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We’re not in 2014 anymore …

May 12, 2017

What’s the current estimated ‘loss’ to government on new student loans issued (to English-domiciled students and EU students studying at English HEIs)?

23 per cent according to the 2015/16 BIS departmental accounts (published last summer). £11.460billion new loans were issued and associated future repayments are expected to amount to £8.826bn over the next three decades or so. It’s those associated repayments, which you would lose by converting loans made to cover tuition fees into grants.

The Treasury has currently set a ‘target impairment’ (or target RAB) of 28% and, as maintenance grants disappear and are replaced with higher maintenance loans, that non-repayment rate is likely to close in on the target. London Economics have an independent estimate of 28.6% for new loans issued in 2016/17.

If the target is missed a particular set of budgeting conventions kick in for the Department for Education, which has taken over responsibility for student loans from BIS. These will require the department to make savings from elsewhere in order to cover any surplus resulting from overshooting the target.

We are a long way from 2014 when the expected ‘loss’ on new loans issued had hit 45% after the government had budgeted for 30%. How has this recovery happened?

Firstly, the repayment threshold for those who have started since 2012 has been frozen at £21,000pa until 2021 – instead of rising in line with average earnings from 2017. A lower repayment threshold means more people in repayment and higher repayments – so more income is generated for the government. This was a retrospective price hike for borrowers.

Secondly, last year the government changed the discount rate on student loan repayments leading it to value future payments more highly. The government now discounts by RPI plus 0.7% rather than RPI plus 2.2%. With RPI at a constant 3%, that would make a future payment of £1000 in five years’ time worth £833 today rather than £774.  In contrast to the threshold freeze, the projected cash stream didn’t change: instead how that stream is valued improved.

Note that the value of £8.826bn repayments will be revised down in the next accounts due to recent upwards movement in RPI. As the discount rate moves up with RPI, the future value of repayments comes down – putting extra pressure on the DfE budget today (earlier this calendar year, DfE made a supplementary resource claim for an additional £11bn to cover movements in ‘the macroeconomic determinants of the student loan book’).

 

 

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12 Comments
  1. Brian permalink

    “earlier this calendar year, DfE made a supplementary resource claim for an additional £11bn to cover movements in ‘the macroeconomic determinants of the student loan book’”

    Where did you find that out?

    • Supplementary Estimates are published by the Treasury every year in Feb. They show what departments have requested in addition to their main budget.
      You can find them here
      https://www.gov.uk/government/collections/hmt-supplementary-estimates

      In this case, the £11bn may not all be used but it will be used to cover a ‘stock charge’ – a deterioration in the value of existing loans. This will be due in part to recent increases in RPI changing the discount rate and, for pre-2012 loans, the decision by the Bank of England to lower base rates to 0.25% in August. The latter lowered the interest rate on pre-2012 loans to 1.25%.

  2. Brian permalink

    Presumably higher RPI also reduces collections from pre-2012 loans due to it raising the repayment threshold at a faster rate?

    Can DfE just claim extra from HMT to cover extra resource charges on the student loan book? I thought they now had to find savings from elsewhere in their budgets and HMT were no longer sanctioning further budget increases to cover them blowing their budget on student loan policy?

  3. Yes – that’s also the case.

    DfE can request this additional resource – you could argue that RPI and bank base rates aren’t in the DfE’s control. But the new accounting treatment mentioned in the post only applies to loans ‘not earmarked for sale’. (ie pre-2012 loans don’t get treated in this way).

    Full text from the latest Consolidated Budgeting Guidance:
    (DEL = departmental expenditure limit)
    (R in RDEL & RAME – stands for ‘resource’, ie budget to spend)
    (AME – annually managed expenditure – for volatile items)

    Higher Education student loans not subject to a sale
    8.22 Any revaluations of the impairment that occur periodically because the original values were based on forecasts that have turned out to be incorrect, or because of updates made to the student loans model, and which go beyond the target impairment set by the Treasury, will be charged to DEL over a 30-year period (unless departments decide to cover the costs from their DEL over a shorter timeframe). One thirtieth of the total cost will be charged to non-ring-fenced RDEL each year for 30 years, with the residual amount each year RAME. The net effect of these entries in RDEL and RAME each year will equal the annual impairment charge due to these forecast changes. Revaluations of the impairment that occur for any other reason will be charged to RDEL in full and in-year, in the same way that the original impairment is charged to RDEL.

