Four Ways States Can Lead the Way in Innovative Education Finance

Whether they’re attending universities or career technical schools, many students now have a variety of options to fund their education outside of traditional student loans. Innovative finance mechanisms like income-contingent financing are rising in popularity among education and training providers. Amid this growing prevalence, some states have begun exploring the role innovative finance can play in the postsecondary education system.

Innovative finance includes a family of emerging models that shift the cost or risk of education off learners, instead relying on education providers, employers, government, community-based organizations, and private investors to take greater responsibility for students’ education. These approaches have the potential to promote greater access, affordability, higher quality, more diverse options, and better employer engagement in education, but states must act intentionally to unlock this potential.

Below are four actions states can take to become national leaders in innovative finance.

Recommendation #1: Clarify and Strengthen Consumer Protections

While income-contingent financing can offer a more affordable, accessible, and equitable financing option compared to traditionally structured loans, models such as income share agreements (ISAs)—one of the most versatile forms of income-contingent financing where the borrower agrees to pay the provider a percentage of their income for a certain period after graduation—can also potentially pose risks to learners. For example, learners may have difficulty understanding the terms and conditions they agree to. ISAs may also lead learners to become overleveraged, especially if they stack the ISA financing on top of their existing student loans. Many of the same concerns around collection practices in the traditional loan market also apply to ISAs, such as inadequate notice of lawsuits and requiring automatic bank account withdrawals and payroll withholding.

Unfortunately, existing regulatory guardrails—at the federal and state levels—were designed for traditionally structured loans with fixed payments. It is unclear which guardrails apply to ISAs, creating uncertainty for providers and funders of innovative finance models. Moreover, directly applying these guardrails to ISAs can lead to unintended consequences because they were not designed for their unique structure, possibly confusing students even more. Finally, these existing guardrails on their own provide inadequate protection for learners.

Clear, strong, and thoughtful regulatory frameworks are necessary to protect students and ensure innovative finance models operate under a standard set of operating rules and are subject to vigorous oversight. Creating a clear, strong, and thoughtful regulatory framework for income contingent financing would ensure that learners are protected, bring more responsible and mission-oriented funders into the innovative finance space, and lead to more favorable contract terms for learners, as funders would face less risk.

Progress has already begun at the federal level. In 2022, the Consumer Financial Protection Bureau (CFPB) signed a compliance plan with ISA provider Better Future Forward (BFF) that clarified that ISAs are subject to the Truth in Lending Act and exactly how ISA providers should comply with that law. Moreover, the bipartisan ISA Student Protection Act, which was recently reintroduced in the Senate, would broadly apply existing federal consumer protection laws to ISAs, ensure that guidance provided to ISA providers is clear and takes the specific design of ISAs into account, and create new protections surrounding the income-based nature of ISAs.

Below are examples of states taking action to create clear, strong, and thoughtful regulatory frameworks for income contingent financing. Note that while rulemaking is useful, legislation is the best approach because it allows states to fully design the regulatory framework rather than trying to tailor rules designed for traditionally structured loans.

Examples:

1. California’s Department of Financial Protection and Innovation (DFPI) clarified the regulatory treatment of ISAs and other income-contingent financing in fall 2022. The California DFPI is in the process of incorporating comments from outside groups, including Jobs for the Future (JFF), the ISA industry, and consumer advocate groups. This rule clarifies that ISAs are covered by the state’s Student Loan Servicing Act, requires disclosure of the effective annual percentage rate (APR) of an ISA given various earnings scenarios, and requires ISA providers to be licensed and follow applicable student loan laws.
2. In late 2022, the Colorado attorney general’s office proposed a rule to clarify the regulatory treatment of ISAs and other income-contingent financing, incorporating comments from various stakeholders. This rule would require ISA providers to disclose the costs of an ISA under multiple earnings scenarios, the maximum APR, and the cost of other education finance alternatives, such as federal student loans.
3. Illinois is the first state to consider a comprehensive regulatory framework through legislation. Introduced earlier this year and passed unanimously by the state House of Representatives, the Consumer Income Share Agreement Act (HB 1519) details how existing state lending laws apply to ISAs and other income-contingent financing. It would also add new protections that don’t already exist in state lending law, including creating lower APR limits for borrowers from low-income backgrounds, requiring income thresholds to be above 200% of the federal poverty line, prohibiting ISAs longer than 180 months, and ensuring ISAs layered on top of existing student loans don’t overleverage students.

Recommendation #2: Promote Better Data and Research

At present, a lack of available labor market data and rigorous research undermines the ability of innovative finance providers to design effective and student-centered solutions.

