Issue Briefs

About

Being deemed financially responsible by the Department of Education is a condition of institutional eligibility to participate in Title IV student aid programs. For private nonprofit and for-profit schools, this standard may be achieved by reaching an acceptable composite financial responsibility score.

The accounting processes used by the Department of Education in the calculation of these composite financial responsibility scores for nonprofit colleges have serious shortcomings that can have detrimental and costly results for institutions. These processes and assessments need to be improved to meet professional standards. NAICU has made several recommendations for change.

History

The current regulations, published in 1997, were developed by accounting experts with input from the higher education community. Financial responsibility and the formulas for determining it received greater notoriety in 2010 following following an article in The Chronicle of Higher Education that listed over one hundred schools that received failing scores following the economic downturn in 2008.

Many NAICU members felt that the failing scores were unjustified, and misrepresented the financial impact of losses in their endowments related to the economic downturn. Nevertheless, they were subjected to penalties, including heightened cash management, and—in some cases—were required to purchase expensive letters of credit.

NAICU, in conjunction with other higher education organizations, has worked to address the problematic financial responsibility standards. The NAICU 2012 Report on Financial Responsibility provides detailed background on some of the accounting and process issues and includes the following recommendations:

• Ensure that the Department conforms to the HEA statute, its own regulations, and follows current standard accounting procedures.
• Retain the alternative methods for demonstrating financial responsibility, as currently defined in the HEA statute and the regulations.
• Require the Department to establish a uniform appeals process as part of the financial responsibility procedures, similar to that used in determining an institution’s cohort default rate.
• Ensure that the Secretary of Education examines the “total financial circumstances” of institutions that fail the ratios test before assessing penalties.
• Establish an advisory panel of nonprofit accounting experts to provide technical guidance to the Department. 

A 2017 General Accountability Office (GAO) report echoed NAICU’s concerns about the financial responsibility standards. According to the report, the composite scores are an imprecise risk measure that fail to address accounting changes, use outdated financial measures, and are vulnerable to manipulation. Like NAICU, GAO has recommended that the Department update the financial responsibility standards.

In addition, it is important to note that financial responsibility composite scores are also used as a threshold for participation in reciprocal agreements related to state authorization for distance education. The use of the scores by the National Council for State Authorization Reciprocity Agreements (NC-SARA) further compounds the negative impact of the flawed formula.

Recent Developments

As part of its proposed rule on borrower defenses to repayment released in 2018, the Education Department convened a negotiated rulemaking subcommittee to make recommendations for reforming and updating the composite scores and ratios embedded within the financial responsibility standards.

Although several technical changes to accounting and financial responsibility standards were incorporated into the now-finalized borrower defense regulations, the Department has indicated that it is considering the establishment of a negotiated rulemaking session to make more significant revisions to the standards.

The prospect of reform is welcome news for private, nonprofit colleges and comes after NAICU testified at a public hearing hosted by the Education Department about the need to update the financial responsibility standards. With changes made by the Financial Standards Accounting Board (FASB) to nonprofit accounting rules implemented in FY2018-19, it is imperative that the Department use the negotiated rulemaking process to update the standards to reflect current accounting practices and norms.

More recently, NAICU’s concerns about the composite scores have risen significantly due to the effects of the pandemic. Private colleges of all sizes and types could face a precipitous decline in their federal financial ratios as a result of both coronavirus-related endowment and revenue losses and increased costs.  NAICU has encouraged the Department of Education to suspend the test for at least three years. NAICU similarly urged NC-SARA to decouple passage of the federal test from their eligibility criteria for participation in the state distance education compact, but NC-SARA has declined to do so.