2017-18 Operating Budget and Parameters
As I have done in each of the recent years, I am writing today with information on the 2017-18 operating budget for the university.
As we look to 2017-18, we can foresee a year in which the university will significantly shift attention away from implementation of the most recent strategic plan (the majority of those elements have been or are nearing completion), and begin to immerse ourselves in what the next decade may hold as strategic planning at the unit level and the university level once again becomes a focal point. On the one hand, it is an exciting time for the community to begin thinking anew about the opportunities for continued growth in program and institutional excellence; at the same time, it will require discipline to determine priorities and their sequencing. It is within this environment that the administration has developed the parameters that inform the 2017-18 budget.
Overall from a financial planning standpoint, the year does not look materially different from recent years. Some subtle changes are encouraging, however. First and foremost, growth in revenues is slightly higher than we have experienced in recent years. This results from the adjustments in student enrollments to more stable patterns; an uptick in inflation that triggers greater endowment payout; and a continued strong focus on gift streams, with the Annual Fund achieving stronger results each year. Some of these additional revenues are offset by compensation costs as we continue to be a highly skilled, people-intensive business. In addition, there are costs associated with an expanding campus whose footprint has grown by 10 percent over the last three years.
Outlined below are the major assumptions and guidelines that we have incorporated in our 2017-18 budget. The overview of our revenues is followed by an overview of our expenditures. We continue to project the ability to fund transfers to reserves while producing a balanced budget for 2017-18, in spite of what appear to be significant headwinds within the investment markets. Continued discipline relative to expenditures, an eye toward review of processes and services, and aggressively but prudently exploiting our financial strength and position will serve us well as we examine the myriad ways of funding the next strategic plan.
Tuition and Fees
Student fees continue to be a significant revenue item for the university. They have three components: enrollment; tuition and room and board rates; and financial aid.
Our enrollment projections assume our historically high retention rates, but we must also account for the phasing back of our total undergraduate enrollment (2017-18 will be the third of a four-year process). For the fall of 2017, we anticipate a first-year class of 461 students, which follows an entering class of 465 (four above the budget target) this past fall. Aggregate undergraduate enrollment continues its planned reduction, with opening enrollment set at 1,808 students in the fall. This includes approximately 50 students studying abroad. The aggregate total is down intentionally from the peak undergraduate enrollment in the fall of 2014 of 1,886 students. By 2018-19, we anticipate opening enrollment of fewer than 1,800 students per year. The School of Law has established an aggregate enrollment target of 325 for 2017-18. While the national legal education market continues to languish, W&L's School of Law has stabilized enrollment, and has in fact exceeded budget targets in each of the past two years. Based on several factors, including an improved ranking of the law school in U.S. News & World Report, we are cautiously optimistic that such a result is possible again in 2017-18, but we are planning conservatively for only 101 new 1L students in the fall.
Moderate tuition and fee increases continue to be the norm for the most selective liberal arts colleges across the nation. The combination of increased public pressure for colleges and universities to address the price of college attendance and Washington's emphasis on accessibility and outcomes in higher education has played a major role in this trend. The days of increasing price dollar for dollar to cover the increased costs of providing an education are over. This puts additional pressure on us to use reasonable efforts to manage our costs, while still preserving the quality of the student experience. This aspect of budget management continues to be a priority. As we examine W&L's tuition and fees against the top 25 liberal arts peers, however, W&L lags behind all but one and has a comprehensive price tag that is approximately $4,000 lower than the average of the peers. This serves as a possible area of financial flexibility as we begin to examine how to fund elements of the next strategic plan, and will almost certainly be a topic of discussion in 2017-18 as we begin to estimate the costs of these future objectives. In reviewing this information, we thought it best to plan a tuition and fee increase that would prevent the gap between tuition and fees from growing larger. With that information as background, the Board of Trustees approved for 2017-18 an undergraduate comprehensive fee of $63,280, a 4.00 percent increase. This fee is composed of undergraduate tuition at $49,170, room rates averaging $6,800, full board rate of $6,310, and mandatory student fees totaling $1,000. We have established law school tuition at $47,165 (a 2.0 percent increase), consistent with the plan endorsed by the board in February 2015.
