Choosing the type of income-contingent loan: risk-sharing versus risk-pooling

By Maria Racionero & Elena Del Rey, Centre for Economic Policy Research, Research School of Economics, Australian National University

There is a growing trend around the world towards increasing students’ contributions to the cost of higher education. One of the advantages is that, when students pay for their education, they do so in the country where they study. Relying on tuition fees to finance higher education can however be both inefficient and unfair, preventing access to higher education to liquidity constrained but academically deserving individuals. Even if loans are available, risk aversion can negatively affect participation. Income-contingent loans (ICLs) provide insurance against adverse labour market outcomes by making repayments dependent on the amount of income earned. In particular, no repayment is typically due when earnings are below a minimum income repayment threshold. Australia was the first country to implement in 1989 an ICL scheme to finance the cost of higher education, and other countries have since adopted similar schemes. These schemes have traditionally relied on general taxation to finance part of the cost of education, and most notably the cost of education of those unable to achieve the minimum income repayment threshold.

In Chapter 8 of “The Mobility of Students and the Highly Skilled: Implications for Education Financing and Economic Policy”, we explore the choice between two types of ICLs: one partly subsidised, often denominated risk-sharing ICL, where the cost of the education of the unsuccessful students falls on the taxpayer; and the other self-financed, often denominated risk-pooling ICL, where the cost of the education of the unsuccessful students falls on the successful graduates of the cohort. Our purpose is to capture the situation faced by governments, such as those in Australia or UK, considering switching from partly subsidised to mostly self-financed funding schemes, while still providing insurance through income contingent repayments.

We consider individuals who are risk-averse and differ in their ability to benefit from education and inherited wealth. We first compare the higher education participation achieved with each scheme. We then show how each individual’s preference over the schemes depends on her ability and wealth and characterise the majority voting outcome. We identify circumstances under which the self-financing ICL is supported by a majority, even if a proportion of those who always study regardless of the scheme in place – precisely those with relatively higher wealth and ability – prefer the subsidised to the self-financed ICL.

Although the risk-pooling ICL may be preferred by a majority of individuals, it may be difficult to implement if students, particularly those who are more likely to succeed, are able to opt out. This problem is likely to be more severe if students are mobile. For this reason, we explore the possibility of letting students self-select into two schemes: a self-financing ICL and a pure loan, which makes each individual responsible for repayment of her individual debt regardless of her luck. In essence, the government offers loans to students and lets them choose whether to have them insured in a risk-pooling fashion or not insured at all. We show that risk-pooling ICLs can be guaranteed without resorting to coercion. Participation is however smaller, because wealthy high-ability individuals opt out. If risk aversion is sufficiently large, however, the possibility of opting out becomes less attractive and the participation pattern is then similar to that obtained when only risk-pooling ICLs are offered: the extra cost successful graduates bear, above the cost of their own education, can be interpreted as the risk premium they are willing to pay for the insurance risk-pooling schemes provide.

Emigration after graduation has also been identified as a potential problem for ICLs. We discuss the implications on participation and voting outcomes of allowing successful graduates to emigrate. We assume that successful graduates repay the loan regardless of whether they stay or emigrate, which is consistent with the rules that apply for instance in the UK ICL scheme. In contrast, successful graduates are not liable for the tax component in the risk-sharing ICL if they emigrate and this affects the cost of this type of ICL for the taxpayer. We show that the support for risk-sharing may in principle increase or decrease when successful graduates are able to emigrate. However, in our examples, the risk-pooling ICL remains the majority voting outcome.

Overall, our results cast a positive light on policy recommendations for full recovery of loans in an income-contingent fashion, such as the repayment extensions and surcharges, proposed by N. Barr (see, among other, chapter 7 in the same volume).

A more detailed version of this study can be found in The Mobility of Students and the Highly Skilled: Implications for Education Financing and Economic Policy (2014), Gérard, M. and S. Uebelmesser, eds. CESifo Seminar Series, MIT Press. See 


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: