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Insuring student loans against the financial risk of failing to complete college

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  • Satyajit Chatterjee
  • Felicia Ionescu

Abstract

Participants in student loan programs must repay loans in full regardless of whether they complete college. But many students who take out a loan do not earn a degree (the dropout rate among college students is between 33 to 50 percent). We examine whether insurance, in the form of loan forgiveness in the event of failure to complete college, can be offered, taking into account moral hazard and adverse selection. To do so, we develop a model that accounts for college enrollment and graduation rates among recent US high school graduates. In our model students may fail to earn a degree because they either fail college or choose to leave voluntarily. We find that if loan forgiveness is offered only when a student fails college, average welfare increases by 2.40 percent (in consumption equivalent units) without much effect on either enrollment or graduation rates. If loan forgiveness is offered against both failure and voluntarily departure, welfare increases by 2.15 percent and both enrollment and graduation are higher.

Suggested Citation

  • Satyajit Chatterjee & Felicia Ionescu, 2012. "Insuring student loans against the financial risk of failing to complete college," Working Papers 12-15, Federal Reserve Bank of Philadelphia.
  • Handle: RePEc:fip:fedpwp:12-15
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    References listed on IDEAS

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    Cited by:

    1. Dominik Sachs & Sebastian Findeisen, 2016. "Optimal Financial Aid Policies for Students," 2016 Meeting Papers 1421, Society for Economic Dynamics.
    2. Kemptner, Daniel & Tolan, Songül, 2018. "The role of time preferences in educational decision making," Economics of Education Review, Elsevier, vol. 67(C), pages 25-39.
    3. Salvador Navarro & Jin Zhou, 2017. "Identifying Agent's Information Sets: an Application to a Lifecycle Model of Schooling, Consumption, and Labor Supply," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 25, pages 58-92, April.
    4. Ionescu, Felicia & Simpson, Nicole, 2016. "Default risk and private student loans: Implications for higher education policies," Journal of Economic Dynamics and Control, Elsevier, vol. 64(C), pages 119-147.
    5. Rajeev Darolia & Dubravka Ritter, 2020. "Strategic Default Among Private Student Loan Debtors: Evidence from Bankruptcy Reform," Education Finance and Policy, MIT Press, vol. 15(3), pages 487-517, Summer.
    6. Lance Lochner & Todd Stinebrickner & Utku Suleymanoglu, 2021. "Parental Support, Savings, and Student Loan Repayment," American Economic Journal: Economic Policy, American Economic Association, vol. 13(1), pages 329-371, February.
    7. Lance Lochner & Alexander Monge-Naranjo, 2014. "Student Loans and Repayment: Theory, Evidence and Policy," Working Papers 2014-40, Federal Reserve Bank of St. Louis.
    8. Lutz Hendricks & Oksana Leukhina, 2018. "The Return To College: Selection And Dropout Risk," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 59(3), pages 1077-1102, August.
    9. Robert J. Gary-Bobo & Alain Trannoy, 2015. "Optimal student loans and graduate tax under moral hazard and adverse selection," RAND Journal of Economics, RAND Corporation, vol. 46(3), pages 546-576, September.
    10. Lutz Hendricks & Oksana Leukhina, 2017. "How Risky is College Investment?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 26, pages 140-163, October.
    11. Aaron Hedlund & Grey Gordon, 2017. "Accounting for Tuition Increases at U.S. Colleges," 2017 Meeting Papers 1550, Society for Economic Dynamics.
    12. Matthew T. Johnson, 2013. "Borrowing Constraints, College Enrollment, and Delayed Entry," Journal of Labor Economics, University of Chicago Press, vol. 31(4), pages 669-725.
    13. Kartik B. Athreya & Felicia Ionescu & Urvi Neelakantan & Ivan Vidangos, 2020. "Who Values Access to College?," Richmond Fed Economic Brief, Federal Reserve Bank of Richmond, issue 20-03, pages 1-5, March.
    14. Lutz Hendricks & Oksana Leukhina, 2017. "How Risky is College Investment?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 26, pages 140-163, October.
    15. Nadia Karamcheva & Jeffrey Perry & Constantine Yannelis, 2020. "Income-Driven Repayment Plans for Student Loans: Working Paper 2020-02," Working Papers 56337, Congressional Budget Office.
    16. Rauh, Christopher, 2017. "Voting, education, and the Great Gatsby Curve," Journal of Public Economics, Elsevier, vol. 146(C), pages 1-14.
    17. Kartik Athreya & Felicia Ionescu & Ivan Vidangos & Urvi Neelakantan, 2018. "Investment Opportunities and Economic Outcomes: Who Benefits From College and the Stock Market?," 2018 Meeting Papers 1151, Society for Economic Dynamics.
    18. Ciprian Domnisoru & Ioana Cosmina Schiopu, 2021. "The Rise of For-Profit Higher Education: A General Equilibrium Analysis," CESifo Working Paper Series 9134, CESifo.
    19. Rajeev Darolia & Dubravka Ritter, 2015. "Do student loan borrowers opportunistically default? Evidence from bankruptcy reform," Working Papers 15-17, Federal Reserve Bank of Philadelphia.
    20. Alexander Monge-Naranjo, 2016. "Student Loans Under the Risk of Youth Unemployment," Review, Federal Reserve Bank of St. Louis, vol. 98(2), pages 129-158.
    21. Matsuda, Kazushige, 2020. "Optimal timing of college subsidies: Enrollment, graduation, and the skill premium," European Economic Review, Elsevier, vol. 129(C).
    22. Tomás Rau & Eugenio Rojas & Sergio Urzúa, 2013. "Loans for Higher Education: Does the Dream Come True?," NBER Working Papers 19138, National Bureau of Economic Research, Inc.
    23. Rajeev Darolia & Dubravka Ritter, 2017. "Strategic Default Among Private Student Loan Debtors: Evidence from Bankruptcy Reform," Working Papers 17-38, Federal Reserve Bank of Philadelphia.

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    Keywords

    Student loans; Insurance;

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