Student financial aid reflects the adjustments to tuition and fees that we must make to ensure economic diversity of our classes and to enroll the strongest possible class from a qualitative standpoint within budget constraints. Since we had failed to meet undergraduate financial aid budgets for entering classes in four of the last five years, we decided to reevaluate the budget level within the context of the profile of recent classes. We concluded that our planned budget target was inadequate to ensure that we could continue to recruit classes similar in profile to those in recent years. As a consequence, we adjusted the budget for the entering class by $680,000 from the initial target (translating to an additional commitment of roughly $2.4 million over four years). When coupled with funds needed for returning students, a budget for undergraduate financial aid of $41.2 million for 2017-18 was approved by the Board of Trustees at its February 2017 meeting. This is a 4.8 percent increase over the 2016-17 budgeted amount.
As identified last year, the law school has recognized that recent aid levels have become unsustainable over the long term and has integrated into its plan a gradual reduction of aid to entering classes, which leads to a reduction in the overall aid budget over the next several years. The law school has successfully managed this expectation over the past two years (increasing net tuition revenue in both years beyond planned levels through a combination of higher than anticipated enrollment, and lower average aid award to entering students). In spite of the challenging demographics of the national law admissions picture, the law school has been successful at achieving its admission targets while underspending its aid budget. The next step calls for an aid budget of $8.14 million in 2017-18, with $2.5 million allocated to the entering 1L class.
The combination of tuition rates multiplied by enrollments less student financial aid yields net tuition revenues. For 2017-18, undergraduate net tuition revenues will grow by $1.09 million over the 2016-17 budget to $44.4 million, an increase of 2.5 percent. On the law school side, net tuition revenues will grow a robust $840,000 to $7.12 million. This is an increase of 13.6 percent. In aggregate, net tuition revenues are expected to increase by 3.9 percent to $51.5 million in 2017-18.
Fees from housing, dining and other sources (technology, health services, Greek membership, etc.) yield an additional $17.74 million in revenues. The 2017-18 academic year will mark the fourth year of a planned reduction in the Greek member fee, from $600 to $400. By 2019-20, the university plans to phase out this fee to lower the costs of Greek life participation for all students, especially those on need-based aid. Overall, these other fees will grow by only $340,000 in 2017-18, or 1.9 percent. Total net student fees for 2017-18 are expected to total $69.25 million, or 48 percent of the total revenue budget. This represents an increase in the budget of $2.275 million, or 3.4 percent.
Investment income is the next major component of the revenue budget, and the allocation from our endowment is its largest element. The endowment is composed of private gifts made by generations of donors and maintains its purchasing power through prudent investment. Unfortunately, investment markets have demonstrated greater volatility in recent years. For instance, the fiscal year 2015 return was just 4.5 percent. This was followed by a -1.4 percent return in fiscal year 2016. Through February of this year, the 2017 fiscal year return is +5.4 percent. But this still falls short of our long-term return assumption of 7.5 percent, and our 10-year return number of 5.2 percent has not allowed the university to preserve its real purchasing power of the endowment over this period. In other words, this last decade has proven to be a challenging environment relative to the long-term objectives of preserving intergenerational equity in the purchasing power of the endowment. Unfortunately, the forecast from our consultant, Makena Capital Management, and other investment pundits for the near term to midterm indicates that this environment is not likely to improve substantially. The result is that endowment payout as a percentage of market value has grown in recent years, and is nearing the 5 percent cap constraint of our endowment spending policy.