Many state data systems are cumbersome to use and lack accurate and/or relevant statistics, exacerbated by insufficient and non-standardized data from educational institutions. This makes it difficult for innovative finance providers to accurately price their products because student payments are contingent on income, which is hard to predict with poor data. Better data would result in more precision in pricing, lowering the risk to the provider and allowing more favorable terms to be offered to students. Moreover, students will be more informed and can make better decisions regarding their education.

While recent studies have begun to shed light on how income-contingent financing affects racial and gender equity, what role adverse selection plays, and how financing can improve student completion, there is still a dearth of evidence about whether and under what conditions these financing solutions can meet their lofty promise and what risks they might pose.

Strong, centralized, and coordinated data systems provide the foundation of state leadership in innovative finance because they help states collect and analyze student and worker data. These data can be used to share information on educational program outcomes, student enrollment and completion rates, diversity data, returns on investment, student earnings, and more.

To improve statewide data systems, states should either conduct or sponsor further research on innovative finance efforts. More research on this subject can help providers and policymakers better understand the innovative finance landscape at all state levels where they operate. This will foster a stronger understanding of which innovative finance programs work well and provide examples of how to design student- and equity-centered programs.

Examples:

1. Over the last decade, Michigan created a Workforce Longitudinal Data System through which the state can collect and analyze educational and workforce data in a centralized fashion. Using this data, Michigan created its Pathfinder tool, which allows Michiganders to explore education and career paths. The state also partnered with Credential Engine to create a portal where students can research training programs that offer credentials.
2. The Kentucky Center for Statistics (KYSTATS) was established in 2012, aligning education and workforce data to inform the public, educational institutions, and policymakers better. KYSTATS unites multiple state agencies to centralize data collection and dissemination. The center aims to connect education and workforce data and make it accessible so that all Kentuckians can make informed decisions. Multiple organizations in the field, such as the National Skills Coalition and Advance CTE, highlight KYSTATS as an example to follow.
3. Since 2010, Maryland has operated the Maryland Longitudinal Data System Center (MLDS Center) to collect and disseminate information about education and workforce outcomes in the state. MLDS Center helps unite and make accessible data from departments across the state government. It releases many outputs from these data, such as data dashboards and presentations, making all publicly available online. The MLDS Center allows Maryland to better understand and influence policy and practice in the field and gives residents the opportunity to understand career and education options and outcomes better.

Recommendation #3: Create Minimum Standards of Program Quality

While many students have had positive experiences with income-contingent financing, some have regretted their decision because they felt the education financed by their school-based ISA was of poor quality. This may seem counterintuitive—after all, income-contingent financing can lead to schools (or third-party financing providers) rather than students bearing the risk of the education not leading to a well-paying job, giving them the incentive to improve the quality of their education and career services. However, this incentive effect doesn’t happen automatically; income-contingent financing can be designed and operated in a way that only appears to shift risk.

The problem arises because schools with poor outcomes can use the income-contingent financing to make prospective students more confident about the quality of the underlying education, often with claims that the school only makes money if the student succeeds. In fact, many students with bad experiences say they didn’t do their due diligence on the program quality because the school’s marketing materials portrayed the income-contingent financing as a kind of “money-back guarantee.” While income-contingent financing can promote improved education quality, it can also attract students to schools with poor outcomes.

The first two recommendations in this document would help address this problem: Stronger regulatory rules can shift the risk of poor education quality away from the student, and students can make more informed decisions with better outcome data. But state policymakers must also hold education programs to high standards and crack down on those that perform poorly. This is particularly true for programs outside the federal accreditation system, including many short-term workforce training programs and boot camps, which may operate with very little oversight.

To ensure income-contingent financing does not lead students to poorly performing programs, state policymakers should attack the problem at the source by developing and implementing minimum standards of program quality for all education programs operating in their state. A state-level accrediting body should hold education providers accountable to maintain program quality and produce career-ready learners.

Improving data systems and research efforts (Recommendation #2) will help states evaluate programs and create quality standards. Programs offering income-contingent financing could be required to report the earnings data they receive from students to state regulators. Some states have already implemented oversight bodies for workforce programs and boot camps that have helped monitor and address negative or harmful provider behaviors. The National Governors Association published recommendations for how governors can best execute workforce development visions, including establishing performance metrics. The National Skills Coalition also supports the creation of—and helps states implement—nondegree credential quality standards. Additionally, Education Quality Outcomes Standards (EQOS), a nonprofit housed within JFF, works to create universal measures of education and training quality standards that governments, employers, and jobseekers can use.

