People buy insurance seeking protection from unanticipated events posing significant financial hardships. Most homeowners insure against their house being destroyed by fire or other natural calamities, and also against unanticipated illnesses or accidents requiring expensive medical treatment. An owner of a car worth, say, $15,000 or $20,000 usually has auto insurance providing protection from theft or destruction from an accident. Yet until fairly recently, most persons going to college did not even consider purchasing tuition insurance, even though a semester of fees (including room and board) at some schools costs far more than the value of a typical car. As college expenses become bigger, the case for purchasing insurance has grown.
With that in mind, a few days ago I chatted with Paul Richardson, an executive at a major national insurance company, Liberty Mutual, which entered into the tuition insurance business just a couple of years ago, motivated by increasing numbers of holders of other policies (e.g, auto or homeowners) inquiring about its availability. Mr. Richardson tells me a small number of companies sell their product directly to consumers, while others make arrangements with colleges to offer protection through the school.
What does tuition insurance protect the policyholder against? Mainly, dropping out of school in mid-semester owing to some totally unexpected circumstance, most prominently a health issue involving the student, or, in some cases, a parent providing substantial financial support. Most schools themselves provide modest protection; a student dropping out after only a few days at the beginning of the semester, for example, usually can get nearly a full tuition refund. While policies vary considerably from school to school, at most of them a student dropping out in the middle of the term, say, after seven or eight weeks, will get relatively little, maybe nothing, in refunds from the institution.
The risk to a typical healthy young person of unanticipated health issues is pretty small, and for affluent students who are not very risk averse, the cost of the insurance (perhaps around one percent of the tuition and fees) may not be worth it. But insurance is a way of providing some piece of mind as a significant amount of money is at risk.
I suppose disputes could arise. A student might get tired of school and want to run off with a friend on some adventure, for example, and claim that he/she is suffering from anxiety or depression or some mental health-related issue, requiring the insurance company to have the student examined medically. Or, the student is floundering academically and wants to cut his/her losses, so feigns an illness. But disputes of this sort are routine any time big amounts of money are involved, and insurance companies deal with them routinely, such as with damages to a home.
When tuition insurance was brought to my attention, I immediately thought of the multitude of unintended consequences the federal student financial assistance programs have had. The government makes low-interest loans available on terms no private lender would consider, enhancing the demand for colleges, which respond by vigorously raising their tuition fees. College financing becomes a much bigger issue in the lives of Americans, and that, in turn, spawns secondary impacts, such as the rise of tuition insurance.
There are other risks associated with attending college, most notably the possibility of dropping out—about 40% of students fail to graduate in six years. The financial consequences of this are potentially nearly devastating—no degree and perhaps $50,000 in college loan debts. In recognition of this, new forms of financing college are evolving, notably income share agreements, which shift most of the financial risk of college attendance from the student borrower to a professional investor who hopes to profit from the student’s postgraduate earnings. This is an idea whose time has come, and its use is growing.
Will the tuition insurance business grow and become a standard expenditure made with respect to college? Possibly. It appeals to the risk-averse and those attending more expensive schools—probably fewer insure over lost tuition fees at low-cost community colleges. Insurance companies, however, must face one reality: college enrollments are actually in decline and the pool of 18- to 22-year-olds will probably be smaller in 15 years than it is today.