Terry’s Columns CollegeIllinois’ promise of tuition benefits looks iffy

CollegeIllinois’ promise of tuition benefits looks iffy

By Terry Savage on March 13, 2011

The recent revelations about the State of Illinois’ prepaid tuition program, CollegeIllinois, are troubling – but not totally unexpected. Every “defined benefit” investment program has shown losses over the past few years. But most plans have a longer time horizon than this program, which is supposed to pay out tuition benefits within 18 years or less.

Suddenly, thousands of parents who thought they were securing their children’s tuition have joined the millions of state employees who are worried about their promised pensions, and the bondholders who are wondering where the state will come up with the money to pay the interest on the bonds they own, much less repay the principal.

Crains’ excellent investigative report highlighted not only the investment deficiency in the funds but the changes in their investment style and accounting methodology. While CollegeIllinois executives defend their investment moves as necessary to “catch up” with the runaway costs of tuition, there is no doubt that the accounting changes give the appearance of “window dressing” to make the plan appear less underfunded.

The fact that the state does not actually guarantee all promised education payments was highlighted in my column a year ago, when the state reneged on its promise to pay a special bonus to holders of the separate, zero-coupon Illinois Municipal bonds that were sold a decade ago. Those bonds promised to pay a $100 cash bonus to holders that redeemed the bonds to pay for in-state college tuition. The payments were not made.

At that time, Illinois Student Assistance Commission head, Andy Davis, said that ISAC was only required to “ask” the state for funds to pay the bonus. Davis said his priorities as ISAC chairman were to distribute available funds to needy students, not to bondholders, as he explained the failed bonus payment. It was very tiny print that applied the same reasoning to the promised CollegeIllinois payouts.

The way out?

There is one big difference between the two situations. The promised bond bonus required a cash payment, while the prepaid tuition promises “credits.” Given the huge political pressure on the part of those who have paid into the plan, it is possible that the state could just require the universities to accept the “vouchers” for tuition that come from the plan, thus keeping its tuition promises.

These “unfunded mandates” have plenty of precedent. For example, the federal government requires states to pay for Medicaid, while not completely funding the payments. And just as the states have to figure out how to deliver the required Medicaid services, so would Illinois’ colleges and universities be required to deliver the promised education to the students who presented the vouchers. Then, there’s the longshot that the state’s plan to diversify its investments could provide the required capital to actually pay the costs in full. That’s a very “iffy” proposition, as many university and hospital endowments are learning after having diversified into hedge funds and venture capital. The difference between those big institutions and the CollegeIllinois plan is the shorter time horizon.

Keep investing?

In answer to a reader’s question posted on my blog in February, I said that I would not invest more into the program, given the uncertain nature of the state’s finances. If ISAC is depending on new contributions to fund the program, that is tantamount to acknowledging it is a Ponzi scheme, where the current contributions are used to pay out benefits to those withdrawing money. No one is alleging that is the case.

So, the fact that people stop making new contributions to the program because of the uncertainties surrounding its future should not impact the likelihood that present holders of contracts will one day receive their benefits.
Withdraw money?

But what if you are so disgusted by the revelations that you want to withdraw the money you already invested? Here is the withdrawal policy, direct from the CollegeIllinois website:

“If you cancel the plan within the first three years of the contract, you will receive a refund equal to the amount of payments made, less applicable fees. After three years, you will receive a refund equal to payments made, less any benefits or other refunds paid plus two percent interest compounded annually. Cancellation fees will apply. All refunds are issued to the contract purchaser.”

That sounds reasonable, except that the unspecified “cancellation fees” are found in the fine print. They are: “The lesser of $100 or 50% of amount paid.” Yes, taken literally, that means you could lose half the amount you deposited by withdrawing from your contract!

For those who are worried about the future of the plan, this is a very difficult decision: Lose half the money now or worry about losing all of it in the future!

There is some uncertainty over whether the word “cancellation” means that you do not make additional contributions to your plan or whether it applies only if you attempt to withdraw money you have already contributed. At press time, I was unable to clarify this with representatives of CollegeIllinois.

In the past, many states have discontinued their prepaid tuition plans. The state of Michigan actually dropped its plan back in the 1980s, recognizing the difficulty of guaranteeing tuition costs that were rising faster than investment results. Of course, there is another option for the State of Illinois: It could hold down tuition costs by demanding universities make budget cuts instead of raising tuiton.

That would give the CollegeIllinois program a fighting chance at making good on its promises. And that’s the Savage Truth.

Terry Savage is a registered investment adviser.



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