Examples:

1. In California, the Bureau for Private Postsecondary Education is a government entity that conducts “qualitative reviews of educational programs and operating standards, proactively combatting unlicensed activity, impartially resolving student and consumer complaints, and conducting outreach,” including oversight of boot camps operating within the state.
2. Illinois delegates oversight of “private business and vocational schools” to the Illinois Board of Higher Education (IBHE). The state requires schools planning to operate in Illinois to apply to IBHE (and submit a renewal application each year) relative to the Private Business and Vocational Schools Act of 2012, which seeks to ensure quality education and protect students in vocational schools. The State Higher Education Executive Officers Association cites Illinois as having high stringency in its state authorization of higher education, with a high priority on academic and consumer protection metrics.
3. In 2020, Louisiana adopted the National Skills Coalition’s criteria on quality nondegree credentials. To be considered a Quality Postsecondary Credential of Value in Louisiana, a credential must show evidence of competencies learned, align to an occupation with high job demand growth, lead to a 20% wage premium over a high school diploma, and provide evidence of student employment/wage outcomes. If a credential aligns with these requirements, it will be deemed a Quality Postsecondary Credential of Value, included in postsecondary educational attainment metrics, allow the Louisiana Board of Regents to track progress toward its master plan, and, by 2030, be included in a system that will recognize credentials of value.

Recommendation #4: Promote and Develop Innovative Finance Programs

Launching an income-contingent financing fund is expensive: Tuition is costly, and the income-contingent revenues will occur many years in the future (and will be lower earlier in students’ careers). Moreover, it can be a risky investment because this is a relatively new model without a long track record, and revenues to the fund depend on several external factors, such as the health of the regional or national economy. Consequently, there is limited capital to start an income-contingent financing fund, and much of the available capital demands a high return to compensate for the risk, meaning students often receive less-favorable contract terms.

These challenges will fade as the model scales and develops a proven track record, but to get to that stage, philanthropic capital and government funds will be necessary. States should use public funds to promote the development of innovative finance models to fund high-quality workforce education and training programs. This could mean a competitive grant program or a government-funded “pay it forward” program, which is a partially (or even fully) self-sustaining revolving fund that offers income-contingent financing.

Examples:

1. Colorado HB1350 created the Regional Talent Development Initiative Grant Program, now called Opportunity Now Colorado, which established a grant program in Colorado “to create or expand innovative talent development initiatives” in the state to meet workforce needs. This could include but is not limited to programs that utilize innovative finance models.
2. In 2022, the Colorado Workforce Development Council (a public-private partnership appointed by the Colorado governor) implemented the Colorado Innovative Financing Roadmap. The first steps in this road map are to document Colorado’s innovative finance landscape, understand existing regulations, and learn about relevant actors to promote responsible, innovative finance for workforce development.
3. New Jersey’s Pay it Forward Program provides zero-interest loans to students to “affordably prepare for good-paying, career-track jobs” in high-demand fields. These loans are considered a pay-it-forward fund, meaning that students’ loan payments will be recycled into the fund to pay for future students’ training.
4. Indiana’s Accelerate Indiana workforce training fund utilizes income share agreements to help students finance short-term education in high-demand career fields, such as manufacturing and health sciences. The fund is recapitalized not only from students’ monthly payments but also from the additional income tax revenue generated from the students’ higher earnings, which is tracked and credited back to the fund.
5. In 2019, Illinois passed the Student Investment Account Act, establishing the Student Investment Account (SIA) to invest in “affordable and responsible education loan products” for students in the state. The Illinois SIA can invest in existing firms, including those offering income share agreements, linked deposits, and student loans, that provide high-quality education funding options.
6. In Virginia’s FastForward program, the state government is effectively in a permanent “pay for success” arrangement with its own community college system: The state pays for two-thirds of the tuition for non-degree training if the learner completes the course and earns the credential (with the learner paying the remaining one-third), but if the credential is not earned, then the school and learner must split the cost.

Looking Ahead

Many states throughout the country are experiencing significant labor market needs, made worse by the COVID-19 pandemic and rising inflation. Even three years after the start of the pandemic in the United States, more than a million jobs remain unfilled in a variety of industries. States need innovative ways to skill and teach new skills to their workers—that do not come at an overwhelming cost to these workers—to meet labor market needs and ensure their populace can find jobs making living wages. JFF supports state efforts to develop, regulate, and promote innovative finance mechanisms to help address labor market concerns.

Becoming a leader in this field not only positions states to lead the country in access to high-quality postsecondary education and training but also in workforce development and economic growth, goals that often garner bipartisan support. Promoting innovative, well-researched, state-led, and student-centered finance methods will help a greater number of workers and learners at all income levels access high-quality postsecondary education and training to gain the skills necessary to earn living wages in high-demand fields.