2016-17 Operating Budget and Parameters
President Ruscio said early in the year that he saw this year as a year of transition. In his remarks he outlined his reasoning for thinking of it in that way and while it did not necessarily translate into financial terms, the term "transition" is a very apt way to describe the budget of the current year as well as 2016-17. Over the life of the Campaign and Strategic Plan, we watched as the revenue pattern shifted from one in which net student fees dominated the equation to today where philanthropy in the form of endowments and gifts play an equal or greater role to student fees. We now face the challenge of adapting our planning and forecasts to give greater consideration to the factors that can impact endowment payout and giving.
Today, we see a revenue model that reflects a low growth trajectory as we shift to lower enrollment models in the undergraduate and law programs, fundraising priorities that are more heavily weighted to physical facilities (Doremus/Warner project) over endowments, and a volatile investment market that could minimize endowment payout growth. It is a transition period that we face on the financial operations side, but it is one in which we can take comfort recognizing that the fiscal discipline of the past allows us the ability to work through the transition and adapt our models and policies to not only sustain the institution but to continue to build on our successes.
On the expenditure side of the ledger, we have had tremendous stability over recent years as endowment fueled program growth, and we have begun to rebuild important reserves that served us well through the financial downturn of 2008 and 2009. The Campaign, through the creation of new endowments, has allowed us to build many new programs including those in ethics and entrepreneurship, expand financial aid and improve compensation. These remain critical elements in our budget support. We are now also seeing the physical manifestation of many of the Strategic Plan objectives. The Center for Global Learning (CGL), Upper Division Housing and the Natatorium will all open over the next several months. Each of these projects will improve the Washington and Lee experience, and as with any new facility, will require support through utilities, maintenance and, in some cases, personnel, all of which were considered as these facilities were planned. Nevertheless, each comes with new demands for resources. In total, these facilities alone increase W&L's physical footprint by 10%.
Outlined below are the major assumptions and guidelines that were incorporated in the development of our 2016-17 budget. First is an overview of our revenues, followed by an overview of our expenditures. We continue to project the ability to fund transfers to reserves while producing a balanced budget for 2016-17 in spite of what appears to be a low investment return environment. Discipline relative to expenditures and an eye toward review of our processes and services will be key to ensuring that we maintain our strong financial position.
Tuition and Fees
Student fees continue to be a significant revenue item for the University. It involves three components: enrollment; tuition, room and board rates; and financial aid.
Our enrollment projections assume our historically high retention rates but we must also take into account the phasing back of our total undergraduate enrollment (a four-year process) on our customary undergraduate entering class size. For the fall of 2016, we anticipate a first-year class of 461 students which follows an entering class of 454 (twelve below the budget target) this past fall. Aggregate undergraduate enrollment continues its planned reduction with opening enrollment set at 1,814 students in the fall (approximately 50 of whom will be participating in Study Abroad) which 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. In the School of Law, the aggregate enrollment target for 2016-17 is 316, which reflects the changes that the W&L School of Law has experienced in the legal education marketplace over the recent past and an entering class of 101. Over time, we anticipate that the Law School will enroll just under 300 students each year as it adjusts to the significantly smaller national applicant pool.
In recent years, most selective liberal arts colleges across the nation have moderated tuition and fee increases. In part, this is a reaction to the economic environment but also to increasing public pressure for colleges and universities to address the price of college attendance. This trend is not going away, as evidenced by the Washington's emphasis on accessibility and outcomes in higher education. The days of increasing price dollar for dollar to cover the increased costs of delivering an education are over. It is equally clear that we must continue all reasonable efforts to manage our costs, and this aspect of budget management will also continue to be a priority. In recent years, we have followed a model of increasing tuition and fees by inflation plus 1%. Our academic peers have followed a course in which increases have averaged between 3% and 4% per year. Subsequently, we have seen the gap between our tuition and fees and that of our peers grow on average from $1,200 to $3,900 over the last four years. In reviewing this information, we thought it best to plan a tuition increase that would prevent that gap from growing greater. With that information as background, the Board of Trustees approved for 2016-17 an undergraduate comprehensive fee of $60,847, a 3.98% increase. This fee is composed of undergraduate tuition $47,280, room rates averaging $6,450, full board rate of $6,130 and mandatory student fees totaling $987. Over the last five years, the rate of change in tuition has averaged just 2.29%; this is the second lowest five-year rate of change in the last sixty years. We have established Law School tuition at $46,240 (a 2.0% increase), which is consistent with the plan endorsed by the Board of Trustees in February 2015.
