program. Since participation is voluntary, new buyers cannot be expected to pay to reduce the unfunded liability associated with earlier enrollees.
Regardless of who is to blame, it is a serious and sad problem for the state, made even sadder in retrospect by the success of the state's 529 college saving program that became available at the same time.
The state is in the midst of a fiscal crisis, associated in part with underfunded pensions, making the assumption of additional burdens painful. The General Assembly may well bail out the prepaid tuition program, but it should do so with the knowledge of who was responsible.
J. Fred Giertz is with the Institute of Government and Public Affairs at the University of Illinois.