    • Dan permalink

      If we’re not in 2014 anymore then we’re certainly not in 2010 anymore when the Browne review used a discount rate of RPI + 2.2% to recommend a real interest rate be applied to learns which the Government of tge time then used to justify setting a rate taper of RPI to RPI + 3% (and postgraduate loans use RPI + 3% flat). So if the discount rate is now RPI + 0.7% surely these no longer justify such a high real rate of interest? Surely there should be some mechanism to review the various variables applied to loans from time to time as the economy changes? How can the Government continue to justify applying a rate that now far exceeds the Government cost of borrowing when the terms are flexible to allow them to review the parameters from time to time? They’re happy to flex terms to suit them (withdrawal of repayment holidays, freezing thresholds for longer than originally announced, setting interest at nil rather than negative when RPI falls below 0) but the only time I’ve seen them flex terms to the benefit of students is when they raised the threshold from £10,000 to £15,000 in 2005 and then by inflation from 2012 but even this was a worse deal than students were originally promised (in 2000 the Government said they intended to raise the threshold by average earnings, in 2005 they said they were instead raising the threshold to £15k and then again annually by inflation from 2010 but it still stood at £15k until 2012). They introduced a new threshold for new students from 2016 of £21k which flexed terms for new borrowers but surely the interest rate is overdue a review if the discount rate has been revised substantially lower as it changes the figure Browne based the recommendation on which led to the current formula.

      • This is an important point and one which would need longer treatment.

        A couple of quick points:

        The government did not accept the Browne recommendations on interest. Browne recommended RPI plus 2.2% for ‘high earners’ and RPI-only for those earning below £21 000, but the tapering would have worked very differently. Browne recommended an ‘interest rebate’ for those who made repayments that were less than the real interest accruing. That is, for Browne there would be no compounding of interest above RPI: for lower earners debts would not grow in real terms.

        From what I understand, the government looked to New Zealand for the RPI + 3 idea. There was also a fair amount of discussion at the time that the long-term average government cost of borrowing was in the region of 3%. Barr & Johnson’s 2010 paper on ‘Interest Rate Subsidies’ wrote:

        “The objective is to design a loan scheme in which subsidies are well-targeted. This suggests an interest rate that fully covers the government’s real cost of borrowing; as already discussed, we regard 3 per cent as the best estimate of that variable. A 2 per cent rate benefits better-off graduates with no change in the position of the least-well off, and is thus less well targeted than a 3 per cent rate coupled with 25-year forgiveness.
        “If 3 per cent were regarded as fractionally higher than the long-term real rate on government bonds, the model analysed here would introduce a small cohort risk premium, bringing an element of social insurance into the scheme. Saying the same thing a different way the scheme would incorporate a small amount of redistribution from richer to poorer graduates in a cohort.
        “Note that we are not proposing that graduates should be charged a 3 per cent real rate, but that they should pay an interest rate equal to the actual rate at which government borrows. The 3 per cent figure is intended to illustrate how the policy would work, rather than a prediction of what will actually happen.”

        Subsequently there were proposals to reduce the discount rate to RPI plus 1.1% by Leunig & Shephard – but, if I recall correctly, these proposals made no mention of altering the interest rate. Note that many think that the high interest rate incentivises those who can to make additional early repayments or to avoid borrowing in the first place (these analyses would underscore the ‘deadweight’ cost of subsidizing those who would have paid upfront and the reason RPI + 3 is applied to undergraduates while studying is to avoid the opportunistic wealthy taking out a loan to invest or spend elsewhere).

        I agree though that the broader issue now needs addressing. A complicating factor was revealed during my research into government accounting and budgeting – the discount rate isn’t really conceptaulised within the Treasury as the ‘cost of government borrowing’ and indeed the Treasury were looking into recasting discount rates in relation to GDP growth until recently.

        A further factor – the real rate of interest was probably explicitly set up at plus 3% in order to facilitate a future sale of student loans. Certainly back in 2011/12 this was the discount rate that the private sector told the government that they would use to price the new student loans.

        And I agree with your general complaint – which has been a theme on this site and my other work since it began – parliament granted the government administrative power to change terms on loan repayments. The 2011 Education Act contained the relevant clauses relating to interest rates on student loans. The government intends to use these powers to control the level of repayments and will ‘manage’ loans accordingly. This is the point of ‘flex’.

