Considerations in Evaluating Your Institutional Discount Rate

Douglas E. Clark
Vice President of Enrollment Management
Ferrum College

John W. Dysart
President
The Dysart Group, Inc.

Discount rates are always an important topic for evaluation and discussion at private colleges and universities. The institutional discount rate is simply the amount of unfunded institutional aid as a percentage of gross tuition revenue. For example, if a college is spending $4,500,000 in institutional financial aid against a gross tuition figure of $10,000,000 then the discount rate is 45%. (Note: The traditional, generally accepted method for calculating the institutional discount rate includes only tuition revenue).

Institutions constantly monitor their rates, seek to control and sometimes reduce their rates and annually compare their rates to those at other colleges and universities. Auditing firms, Boards of Trustees, Presidents and other campus administrators closely track the discount rates. While discount rates are obviously an important variable, higher education administrators should understand that many things influence the discount rate besides financial aid policies. Enrollment Vice Presidents and Financial Aid Directors are often held accountable for rates that are primarily influenced by market conditions and decisions made outside the division of enrollment management. Board members and chief campus administrators should understand all of the variables and decisions that impact the discount rate.

Location, location and location are the three top considerations for real estate investment. Location can also have an influence on institutional discount rates. The differences in taxpayer-supported funding for financial aid as a function of individual state can be huge. If your institution is located in Alabama, you can expect an average state grant of approximately $21 for every enrolled student. Move your college to Alaska and the average state grant per student increases to more than $2,200! Significant differences in state support for higher education in the form of scholarships and grants can greatly influence discount rates.

Given the role of state aid, the number of students enrolled from your state will also make a difference. While geographic diversity is certainly desirable, colleges and universities enrolling large percentages of students from out-of-state are more likely to have higher discount rates because the institution must often replace aid normally available from the state with scarce institutional funds. Key administrators must understand that there is a price to be paid for better geographic representation.

Retention plays a role in discount rates that is often overlooked. The structure of the Federal Stafford Loan program increases the importance of retention in controlling discount rates. This program is the largest source of financial aid. It dwarfs expenditures in all other state and federal aid programs combined. Eligibility is based upon grade level and the dollar amounts of eligibility increase as a student progresses grade levels. Freshmen are eligible for $3,500, sophomores are eligible for $4,500 and juniors and seniors are eligible for $5,500 per year. Schools generally make up the difference in aid for freshmen and sophomores using institutional aid until their eligibility increases to the maximum amount. A college that continuously funds the shortfall for first and second year students but often does not receive the benefit of full Stafford funding because most students never progress to junior level is going to have a high discount rate. Institutional leaders can add increased net revenue to the myriad reasons to improve retention.

Another important consideration in evaluating discount rates is the percentage of students residing on campus. Discounts are calculated based upon tuition, but financial aid packages also include the costs of room and board. Obviously, a school with few students residing on campus is likely to have a lower discount rate than a college where the majority of students reside on campus. Caution is in order when comparing discount rates at residential colleges to those at commuter colleges. Recall also, that while residential students tend to increase institutional aid expenditures and thus increase the discount rate, they also generate higher revenue. For many colleges and universities it is preferable to have more students living in the residence halls and using institutional meal plans even if that means a higher discount rate.

As any business administration student will tell you, there are two types of accounting: Financial Accounting for “outside” audiences such as auditors, analysts, and stockholders and Managerial Accounting which is for internal control purposes. Likewise, the generally accepted method of tuition-only discount calculation seems to be the preferred measure for external audiences such as auditors and various organizations which use that metric to assess or “rate” institutions. Since it is auditors who prepare college financial reports, trustees and business officers will rely on the discount rate that is calculated in the generally accepted manner. For internal control and management purposes, however, both trustees and business officers should look at another discount rate that is calculated using all student revenue – room and board in addition to tuition. Since, as noted above, financial aid eligibility is calculated based on total student costs including room and board, there should be a discount rate measurement that takes these costs into account. Some institutions already employ this more broadly calculated discount rate but all institutions would be well advised to do so for internal purposes.

This calculation can give institutions a clearer picture of how efficiently they are using financial aid dollars to leverage additional revenue. In all fairness to enrollment officers, they are generating more than tuition revenue and their financial aid strategies need to be measured against all student revenue. Although the discount rate will be lower when calculated this way, it will also be a more accurate measure of how well institutions are using their financial aid resources to generate student revenue.

Another factor to consider is tuition generated from non-discounted enrollments such as part-time students and adult degree programs. In many cases, part-time students and adult students are not receiving institutional aid so they generate tuition revenue without financial aid costs. This will, of course, reduce the institution’s overall tuition discount rate. But it may also mask the discounting that is going on with traditional- aged students in discounted programs who are receiving institutional aid. Institutions, therefore, may actually have a discounting problem but it is not showing up because of tuition growth in the adult degree program. One solution to generate a more meaningful internal rate is to calculate the rate for traditional, full-time students separately.

