2018-19 Operating Budget and Parameters
As I have done in each of the recent years, I am writing today with information on the 2018-19 operating budget for the university.
In 2018-19, the university will significantly shift attention toward a new strategic plan, developing implementation strategies as well as preliminary schedules for implementation over the next decade. It is an exciting time for the community as we begin to shift from thinking about what should be in the plan to executing the priorities that will result in continued growth in program and institutional excellence. However, it will also require discipline to determine those priorities, their funding and their sequencing. This is the environment in which the administration has developed the parameters that inform this budget.
From a financial-planning standpoint, the year does not look materially different from recent years. Operating-revenue budget growth is healthy, with an expected increase of 3.7 percent. This growth results from three primary factors: net student fees, endowment payout, and Annual Fund. Of course, 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 expanded debt to help underwrite the construction of the Richard L. Duchossois Center for Athletics and Recreation and renovations to Woods Creek Apartments.
Outlined below are the major assumptions and guidelines that we have incorporated in our 2018-19 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 (an effort to move to industry best practices of funding depreciation) while producing a balanced budget. 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 FeesStudent 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 phased reduction of our total undergraduate enrollment. For the fall of 2018, we anticipate a first-year class of 461 students. This follows an entering class of 471 students (10 above the budget target) from last fall. Aggregate undergraduate enrollment continues its planned reduction, with opening enrollment set at 1,808 students in the fall of 2018. 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. Our forecasts anticipate fairly stable undergraduate enrollment, with opening enrollment of approximately 1,800 students per year, with 1,750 on campus.
The School of Law has established an aggregate enrollment target of 378 for 2018-19. This reflects the large enrolling class from this past fall (165 against a budget target of 135) along with more normalized classes at the 1L and 3L levels. After nearly a decade of declines in the national legal education marketplace, national applications have risen for the fall of 2018, and the W&L pool is the strongest in recent years. The Law School has, in fact, seen far greater growth over the last two years in applications than has been experienced at the national level. It is working to capitalize on these developments by improving the academic qualifications of the students entering as 1Ls in the fall. Once that class graduates, we plan for the Law School to stabilize enrollment at approximately 330 students.
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 manage our costs, while still preserving the quality of the student experience. This aspect of budget management continues to be a priority.
At the same time, we will soon begin to examine how to fund elements of our new strategic plan. Because W&L's comprehensive fee is approximately $3,500 lower than the average of the top 25 liberal arts peers, we believe there is flexibility to bring our price closer in line with those of our peers over the next several years, utilizing the additional revenues to underwrite elements of the strategic plan. With this in mind, the Board of Trustees subsequently approved for 2018-19 an undergraduate comprehensive fee of $66,380, a 4.90 percent increase. This fee is composed of undergraduate tuition at $51,420, room rate of $7,300, full board rate of $6,625, and mandatory student fees totaling $1,035. We have established Law School tuition at $48,110 (a 2.0 percent increase), consistent with the plan endorsed by the board in February 2015.
Meanwhile, we must also adjust student financial aid to ensure economic diversity of our classes and to enroll the strongest possible class from a qualitative standpoint within budget constraints. The results of our admissions efforts in recruiting the Class of 2021 were encouraging, with many notable improvements in class composition. We must maintain this progress, especially because many of the initiatives coming from the strategic plan task forces call for increasing the racial, ethnic and economic diversity of the student body. As a consequence, we have targeted a financial aid budget of $44.8 million - $2.6 million greater than budgeted in 2017-18.
The Law School has shifted focus toward managing net tuition revenues within a range that allows for its long-term financial stability. With the larger entering class this past fall, net tuition revenues at the Law School far exceeded budget expectations, providing flexibility to improve entering-student qualifications in the current admissions cycle. As a result, following a period of stagnating or declining aid budgets on a per-student basis, the Law School budget for financial aid will be $10.77 million, an increase of $1.2 million over this year.
The combination of tuition rates multiplied by enrollments, less student financial aid, yields net tuition revenues. For 2018-19, undergraduate net tuition revenues will grow by $550,000 over the 2017-18 budget to $44.4 million, an increase of 1.25 percent. On the Law School side, net tuition revenues will be $50,000 greater than budgeted in 2017-18. In aggregate, net tuition revenues are expected to increase by 1.15 percent to $51.7 million.