        There was a long discussion about the repayment threshold for pre-2012 loans and RPI under a post back in January. I think we concluded that since the relevant RPI in 2011 was negative, borrowers were spared a reduction in the threshold then. My reading though is that the new Coalition government did not reintroduce the annual RPI uprating because they wanted to keep a commitment an earlier government had made; instead some form of indexing was required in order to prepare the pre-2012 loans for sale (a change of plan – the intention stated in the 2011 white paper was to sell the new post-2012 loans and not to undertake a ‘retrospective’ sale – where the interest rate cap presents difficulties in achieving value for money).

  4. ps owing to illness last year, I was slow to realise that the government has a flat interest rate of RPi plus 3% for postgraduate loans. I see these loans as problematic and would always have preferred any extra cash to go into increasing the loan amounts available for undergraduate maintenance.

    pps owing to a legislative ‘pecularity’, interest is not calculated as you would expect. It is RPI plus 3 percentage points rather than a 3% increase on top of an RPI increase. That means e.g 1.031 + 0.03 rather than 1.031*1.03. Or 6.1% rather than 6.2%!

    • Brian permalink

      Very interesting post re: interest and flexing loan terms and one which I totally agree with. For borrowers like me with both pre and post-2012 loans the interest rate has a different effect – it keeps me in repayment longer if I’m a lower earner due to my write off date for being student debt free being far longer than 30 years away ‘overall’ and the decision to collect my joint loans above a lower repayment threshold (the uprating of which was delayed) serves as a double whammy – higher repayments for longer. So the interest on post-2012 for me is particularly relevant as its punitively high rate could result in me losing both of the main subsidies/benefits of pre-2012 loans – the lower rate (as it’s written off with the rest of the loan after 25 years and the write off as the higher interest on the post-2012 loan keeps me in repayment beyond the date my pre-2012 is gone).

      The post Andrew refers to regarding uprating of the pre-2012 repayment threshold is this one:
      https://andrewmcgettigan.org/2016/12/20/sale-of-student-loans-confusing-post-2012-and-pre-2012-loans

      To provide some more evidence of the RPI uprating of the pre-2012 threshold merely been a belated implementation of the outgoing Labour Government’s plans, Nick Hillman sent me an email after I extensively commented on his piece http://www.hepi.ac.uk/2016/07/28/why-the-moneysavingexpert-is-wrong

      He was Special Adviser to David Willetts when the decisions were made so if anyone knows what happened he does. I copy his email below:

      Nick Hillman
      Wed 14/09/2016 08:57

      Thanks Brian,

      One of the things I learnt from your piece was that £15k was meant to rise form 2010. From memory, I think what happened was that our officials insisted it should increase from 2012 in line with inflation because that was what the previous Government had proposed (which your evidence suggests is only half-true at best). I suspect there was a political and an economic reason for not raising it to £21k – politically, politicians wanted to be able to say that the post-2012 students would repay less each month and economically, the Treasury would not have allowed us, I suspect, to raise the £15k to £21k. But the way it affects your loan balance is fascinating.

      I have written at length on other aspects of the Coalition’s HE reforms, which may be of interest – see http://www.tandfonline.com/doi/full/10.1080/03054985.2016.1184870.

      Nick

      There’s also several other things that evidence the Government being unwilling to alter the existing system too much (and the intention to sell was probably a contributing reason for this) which I pointed out on Nick’s piece:

      In Parliament in 2010, a Liberal Democrat MP asked: “If raising the repayment threshold is to benefit every single graduate, in the Minister’s [David Willetts’] words, can he confirm that current students—and indeed, current graduates—will see their repayment threshold raised also?” https://hansard.parliament.uk/Commons/2010-11-03/debates/10110358000003/HigherEducationFunding
      In reply, David Willetts, as universities minister said: “These are proposals for the future, which come in for 2012. They are not retrospective changes, and for current graduates the existing regime will not be changed. This is only for the future from 2012 onwards. I am grateful for this opportunity to make that clear.”

