State halts sales of underwater college savings plan

The state agency running the College Illinois prepaid tuition program has halted sales of new contracts; meanwhile, a new financial study concludes that the $1.1-billion fund backing the college savings plan remains in a substantial hole.

The new report, commissioned by the Illinois Student Assistance Commission, finds that, as of March 31, the fund was 30% short of what it needed to meet its long-term obligations. That was about the same shortfall found on June 30, 2010, the date of the previous financial-health study. But the latest review incorporates lower, and probably more realistic, forecasts on investment returns and sales of new contracts, assuming they resume.

A Crain’s investigation published March 7 reported that the College Illinois plan had the greatest deficit of any prepaid tuition program in the U.S. It also revealed that its executive director, who was subsequently cashiered, was pumping money into unconventional investments like hedge funds to try to close that gap and keep pace with steep increases in tuition at Illinois universities. In addition, many parents were stunned to learn that the tuition plan is not guaranteed by the state.

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Kym Hubbard, tapped by Gov. Pat Quinn to lead the tuition-plan administrator and restore confidence in the savings plan, says in her first interview that the commission will make comprehensive recommendations to the governor and lawmakers early next year on how to fix College Illinois. Those recommendations are likely to include major changes to the 13-year-old program, including “probably” asking universities and new contract buyers to assume some of the risk of rampaging tuition inflation. That could mean universities, parents or both would have to plug the gap between what the plan accumulates and actual tuitions.

“Personally, I’m confident” about the future of the college savings program, says Ms. Hubbard, who is Ernst & Young LLP’s treasurer and chief investment officer, based in Chicago. “But final decisions must be made by the governor and the General Assembly.”

Asked whether the commission will consider closing the fund to new investors, as other states have with their prepaid plans, Ms. Hubbard says, “We’re not going to leave anything off the table.”

But that’s clearly not top of the list. “Everyone wants it to work,” she says, “which is a good thing.”

College Illinois allows parents to lock in tuition costs at the state’s public universities and colleges years before their kids reach college age, giving them the chance to hedge their exposure to rapidly rising tuition. More than 30,000 Illinois families hold contracts benefiting more than 50,000 future students.

Mr. Quinn appointed Ms. Hubbard to the unpaid position of ISAC chairman and named a new slate of commissioners in May. Shortly after that, Executive Director Andrew Davis, originally appointed by Gov. Rod Blagojevich, left his position. Ms. Hubbard says ISAC is interviewing candidates to succeed Mr. Davis and expects to hire someone soon.

Following Crain’s initial report last March, sales of new contracts slowed dramatically; ISAC stopped them entirely on Oct. 1. Refunds to participants more than doubled to $22 million in the fiscal year ended June 30 from $10 million the year before. Contract cancellations soared to $4.5 million in March and held above $4 million a month through June, dropping each month since then to $1.8 million in November. Still, that was up more than threefold from $573,000 in November 2010.

Despite the setbacks, the plan could make tuition payments for the next decade before running out of money even if it were closed to new investors, according to the new actuarial soundness report performed by Southfield, Mich.-based Gabriel Roeder Smith & Co. It could continue longer if, as the agency now forecasts, parents buy at least 2,500 new contracts a year, the average annual number purchased from 2008 to 2010. ISAC sold 1,309 contracts over the past 12 months.

The fund’s solvency also is predicated on a 7.5% annual return on investments, down from 8.75% predicted previously, and 8.5% yearly hikes in tuition at the University of Illinois.

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State Rep. Jim Durkin, R-Western Springs, who holds a College Illinois contract on behalf of his daughter and is leading Republican legislative efforts to shore up the program, says he will introduce legislation next year to make ISAC’s decision-making on College Illinois more transparent. In the past, the commission routinely discussed matters like where to invest funds in executive session.

Mr. Durkin says his bill won’t add a state financial guarantee for the fund, something that many holders of contracts called for in hearings Mr. Durkin and other Republican House members held earlier this year on College Illinois. Many of them argued that the state sold the program as a worry-free alternative to college savings plans in which parents knowingly take investment risk.

But Mr. Durkin says he will raise the issue. “We will have a real sincere discussion with my colleagues and the administration on the commitment they will give this fund considering the way it was marketed,” he says.

The state’s universities, which have been increasing tuition annually in the high single digits as the state’s contributions to them decline, also will be asked to help. “The universities have to be part of this,” Mr. Durkin says.

Ms. Hubbard says she’s supporting Mr. Durkin’s efforts to make ISAC’s decision-making more transparent. She’s not ready yet to discuss whether the state should backstop the plan.

She says she’s had “preliminary discussions” with some of the state’s university presidents. “I’ve had some . . . ask me how they can help,” she says. She declines to identify them, saying only that they don’t include anyone with the state’s flagship University of Illinois at Urbana-Champaign.

ISAC staff has been asked by January to furnish the commission with ideas to put College Illinois on better financial footing. The agency soon will announce the hiring of investment consultant Callan Associates Inc. of San Francisco, which will review the fund’s allocation of assets. Under Mr. Davis, ISAC targeted 47% of its assets for “alternative” classes like hedge funds and private- equity funds. That share now is at 46%, up from 38% at the start of 2011. That’s well above levels at other state prepaid tuition plans, many of which limit investments to stocks and bonds, and a larger share than even at much larger pension funds.

“The percentage that our portfolio has is probably a little higher than it should be,” Ms. Hubbard acknowledges. She says lawyers are reviewing what flexibility ISAC has to bail out of some of Mr. Davis’ investments, though she notes that generally hedge-fund and private-equity managers require new investors to stay put for at least three and sometimes as long as seven years.

In the first nine months of 2011, the College Illinois fund suffered a 4% loss. But, unlike in 2010, when it lagged a soaring stock market, the fund performed better than the 6.8% loss turned in by a typical investment mix of 60% bonds and 40% stocks, according to Chicago-based Morningstar Inc.

(This story first ran in Crain’s Chicago Business, a sister publication of InvestmentNews)

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