How do you structure ISAs for high-risk and non-STEM students?

To briefly introduce ISAs for those not familiar, they are a financial instrument that students can use to pay for their education without taking out debt. In an ISA, an institution says to a student “You can study here, and you don’t have to pay us right away, but you have to pay us a portion of your future salary”. The key components of ISAs are:

1. The term (the defined period of time after graduation during which a student must make payments to a university)
2. The cap (the total possible multiple of tuition a student might pay back, usually 1.5–2.5x tuition)
3. The floor (the minimum repayment amount required even if the student does not successfully gain employment)
4. The rate (the percentage of a student’s future salary to be paid back each month)

Can you finance students without historical educational and labor market success?

Typically, ISAs are provided for students at coding bootcamps, who generally aren’t considered at-risk populations. These students typically have six years of work experience and a bachelor’s degree already, so it’s fairly likely that they will complete the course of study successfully and be on their merry way. However, for ISAs to be truly successful as an asset class, they need to be available to students who are looking for the downside risk protection that ISAs offer but may not have savings from previous employment or previous schooling on which to draw. This is not only an imperative from a standpoint of growing the asset class, but also from the socioeconomic diversity necessity of understanding that it would be a moral failure for ISAs to only be accessible to a certain class of people that was already successful or semi-successful to begin with.

Assuming you, the reader, agree philosophically that we need to develop different ISA product structures that work fairly for many types of students, let’s start with an example. Let’s say that you have two coding bootcamps: one for previous college graduates who want to become hedge fund quants, and one for low-income, single parents who want to develop skills to get a higher paying job (in reality you won’t have a cohort of low-income single parents only but this extreme example helps make this point). The risk profile on the first group will be lower as their educational history suggests lower likelihood of default than market average, so ISAs will be less expensive and have a lower return profile. Low-income, single parents however have the profile of students who tend to persist at lower rates than the national average, and so ISA financiers (the investors that provide up-front capital for schools offering ISAs so that they can cover operating expenses) may shy away from financing their ISAs because they fear their dropout rate will be higher, and thus an unsuccessful investment.

These fears can be assuaged if bootcamp managers shore up their program with wraparound services, including childcare allowances, financial coaching, job placement services, and emergency cash funds. These services de-risk your cohort (with these services, students are more likely to persist and ultimately graduate) and make the risk profile more attractive to investors. If this cohort’s risk profile remains higher than the other cohort’s, you simply need to compensate investors with higher caps, rates, or terms to increase overall return. Although one could be forgiven for jumping to the conclusion that this is predatory, the additional risk compensation is merely a circuitous payment for the wraparound services that enable successful completion of the educational program for this demographic.

ISA investors have to get their money from somewhere. These capital allocators are more concerned with preserving their capital (they are extremely risk averse as a rule of thumb), and so you could, as an ISA financier, choose to diversify your business in order to appeal to your investors more. For example, you could be an ISA financier that only invests in low-risk, low-return schools (e.g., college grads going into quant hedge funds). Or you could only invest in higher-risk, high-return schools (e.g., low-income, single-parent schools that offer wraparound services). Or you could invest in both and market to your investors (someone has to give them their money, after all) that you are a diversified ISA financier. Scale with diversification would give ISA financiers an element of credibility and risk mitigation that would be appealing to their investors, thereby enabling further growth (or your investors want to buy tranches of equity, which I cover here).

Can you finance students who want to enter fields outside of coding?

Our previously mentioned CS degree hedge fund hopefuls are excellent candidates for ISAs because strong labor market outcomes are the crux of the financial instrument, and they would be entering a field with strong labor demand. What about if you’re a Theatre major and getting ready for a lifetime of saying, “Would you like fries with that?” Who in their right mind is going to grant you an ISA?

B2C ISA financiers likely wouldn’t go anywhere near Theatre students. This selectivity makes sense from a P&L standpoint if the ISA provider expects that under feasible contract terms, Theatre students will not achieve post-graduation compensation levels high enough for the ISA financier to recoup their investment. An unwillingness to finance less career-oriented fields of study presents a problem if you subscribe to the educational philosophy that preserving the arts plays an important part of culture production (both for national consumption and international export), which is an essential part of a highly-functioning state.

However, higher education institution that contract with ISA financiers directly need not necessarily run into this problem. Institutions that choose to offer ISAs, and that offer a well-rounded suite of programs ranging from the arts to engineering, need only to assert to ISA financiers that ISAs will be offered to all students regardless of their field of study. The risk-return profile of a B2C ISA financier engaging with a Theatre major looks very different than a B2B ISA financier engaging with a school that offers ISAs to not only Theatre majors, but also to students pursuing other fields of study with labor market outcomes of lower risk and higher average post-graduation compensation. The schools will still have to model an overall risk-return profile that appeals to ISA financiers, and achieving a desirable risk-return level could potentially require setting quotas on the number of students pursuing higher risk and lower average compensation fields of study. Nonetheless, having cohort risk-return profiles that investors find appealing would allow institutions to preserve the integrity of their suite of educational offerings rather than transform into purely career-oriented institutions because of financing pressures.

Furthermore, offering cohort-level ISAs to a diverse set of students might even be a good thing for ISA financiers from the risk-return standpoint. If an institution can show certain cohort level risk and labor market outcome figures, then two factors are at work: (1) ISA providers probably don’t actually care what schools teach their students so long as cohort risk-return levels are satisfactory, and (2) they may actually be happy that schools are offering ISAs to Theatre kids, because this diversification removes market cycle labor demand shortage risk. Here is a purely illustrative example meant only to illustrate a point: in expanding markets, you want to have Theatre majors, because people have enough disposable income to frequent the Theatre, while in contracting markets, you want to have CS majors so that your financial institutions can have the talent they need to preserve your investments. A school with a cohort that includes CS and Theatre students (and students pursuing myriad other degrees) can advertise to their ISA liquidity providers that regardless of market timing, they have sufficiently diversified their educational offerings and thereby minimized labor market risks.

One of the other possibilities is cohort level B2C. While true that B2C ISA financiers wouldn’t view Theatre students as an attractive ISA recipient individually, they may be keen to engage with a cohort of Theatre students. In this scenario, B2C ISA providers still liaise directly with students, but do so under the configuration of a pooled capital arrangement. Theatre students would collectively decide to buy into a cohort-level ISA with the understanding that one of them will make it big while the others flounder (generally true of the Theatre industry). The students who achieve a great deal of success and go on to secure roles in productions like Hamilton achieve higher compensation than their less successful peers and are required to assume the brunt of the cost of the cohort-level ISA. These successful students bear this responsibility willingly; however, recognizing that should they have had unsuccessful careers, it would have been their more successful cohort counterparts shouldering higher ISA payments.

The beauty of ISAs here is apparent: they are incredibly flexible financial instruments and can be adjusted to serve a number of purposes. They can be offered directly from students should they so choose, or through schools as intermediaries. They can shift the burden of payment for services that enable successful program completion out into the future when students may be more equipped to pay for them. They could even be negotiated collectively for otherwise unusual candidates for ISAs! If executed properly, I would wager that ISAs really could cover more situations than they currently are known for, and in ways that would leave students better off than had they either paid upfront or taken out loans.