      David Willetts made the point of emphasising in a letter to NUS that the Government had made no changes to the pre-2012 lian terms other than for a “pre-planned” annual increase in the repayment threshold by RPI:

      http://nussl.ukmsl.net/asset/Blog/23/Willetts.pdf

      As I posted elsewhere the following FOI releases (submissions to the ministers) give an excellent insight into the narrative of events:

      https://www.whatdotheyknow.com/request/353572/response/967020/attach/3/Annex%20A%20Repayment%20Threshold%20Redacted%20FOI.pdf

      https://www.whatdotheyknow.com/request/353572/response/939043/attach/5/Gibney%2020936%20Annex%20B.pdf

      • Dan permalink

        In Australia the HECs (Higher Education Contributions) repayment threshold is to be lowered to $42,000 from over $55,000 for all graduates. I’m not sure if this differs much from the New Zealand and UK schemes of income-contingent loans but it underlines how it isn’t the norm as in the UK to run separate repayment thresholds for different cohorts of borrowers. There’s usually one repayment threshold for the overall scheme that is amended like tax thresholds from time to time for everyone.

        https://www.google.co.uk/url?sa=t&source=web&rct=j&url=https://finance.nine.com.au/2017/05/02/09/53/budget-to-lower-hecs-repayment-wage-for-students-to-42000&ved=0ahUKEwjvg7W4ofTTAhVKC8AKHQZYDPIQFggcMAA&usg=AFQjCNFm7qjjH0l_CcyU5dK2ZxeQHM53lw

        The problem I have with the system in the UK is that there is inconsistency in who new proposals are applied to. There’ve been instances of applying new terms to all borrowers and also instances of applying new terms to only new borrowers. And with this lack of consistency there is little incentive for Government to apply more generous terms for all borrowers as the more loans there are to apply it to the more expensive it is. So it is all too easy for a Government to come along with this attractive policy of reducing student loan repayments by raising the repayment threshold so all those in work get excited only for them to announce that it only applies to future starters! This is a particular problem if the Government adopt a structure of periodic reviews of thresholds. It’s all too tempting – as the Government did in 2010 – to act on a recommendation to raise the threshold from £15k to £21k as it hadn’t been raised since 2005 and twist it into a comparison of “the new system will be better than the old one” leaving existing borrowers still with the lower threshold which prompted the recommendation to increase it in the first place! I can’t help but think had Labour still been in power when the Browne review was released that they’d have made different decisions and made changes to the existing system (like they did in 2005) making the threshold £21k for existing borrowers too, rather than flat out refusing to change the existing system. There certainly wouldn’t have been this political nonsense of “that is Labour’s system and Labour’s threshold and this is ours and ours is better”…

      • Brian permalink

        Just noticed that RPI for April has been announced today at 3.5% and although this rate doesn’t affect student loans (the 3.1% from March is used) it’s a sign of things to come I think and if March 2018’s RPI is 4%+ then we’ll be seeing the first 7%+ rate for UK student loans since the very first year of mortgage-style loans in 1990/91 when the rate was 9.8%! https://en.m.wikipedia.org/wiki/Student_loans_in_the_United_Kingdom#Repayment_and_interest

        If that happens then I can see two things resulting:
        (a) the media will slate the interest rate even more than this year; and
        (b) it will raise the pre-2012 threshold from £18,330 in 2018 to above £19k in 2019 which means it is rapidly closing in on the £21k post-2012 threshold, making it much more likely that the thresholds will be merged into a single threshold in the early 2020s. I can see no desirable reason for running two thresholds that are barely different from each other…

  5. Yes – we also had the conversation about repayment thresholds and different terms for pre-201 and post-2012 loans back in January on the same post that Brian has linked to.
    Briefly, I believe the current government’s intention is to freeze the post-2012 threshold until the pre-2012 catches up and then link the post-2012 to RPI.

    On the other hand, the interest rates for pre-2012 are set in primary legislation to be the lower of bank base rates plus 1 pp or RPI. For post-2012, the coalition gave governments leeway to set anything up to the equivalent of commercial rates.

    The main reason why things are not equalised across the board is that graduating debt is not the same and the combination of parameters (threshold, interest, repayment rate above threshold, write-off period and graduating debt) have complex interactions. The main idea behind the post-2012 combination was to mimic a proportionate graduate tax – see the graph from IFS in the 12 May post on the cost of abolishing tuition fees.

    On the subject of RPI – we do have a central bank that’s meant to target 2% inflation … pre- and post-2012 loans were not designed with the current macro state of affairs in mind (but for the latter on the assumption that we would return to the trends of the ‘great moderation’ much more quickly)!

    I don’t think the threshold freeze was justified for existing borrowers but I do think a revision of interest should be considered for September (when March’s RPI is due to determine the rate applied for AY 2017/18).

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