NAICU Report Addresses Financial Responsibility Regulations

NACUBO has been part of a task force organized by the National Association of Independent Colleges and Universities (NAICU) to review issues with the Department of Education's (ED) financial responsibility calculations. NAICU released the final report of the financial responsibility task force on November 28, 2012. The report offers recommendations to both ED and Congress to overcome identified issues. The hope is that the federal system can better align with current not-for-profit accounting practices and offer higher education institutions an improved process for appealing ED calculations.

Fifteen years ago, ED issued regulations that established a methodology for determining the financial stability of nonprofit institutions participating in the Title IV federal student financial aid programs (34 CFR 668.171). The rules are intended to ensure that institutions have the necessary resources to provide promised educational services and protect against precipitous closure. The Financial Responsibility Standard requires that three ratios be calculated by ED from audited financial statements: primary reserve, equity, and net income. The ratios are weighted and combined into a single composite score that by definition can be no lower than -1 and no higher than 3. An institution with a composite score of 1.5 or above is considered fully financially responsible.

Since the economic downturn in FY2009, the number of institutions with financially healthy composite scores has decreased. Although some of the decline is due to the effects of the recession, NACUBO believes that ED's calculations have exacerbated the problem. NACUBO raised a number of concerns about how ED treats key elements of the ratio calculations, including total expenses, endowment losses, trustee pledges, long term debt, and net asset classifications. In 2011, after NACUBO and NAICU had been repeatedly frustrated by efforts to get ED to reconsider its interpretations, the NAICU board convened a task force to examine the Financial Responsibility Standard and invited NACUBO to participate.

The following recommendations, to both ED and Congress, are discussed in greater detail in the final report:

1. Ensure that the department conforms to the Higher Education Act (HEA) statute, follows the current financial responsibility regulations, and uses standard accounting definitions when determining nonprofit colleges' financial responsibility.
2. If the department continues to treat endowment and other losses as expenses for nonprofit institutions, then the primary reserve ratio should be expanded to include all net assets (unrestricted, temporarily restricted, and permanently restricted) of the institution in the formula for expendable net assets.
3. Retain the alternative methods for demonstrating financial responsibility as currently defined in statute and the regulations, even if other changes are made in the calculation of financial responsibility composite score.
4. The Department of Education should establish a uniform appeals process as part of the financial responsibility procedures. This would assure institutions of the opportunity to correct or update financial information before their composite financial responsibility scores are made final and released to the public.
5. The Secretary of Education should fully implement the legal requirement, under Section 498(c)(3)(C) of the HEA, to step back and examine the "total financial circumstances" of institutions that fail the ratios test before assessing penalties.
6. Establish an advisory panel of objective nonprofit accounting experts to provide technical guidance to the department.

The final report is available on NAICU's website.