Fortunately, we have not experienced such a constraint since the 2010 fiscal year (following the market sell-off in 2008-09). For 2017-18, we anticipate that we will be able to follow our spending formula to increase spending on a per-unit basis by inflation plus 1 percent. This translates to a 3.1 percent increase in unit spending. This adjustment also increases the payout rate, however, to 4.96 percent in 2017-18 (it was just 4.38 percent in 2014-15). This places us very close to the 5 percent cap. Without a market return of approximately 8 percent over the next year, the university likely will face the cap constraint in 2018-19. As endowment payout has become an increasingly large share of the revenue stream, it will be important to look for ways to mitigate payout volatility in our policies and practices. This is a topic that the Finance Committee of the board will be discussing over coming meetings. This payout on endowment, when coupled with the supplemental payout the board approved for law endowments to help better support the school through its transition to a smaller student population, is estimated to produce $41.7 million in support of operations. This is an increase of $1.65 million, or 4.1 percent over the current year's budget. With conservative return assumptions in our multiyear model, this is the peak of endowment payout, with expected declines of $1.5 million in payout in each of the next three years. Clearly, this is why managing payout volatility will be an important issue to address.
Beyond the traditional endowment, the university also benefits from outside trust distributions. These include, most significantly, the Lettie Pate Evans Foundation Trust, but also the Lewis Trust and several others. These will provide a total of $14.84 million in distributions in 2017-18, an increase of 6.1 percent over 2016-17. Of this $14.84 million, $976,000 will be allocated toward capital reserves, reflecting the board-adopted policy to allocate a portion of the Lettie Pate Evans Trust distribution toward this long-term need. Over time, this policy should allow the university to effectively budget full depreciation on capital assets and ensure that we are able to maintain these assets with little or no deferred maintenance, an important best-practice objective.
The final component of investment income, and by far the smallest, is short-term investment earnings. A low rate environment has been the norm over the last eight years, with only recent signs indicating a slow but steady increase in short-term rates. These assets are now yielding a minimal amount of revenue, and we expect only modest increases in the coming months in these rates, so this line is budgeted at just $323,000 in 2017-18, which represents a nearly 60 percent increase over the expected results in 2016-17. These assets, however, do provide a natural hedge to the university's variable rate debt, which is just under $29 million.
We anticipate aggregate investment income (endowment, trusts and short-term earnings) in 2017-18 to provide 39 percent of the university's operating revenues.
Annual support from alumni, friends and parents - primarily through the unrestricted Annual Fund - has traditionally been, and continues to be, an important source of support for operations. We are budgeting a 4.5 percent increase in the Annual Fund for 2017-18 over this last year's final result ($10.3 million). This increase puts the budget at $10.775 million, $225,000 greater than the current year's public goal. This percentage increase reflects the outstanding performance of the Annual Fund over the recent years and the investments made into the support structure of the Annual Fund. The Annual Fund showed tremendous growth through the campaign and continues to thrive as the program adapts and employs best practices in the industry. Of course, the unrestricted nature of this support plays a significant role in the university's ability to fund programs and activities. Expendable gifts supporting both Annual Fund and student financial aid provide 8 percent of our revenues, or $11.79 million.
It is worth noting that the university continues to benefit greatly from gifts to fund capital projects, although those funds are not flowing through from an operations standpoint. With the completion of Tucker Hall this summer, the Colonnade renovations will be complete, including a maintenance endowment, and have been fully funded through gifts. In addition, the projects comprising the indoor athletics and recreation initiative, including the new natatorium as well as the planned renovation for Doremus and the rebuild of what we now know as the Warner Center, will be significantly funded ($50 million) through gifts. These are just some of the examples of the importance of philanthropy in providing excellent programs and facilities from which our students benefit.
Over the last decade, the operating budget transitioned from a majority student-fees-based budget to one in which philanthropy (endowment and trusts held by others distributions and annual giving) plays as significant a role in revenues. This strong revenue diversity is a positive development and sets us apart from the majority of other higher education institutions. It is worth noting that over the decade, philanthropy initially represented 38.4 percent of operating revenues, while net student fees accounted for 54.9 percent. In 2017-18, we project these ratios to be 48 percent and 48 percent, respectively. In many respects, this growth in philanthropy helps to secure the gains made in student financial aid and academic and co-curricular programs through the Strategic Plan.