Fees from housing, dining and other sources (technology, health services, Greek membership, etc.) yield an additional $18.28 million in revenues. The 2018-19 academic year will mark the fifth year of a planned reduction in the Greek membership fee, from $400 to $200. 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 $940,000 in 2018-19 over the 2017-18 budget, or 5.4 percent. Net student fees are expected to total $70.38 million, or 47 percent of the total revenue budget. This is an increase in the budget of $1.54 million, or 2.2 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. The last decade has been a volatile decade for investment returns, with the large declines in 2008 and early 2009 followed by periods of strong returns and stagnant markets. Overall, during the last decade, the university's annualized return on endowment has been 5.5 percent. This falls short of our long-term return assumption of 7.5 percent, and over this 10-year period, this return has not allowed the university to preserve the real purchasing power of individual endowments. (It should be noted that with new gifts to the endowment over the last decade, aggregate endowment spending has increased more rapidly than inflation.) 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. The general 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 the annual payout from our endowment 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 on endowment spending since the 2010 fiscal year (following the market sell-off in 2008-09). We anticipate that we will 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. However, this adjustment also increases the payout rate to 4.84 percent in 2018-19 (as opposed to just 4.38 percent in 2014-15). This places us very close to the 5 percent cap. Unless we meet our long-term return assumption of 7.5 percent over the next year, the university likely will face the 5 percent cap constraint in 2019-20. Because endowment payout has become an increasingly large share of the revenue stream, it is important to look for ways to mitigate payout volatility in our policies and practices. The Finance Committee of the board has been discussing this topic and will continue to evaluate it over coming meetings. This payout on endowment, when coupled with the supplemental payout the board approved for law endowments to better support the school through its transition, is estimated to produce $44.8 million in support of operations. This is an increase of $1.4 million, or 3.2 percent over the current year's budget. With very conservative return assumptions in our multiyear model, this is the peak of endowment payout. Under this scenario we expect declines of $3.0 million in payout over the next three years. (It should be noted that if returns are at our long-term return rate assumption of 7.5 percent over the next several years, the forecast becomes far more robust from a revenue standpoint.) 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 $15.8 million in distributions, an increase of 6.5 percent over 2017-18. Of this $15.8 million, we will allocate $1.25 million 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 nine years, with only recent signs of persistent, steady increases 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 $441,000, which represents a 40 percent increase over the 2017-18 budgeted level. 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) to provide 41 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 tentatively budgeting a 5.0 percent increase in the Annual Fund for 2018-19 over this year's goal ($10.775 million). This increase puts the budget at $11.3 million, or $539,000 greater than the current year's public goal. This percentage increase reflects the outstanding performance of the Annual Fund in recent years and the investments made in 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. It is worth noting, that the actual goal for the Annual Fund will be determined over the summer and will evaluate the 2017-18 results along with other trends and factors that may impact the environment. 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 $12.5 million.
It is worth noting that the university continues to benefit greatly from gifts to fund capital projects, even though those funds are not flowing through from an operations standpoint. The Duchossois Athletic Center will be primarily funded through gifts supporting the two projects associated with the indoor athletic and recreation facility initiative. Likewise, as we develop the new strategic plan, we anticipate that we will fund through gifts a number of capital needs identified in that plan. 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, our operating budget has changed from one in which the majority of revenue came from student fees to one in which philanthropy (distributions from endowment and trusts held by others, 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. At the beginning of the decade, philanthropy initially represented 38 percent of operating revenues, and net student fees accounted for 55 percent. In 2018-19, we project these ratios to be 49 percent philanthropy and 47 percent net student fees. In many respects, this growth in philanthropy provides the greatest financial resource to long-term economic sustainability at the university.
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 2018-19 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 additional 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 1.6 percent in 2018-19 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 to restrict adding new positions, we have in fact added both faculty and staff members, typically through cost-neutral arrangements. This approach has been reasonably effective at addressing needs but not necessarily well understood within the community. For 2018-19, we will evaluate the efficacy of proceeding with a small group of new positions (both faculty and staff) that emerge from strategic planning. Beyond that, any additions will come through reallocations that are budget-neutral.
