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Aon Hewitt Retirement and Investment Blog

Tax Reform: Potential Impact on Colleges and Universities: What should endowment fiduciaries do?

For private universities and colleges[1], the specter of taxation has finally arrived front and center with the unveiled tax proposal in Congress, approved by The House Ways Committee on November 9. A glaring part of the proposed bill imposes a 1.4% excise tax on endowments greater than $250,000 per student.[2] In its current form[3], this proposed provision appears to be a lever to partially offset the expected tax revenue from corporate tax cuts. While the final outcome remains uncertain, the proposed bill could have a negative impact for many private colleges and universities’ finances.[4]  This puts additional pressure on endowment fiduciaries, who are already under scrutiny for issues such as endowment offshore investments, ESG[5] considerations, and growing spending needs on the endowment.
 
How can fiduciaries address the external forces and remain true to their fiduciary obligation to the endowment and the mission of the institution it supports? AHIC believes the issues are significant and warrant not merely an exercise by the institution’s Treasury office and investment committee, but require a more comprehensive and collaborative effort across functional departments to assess financial implications across the institution. Endowment fiduciaries specifically should evaluate risks to the endowment stemming from the proposed tax provisions.
 
In the following table, we highlight some key provisions in the proposed bill that could impact the financial profiles of private universities and colleges.[6] It is important to note that the specifics of each provision are subject to change.  The aggregate impact of the provisions can potentially lead to a fundamental shift in the relationship between the endowment and its institution, such as an increased reliance on the endowment to meet current over future needs, or reduce the endowment’s ability to support the institution’s mission.


As pressure mounts, could a tipping point be reached where endowment investment activities reduce or investment strategies significantly alter to accommodate greater funding needs? If the proposed changes are passed, we believe endowment fiduciaries today should focus on three areas:
  1. Review spending expectations and thresholds. Endowments tend to conduct a spending analysis as part of their regular strategic asset allocation review. We suggest that an independent and comprehensive spending analysis be conducted to better understand the endowment’s spending discipline and how varying the spending rate and methodology may help instill greater discipline. Additionally, it may be useful to not only identify the endowment’s low-end and high-end spending rate thresholds, but also to stress test those thresholds under various revenue and expenditure scenarios.
  2. Work cross-functionally to better understand short-term and long-term financial implications for the institution. While endowment fiduciaries are charged solely with the oversight of investments, reaching across the functional barrier to develop a broader understanding of how rule changes can impact the institution’s finance operation, strategies and activities facilitates more mission-informed decision-making. For example, could the portfolio need more liquidity due to greater current or expected funding burden? Test the endowment’s investment liquidity profile relative to fiscal scenarios with the rule changes to see if any changes to the investments are needed.
  3. Review the endowment’s investments. Consider if changes are needed to investments. Would the regulatory changes affect the endowment’s views on risk and return trade-offs, and if so, how should that affect current and future investments? Are there other investment models and mechanisms that can serve a dual purpose to address the institution’s mission and target a market rate of return? For example, could the endowment participate or lead infrastructure development projects that are structured to generate financial return alongside social return for the institution’s beneficiaries and/or communities? 
In the ensuing taxation debate, no doubt higher education advocates will be challenging the proposed provisions and many will wait for the bill to be signed into law before taking action. We believe the debate could act as a catalyst for endowment fiduciaries to consider the overall changing landscape of funding higher education and the role of endowments. AHIC will continue to monitor the situation closely.
 
Lila Han is a Senior Consultant in Aon Hewitt Investment Consulting’s Non-Profit Solutions group.

[1] Impacts those tax-exempt under 501(c)(3) section of the U.S. IRS Code
[2] Initial proposal was for endowments greater than $100,000 per student and for institutions with more than 500 students
[3] As of November 10, 2017
[4] A summary of proposed tax provisions affecting private higher education institutions can be found in NACUBO’s Statement on Tax Reform web link (http://www.nacubo.org/Initiatives/Tax_Reform/Summary_of_Key_HR_1_Provisions.html).
[5] ESG – Environment, Social, and Governance
[6] Other proposed provisions such as impact on executive compensation and retirement benefits are being monitored by Aon Hewitt’s Retirement team. They are not discussed here as the potential endowment impact is less clear. 

Content prepared for U.S. subscribers, but available to interested subscribers of other regions.

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