Auxiliary operations are the final factor in developing the revenue budget. These include catering services, the University Store, Printing and Copying Services, student cable, and rental properties, to name a few. Adjustments for 2017-18 reflect changes in business practices, pricing, and the operating environment. Each of these operations faces pressures from changes in the external environment. In the case of the University Store, students have a greater array of purchasing options for texts (online, rental, used, Amazon, etc.). The store has altered its practices in recent years to provide students a greater set of options for required texts, with the objective of retaining a portion of this business while also providing students with these greater options where possible on entry price point. Likewise, in Printing and Copying Services, the use of electronic media has replaced many of the printed materials that were once the bread and butter of the business. The center has adapted by growing its ability to do specialty printing and improving turnaround time to maintain revenues. We expect auxiliary operations to grow by 1.8 percent in 2017-18 over the current year's anticipated result, contributing 5 percent of operating revenues.
Compensation, which consists of salaries, wages and fringe benefits, remains by far the single largest component of the expenditure budget. For salaries and wages, the two primary factors are the number of positions and increases in pay. In recent years, while our official approach has been no new positions, we have in fact increased both faculty and staff numbers, typically through cost-neutral arrangements. This approach has been reasonably effective at addressing needs but not necessarily transparent within the community. Following a year in which each senior administrator was canvassed relative to pressing staffing needs in each area, along with possible financing alternatives to meet those needs, the approach for 2017-18 has reverted to the more ad hoc approach of evaluating individual requests. This has led to the identification of three new positions for 2017-18, with funding coming from retirement savings. The three are director of the Johnson Program, director for Community-Based Learning and an additional position in the Career and Professional Development Office. These three positons relate directly to areas in which student use and demand have grown exponentially and require additional staffing to meet student needs. With budgeted undergraduate faculty remaining at an all-time high of 209 (exclusive of Athletics and the library) but enrollment reduced over the last three years, the student-to-faculty ratio is scheduled to be 8.4 to 1 in 2017-18. This benchmark is consistent with the mean of the top 10 liberal arts colleges. Law faculty numbers are being reduced through normal attrition and in accordance with plans that anticipate a smaller law school.
2017-18 will be the first year in many years in which there is not a Lenfest pool of funds to supplement faculty salaries. As many of you are aware, we used those funds to bring faculty compensation much closer to the levels of our academic peers. That led to significant progress in this area. This outcome must continually be reviewed to ensure that the university does not take a step back. Likewise, we benchmark administrative and staff salaries against our peer schools, and have used a smaller pool of funds to address needed adjustments over the years. This practice has moved us in the right direction, but there is still work to do. For 2017-18, the operating budget anticipates a salary pool of 3.0 percent, which will be distributed based on the university's practices and guidelines for salary administration. In addition, the pool will be supplemented by .5 percent for promotions within the faculty, and an additional .5 percent for administration and staff, to continue progress in moving individuals toward the targets relative to range and experience for a position. Within the law school, faculty salaries will be frozen for one more year, with adjustments available for promotional increases.
The fringe benefits budget will moderate in growth in 2017-18 as the assumptions that guide the budget for the health insurance renewal lead to a lower-than-expected level of increase. Maintaining the plan's current design, but adjusting for expected medical inflation, claims experience, expected enrollments, and anticipated levels of reserves, we anticipate the health insurance budget to increase by only about 3 percent in 2017-18. This marks the fourth year in which increases have been held under 10 percent. Employees can reduce their health insurance contribution portion through incentives earned in the Wellness Program, which will be substantively altered and, I believe, improved in 2017-18. This will be possible as a result of the good work of the HR staff in evaluating the existing program and developing a responsive approach to both the accolades and criticisms of the existing program. Based on data that the university has collected on its peers, benefits compare favorably to those offered by peers in both scope and magnitude. Other benefits reflect only marginal changes, and so the majority of the balance of the increases in benefits costs is driven by the higher aggregate salary numbers. Benefits are expected to represent 36 percent of salaries.
