Insuring Student Loans Against the Financial Risk of Failing to Complete College

30 Pages Posted: 13 Jun 2012 Last revised: 11 Feb 2013

See all articles by Satyajit Chatterjee

Satyajit Chatterjee

Federal Reserve Bank of Philadelphia

Felicia Anamaria Ionescu

Colgate University

Date Written: May 1, 2012

Abstract

Participants in student loan programs must repay loans in full regardless of whether they complete college. But many students who take out a loan do not earn a degree (the dropout rate among college students is between 33 to 50 percent). We examine whether insurance, in the form of loan forgiveness in the event of failure to complete college, can be offered, taking into account moral hazard and adverse selection. To do so, we develop a model that accounts for college enrollment and graduation rates among recent US high school graduates. In our model students may fail to earn a degree because they either fail college or choose to leave voluntarily. We find that if loan forgiveness is offered only when a student fails college, average welfare increases by 2.40 percent (in consumption equivalent units) without much effect on either enrollment or graduation rates. If loan forgiveness is offered against both failure and voluntarily departure, welfare increases by 2.15 percent and both enrollment and graduation are higher.

Supersedes Working Paper 10-31

Keywords: College Risk, Government Student Loans, Optimal Insurance

JEL Classification: D82, D86, I22

Suggested Citation

Chatterjee, Satyajit and Ionescu, Felicia Anamaria, Insuring Student Loans Against the Financial Risk of Failing to Complete College (May 1, 2012). FRB of Philadelphia Working Paper No. 12-15. Available at SSRN: https://ssrn.com/abstract=2083258 or http://dx.doi.org/10.2139/ssrn.2083258

Satyajit Chatterjee (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States
215-574-3861 (Phone)
215-574-4364 (Fax)

HOME PAGE: http://sites.google.com/site/chatterjeesatyajit/home

Felicia Anamaria Ionescu

Colgate University ( email )

13 Oak Drive
Hamilton NY 13346, NY 13346
United States

HOME PAGE: http://people.colgate.edu/fionescu/

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