Keep in mind that there are many ways to calculate discount rates. Make sure that if you are comparing your rate to the reported rate at another institution that you understand their method for determining the discount rate. Differences in calculation methods can be significant.

Scholarship athletics will influence institutional discount rates. As a general rule, institutions offering athletic scholarships (and talent scholarships for participation in activities such as music, art, theater and dance) will have higher discount rates than schools that do not fund such programs with institutional aid dollars. Again, there is nothing wrong with athletic or talent scholarships but leaders should understand that these scholarships usually increase discount rates. It is just another institutional goal that must be addressed with institutional aid funds. The higher the percentage of participation in scholarship-funded athletics and talent programs, the greater the impact on the budget. An institution where 45% of currently enrolled students participate in scholarship athletics will tend to have a higher discount rate than a college where only 15% of students participate.

Academic quality can also make a difference at institutions offering merit scholarship and grants. Beware of your success in attracting large numbers of students eligible for your institutional merit scholarships and grants. Success in recruiting high ability students can cause expenditure strains when it comes to the discount rate.

It is best to avoid full-tuition scholarships and full tuition, room and board scholarships if you are seeking to control the discount rate. Such awards ensure that expenditures will rise consistently every time an increase in price occurs. The same is true of scholarships and grants based on a percentage  of cost. A scholarship guaranteeing 50% of tuition will need to be increased every year while flat awards will remain stagnant as costs rise. While there is nothing inherently wrong with full ride awards and percentage scholarships, administrators should be aware that they impact the ability of enrollment and financial aid officers to control average institutional aid expenditures.

Pricing can also make a difference. It is generally more difficult to control discount rates at high-priced colleges and universities. High tuition rates minimize the controlling benefits of campus-based aid, Federal Stafford Loans, Federal Pell Grants and state grants. It is easier to control the discount rate when tuition is $12,000 because a full Federal Pell Grant and a freshman Federal Stafford Loan ($6,675) already cover 56% of tuition cost. The same awards only cover 39% of tuition at a school charging $17,000 and thus an institution is more likely to have to utilize institutional funds to meet financial need.

History will influence discount rates. It is interesting to note the sometimes vast differences in campus-based funding (FSEOG, Federal Perkins Loan, Federal Work-Study) allocations among institutions dependent on when they first participated and their aggregate financial need and size at the time. Some campuses enrolling fewer than 800 students have more campus-based funds at their disposal than institutions three times larger. Obviously, the higher the campus-based allocations, the easier it is to control the discount rate.

Administrators should be aware that tuition discount rates can be subject to manipulation. Institutions looking to reducetheir discount rate can simply put all cost increases into tuition instead of spreading cost increases over tuition, room and board. This inflates tuition which causes the traditional discount rate to go down and can make the institution look better in the eyes of the auditors and the trustees who rely on the traditional discount rate reports.

Another form of manipulation is an institution’s receivables or uncollected student charges. Students with balances that are carried by the institution from semester to semester and never paid are, in effect, receiving institutional financial aid by other means (like much institutional financial aid, unpaid balances are uncollected tuition, room and board). If institutions offer less generous financial aid packages in an effort to “do something” about the discount rate, they can control expenditures but can place students and families in positions where they will never be able to pay the charges. Institutions that still allow students with unpaid balances to enroll and start class have, in reality, transferred the discount rate “problem” from the Financial Aid Office and Enrollment Division to the collections operation in the Business Office.

While the discount rate is an important metric, it is not the only metric and usually does not tell the whole story. In addition to the discount rate, institutional representatives also need to look at net tuition revenue. If a modest increase in the discount rate produces a significant gain in net tuition revenue then the discount rate increase is a positive for the institution. Some institutions, in their zeal to “do something” about the discount rate, actually end up reducing enrollment and net revenue so they could deliver the “happy news” to auditors and trustees that the discount rate is now “under control.” The most important metric is net revenue. It is suggested that chief administrators find the answers to the following questions in order to have a better understanding of their discount rate:

  • How does your state rank in average aid to students enrolled in higher education?
  • What percentage of your students resides in your state?
  • What percentage of your students participates in scholarship athletics?
  • What is your average institutional discount rate for scholarship athletes compared to other enrolled students?
  • How does your retention rate compare to your peer institutions?
  • What percentage of your students resides on campus?
  • How do you calculate your discount rate?
  • What percentage of your students is less than fulltime and what percentage is enrolled in non-discounted programs?
  • How does the academic quality of your students (entering standardized test scores and high school grade point averages) compare to your peer institutions?
  • Do you offer full-tuition scholarships or scholarships and grants based upon a percentage of tuition?
  • Where do you rank in terms of pricing in your state?
  • Have you discussed your allocations for campus-based federal aid with your Director of Financial Aid?
  • What percentage of your students is “first generation” college students and what percentage is minority?
  • What are your outstanding receivables for the last three years?
  • How do your allocations for campus-based aid compare with your peer institutions?