Pre-Paid College Tuition Plans Rocked By State Funding Shortfalls

A shocking new development is sending shocking waves through the hearts of many families across the nation.

Many college prepaid plans, which so many families were banking on to pay for college are now operating in the red, putting their promises to investors in jeopardy. For now, the states still are paying tuition as they agreed. But the fine print in some state contracts gives them some wiggle room to pay out less than the promised amounts.

Prepaid tuition plans, also known as Prepaid Education Arrangements (PEAs), allow families to buy all or part of a public in-state education at present-day prices. The value of the investment is guaranteed (not entirely true, which you’ll find out by reading further) by the state to meet or exceed annual in-state public college tuition inflation (currently in the five to eight percent range). Plan costs can vary, depending on how close the student is to college.

Investors had flocked to prepaid plans in recent years as they witnessed skyrocketing tuition and huge market losses on their monthly statements for more-popular 529 college savings plans, which often invest in mutual funds.

But market losses also hammered prepaid plans—just less visibly than conventional 529 savings plans. Prepaid plans hold roughly $15 billion in assets, and their investments are still recovering from recent stock-market declines. At the same time, schools are jacking up tuition to cover state budget shortfalls. That is forcing states to raise prices and impose fees—a move that makes it more expensive for new families to join and threatens to damp future cash flows into the plans, making them less solvent.

As reported in the Wall Street Journal, “some states now are asking for a bailout. In Alabama, lawmakers are considering legislation that, among other things, would inject at least $236 million into the prepaid program. In South Carolina—whose plan is estimated to run out of money by 2017—the General Assembly is considering funding options to keep it going, such as making a lump-sum payment of $69 million this year. Included in Tennessee’s proposed state budget is a request for a $15 million infusion into the prepaid plan, while West Virginia recently received $8 million from the state’s unclaimed-property fund to shore up its program.

For the prepaid plans, it’s déjà vu. After the dot-com bubble burst earlier this decade, a number of states—including West Virginia, Ohio, Kentucky, and Texas—barred new participants when poor market returns, paired with sharp tuition increases, bled reserves faster than expected. That allowed them to keep their tuition promises to existing participants.
But with state funding for higher education waning, more state legislatures are giving universities the authority to increase their own tuition above what is set each year by lawmakers.

After Florida passed a law in 2007 that allowed the state’s research universities to charge a “differential” tuition on top of state’s base tuition, prices more than quadrupled for one of its plans aimed at covering that difference. Washington expects prices for its prepaid plan to increase by at least 14% this fall—in step with tuition increases. Michigan raised contract prices 15% for the current enrollment period.

Faced with the prospect of hefty tuition increases, Nevada, which is waiting for a state-legislature committee to approve a $5 million loan to bolster its prepaid plan, raised rates about 10% this year, up from 6% and 7% increases in prior years. So families buying a four-year university plan now have to pay $20,250 for a newborn if they are making a lump-sum payment, up from $18,350 last year.
But as more states raise prices, some parents and advisers are backing off the plans

Five state plans are backed by the full faith and credit of the state. Other states, including Illinois and Maryland, are required by law to consider helping out the funds if there is a potential shortfall. States including Alabama, Michigan, Nevada, Pennsylvania, and Tennessee are backed by the funds’ assets, meaning investors can lose money if the funds run dry and states don’t rescue them.”