As a result of these budgeted changes, total compensation is anticipated to increase by 2.7 percent in 2017-18 to $94.7 million, or 65 percent of all operating expenses.
Management of departmental budgets continues to be a strength across the campus. Departments have thoughtfully reallocated funds, when needed, to higher priorities, and many areas continue to look for and generate savings where possible. Technology has aided this effort in some cases, but a significant portion has been accomplished through simply greater diligence in managing expenses. In addition, the university has focused attention in areas to minimize costs and waste. We all know that utility management has been a major area of focus over recent years, and the efforts have paid off: electricity usage has dropped by 20 percent, and natural gas usage has fallen by 38 percent since 2008-09 in spite of a more than 10 percent increase in campus square footage during this time frame. Centralized management of software purchases, licensing and maintenance through ITS has also yielded substantial savings from the use of negotiated contracts and competitive vendor evaluations to force prices down. This level of attention and discipline to budget management has allowed the university to increase departmental budgets marginally. 2017-18 is not materially different from prior years, with the majority of departmental budgets scheduled to increase 1 percent. Certain areas of the budget grow by inflationary or greater than inflationary levels (dues and memberships, property insurance, etc.). As a result, the aggregate adjustment of 1.9 percent accommodates these areas within the budget. At $31.98 million, departmental budgets represent 22 percent of the expenditure budget.
Capital Budget and Debt
The annual capital budget within the operating budget is one of the important sources to ensure that facilities and equipment are renewed and maintained on a regular basis. It is scheduled to grow to $4.54 million in 2017-18, a 5.8 percent increase over the current year. This budget is supplemented by the major projects budget, which utilizes gifts and debt to fund the most significant projects on the campus. In aggregate, the university anticipates investing approximately $9.65 million in facilities and equipment in 2017-18. The renovation of Stemmons Plaza (phases 3 and 4), the completion of design work for the new indoor athletics and recreation facility, the creation of swing space for Athletics, and the renovation of the Reeves Center are major projects that will be visible on campus over the coming year.
The university periodically utilizes debt to supplement funding for capital projects. Having peaked two years ago with total debt in excess of $200 million, principal payments over this period have brought the balance down to $192 million. For 2017-18, principal payments on debt are scheduled to be $4.62 million, with interest payments planned at $8.73 million (assumes that the average variable rate debt cost will be 2.75 percent for the year). At $13.35 million, debt service represents 9 percent of the operating budget, which places this element near its cap of 10 percent. As we move closer to the start of construction of the indoor athletic and recreation facility, we may need to borrow a relatively small amount to cover the gap between fundraising and project costs. A decision on additional borrowing and its magnitude will likely be made in the spring or summer of 2018.
As part of the university's debt structure, the debt is rated by Moody's Investor Services and Standard and Poor's. Periodically, these organizations review the university's credit and credit capacity and provide guidance for investors. The most recent ratings from Moody's and S&P were Aa2 and AA, respectively. Both ratings were accompanied by a stable outlook and outlined the strong financial resources and student demand of the university in support of the ratings. Within the higher education industry, this is an enviable financial rating.
Transfers and Adjustments
Over the recent years, the university has been fortunate to be in a position to build reserves to assist with future periods of uncertainty or economic hardship. The Finance Committee of the board and the senior administration have worked diligently to adopt these best practices. As the financial picture has improved over the last two years, reserve allocations have been able to increase modestly. For 2017-18, capital reserves are anticipated to increase by approximately $1 million, and the trustee reserve will increase by more than $800,000. As we develop a new strategic plan, the administration will be examining the size of the trustee reserve and whether it needs to grow, or whether the allocation in future years can be deployed to underwrite strategic objectives.
I hope you find this overview helpful in providing the factors and thought processes that went into developing the 2017-18 operating budget. As always, please feel free to contact me with any questions.