Insuring College Failure Risk

Under current law, participants in (college) student loan program must repay their loan in full regardless of whether they complete college. Dropout rate among college students from low-income background is anywhere between 33 to 50 percent. The combination of lack of family resources, unconstrained access to student loans and high dropout rates means that for a substantial fraction of low-income students the attempt to acquire a college degree ends in low earnings and high indebtedness. In this paper we examine whether the student loan program can gainfully offer insurance against college failure risk. We argue that such an insurance scheme is administratively feasible and provide conditions under which such insurance can be gainfully offered taking into account the constraints imposed by moral hazard. We show that the provision of such insurance will raise enrollment rates, dropout rates, and average welfare. The model is calibrated to US data on college costs, enrollment rates, college premium, and average indebtedness of program participants. Insurance against college failure risk raises enrollment rates by 4 percent, decreases college completion rate from 61 percent to 40 percent and increases welfare by about 0.24 percent.