With budgeted undergraduate faculty at an all-time high of 211 (exclusive of athletics and the library) and enrollment reduced over the last four years, the student-to-faculty ratio is projected to be 8.3 to 1 in 2018-19. This benchmark is consistent with the mean of the top 10 liberal arts colleges. With better-than-expected enrollment figures at the Law School, the law faculty size will increase with the introduction of three instructors who will lead a Legal Writing Program. They will be funded by an open faculty line plus a budget supplement. We do not expect further reductions in faculty or staff at the Law School as part of the transition plan.
We benchmark faculty and staff salaries relative to the Top 25 liberal arts colleges, with adjustments for Williams School faculty and Law School faculty. Our goal is to have competitive salaries and compensation that puts us at or near the mean of the peer group. The Lenfest funds of the last capital campaign served a valuable role in assisting the university in moving faculty salaries toward these levels. Absent Lenfest funds, we must use the salary pool, promotion pool, and equity adjustment pool to maintain position. We do not yet have data on faculty salaries to make the comparisons that we would like for the current year, since that data is not released until later in the spring.
However, we do evaluate the most recent information to assist in establishing the annual salary pool. For 2018-19, the operating budget plans 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. For the 2018-19 year, Law School faculty salaries will benefit from the salary pool after three years of a salary freeze.
The fringe benefits budget will moderate in growth in 2018-19 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. This marks the fifth year in which increases have been held under 10 percent. Employees can reduce their health insurance contribution through incentives earned in the Wellness Program, which was substantively altered this year. 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 in the underlying plans, with the majority of cost increase directly related to higher aggregate salary numbers. Benefits are expected to represent 36.4 percent of salaries. This is extremely competitive within the top 25 liberal arts peers.
As a result of these budgeted changes, total compensation is anticipated to increase by 3.7 percent in 2018-19 to $97.9 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 these efforts have paid off: electricity usage has dropped by 17 percent, natural gas usage has fallen by 32 percent, and water usage has declined 9 percent since 2008-09. This has occurred in spite of an increase in campus square footage of more than 10 percent during this period. Centralized management of software purchases, licensing and maintenance through ITS has also yielded substantial savings from 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. The fiscal year 2018-19 is not materially different from prior years, with the majority of departmental budgets scheduled to increase 1.5 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 $32.57 million, departmental budgets represent 22 percent of the expenditure budget.
Annual 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 $4.84 million in 2018-19, a 6.6 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 $29.6 million in facilities and equipment in 2018-19. The development of the Duchossois Athletic Center and renovations to the Woods Creek Apartments are the two 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 reduced the balance to $188 million. However, for 2018-19, the university anticipates issuing an additional $22 million in debt to help underwrite the Duchossois Athletic Center as well as the renovations to Woods Creek Apartments. This will bring total debt to $210 million early in the fiscal year. With the additional debt, debt service is expected to increase in 2018-19, with $4.63 million allocated to principal repayment and $9.39 million allocated to interest payments (this assumes that the average variable-rate debt cost will be 3.0 percent for the year). At $14.0 million, debt service represents 9 percent of the operating budget, which places this element near its cap of 10 percent.
As part of the university's debt structure, Moody's Investor Services and Standard and Poor's rate our debt. These organizations periodically 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. These are enviable financial ratings within the higher education industry.
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 increased modestly. For 2018-19, capital reserves are anticipated to increase by approximately $1.3 million, and the trustee reserve will increase by $100,000. Stress-testing of the operating budget model suggests that the Trustee Reserve is appropriately sized with modest year-to-year adjustments. There remains in place a plan to increase capital reserves to a level that would allow the university to effectively fund depreciation of its capital assets on an annual basis.
I hope you find this overview helpful in providing the factors and thought processes that went into developing the 2018-19 operating budget. I will recap this information and answer questions from the campus community in our annual Budget Town Hall, scheduled for April 11 at 10:00 a.m. in Stackhouse Theater. I hope to see you there. In the meantime, as always, please feel free to contact me with any questions.