Over the past few years, the University has been working to bring the undergraduate discount rate (total institutional aid awarded divided by gross tuition revenues) for entering students to 42% following a period of aggressive financial aid increases that pushed this number into the mid-40% range over the last several years. The 42% rate is consistent with the objectives outlined in the University's Strategic Plan and is needed to limit student financial aid from crowding out other budget components in an environment in which enrollment is expected to drop back to pre-2009 levels.
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 in the discount rate for each entering first-year class. The first step on this path occurred this past fall as the Law School reduced the discount rate by 2%. A similar reduction is planned for 2016-17 and for at least the subsequent four years. This is a challenge for the Law School given the current demographics of the legal education marketplace where nationally, and at W&L, applications continue to decline. Nevertheless, this must be done to ensure financial stability for the Law School and minimize the financial impact of the Law School on the undergraduate programs. The Law School has developed strategies for accomplishing this objective.
With those elements as background, we have recommended and the Board of Trustees has approved an aggregate financial aid budget of $47.5 million for 2016-17. This budget includes $39.3 million dedicated to undergraduates with $9.14 million reserved for the entering class and $8.2 million for the Law School with $2.5 million dedicated to the entering cohort.
The combination of tuition and fee rates, enrollments less student financial aid yield net student fees. It is expected that net student fees will grow by $2.67 million from the 2015-16 budget to $66.4 million. Of this growth, revenues from the additional housing capacity on campus contribute $2.45 million in 2016-17. It is worth noting that without these new housing revenues, which are accompanied by increased operating expenses, net student fees would grow by just 0.3% for 2016-17and are less than the net student fees collected by the University in 2012-13. Net Student Fees are expected to contribute 48% of the operating revenues in 2016-17.
Investment income is the next major component of the revenue budget, and the allocation from our endowment is its largest component. The endowment is composed of private gifts made by generations of donors and maintains its purchasing power through prudent investment. Investment markets have been quite choppy over the last eighteen months or so. The endowment returned 4.7% in fiscal year 2015, but is down approximately 4% through the first nine months of the 2016 fiscal year. Our endowment spending formula calls for spending to increase by inflation plus one percent year-over-year, tested against a 5% spending level cap. In addition, the Law School transition plan calls for an increased level of spending from law school-only endowments at 7.5% of the market value for the three years of 2016 through 2018. While the University's Investment Committee continues to be concerned about the volatility of market returns and reliance on the monetary policies of central banks around the world to stimulate growth while recognizing that it is a formula that cannot be maintained over the long-term, we anticipate being able to increase endowment spending in 2016-17 on the majority of the endowment by the prescribed levels and still remain under the 5% endowment spending cap. It is important to recognize that within the Law School, a market based spending formula (7.5% of the endowment value) requires growth of at least 7.5% to increase endowment spending from year-to-year. This was identified as one of the major variables in the Law School model over which we have little control, and we do anticipate that endowment allocations at the Law School will decline in 2016-17 as a result of the decline in market returns over the first nine months of this year.
Based on the information available today, the University's traditional endowment allocation will be $40.1 million of support for operations in 2016-17. This is flat with the current year, and with conservative return assumptions in our planning model and the planned step-down in the payout rate on Law School endowments beginning in 2018-19, the University currently forecasts endowment allocation for operations declining over the next five years to $36.5 million. If actual returns surpass these assumptions, then we could see steady increases in endowment spending of roughly $1.5 million per year. As the University grows more dependent on the endowment as a revenue source, it will be important for the administration to consider adjustments to the payout formula to minimize the volatility in spending allocations in an effort to avoid declining endowment support.
Beyond the traditional endowment, the University also benefits from outside trust distributions, including most significantly the Lettie Pate Evans Foundation Trust, but also the Lewis Trust and several others. These will provide a total of $13.96 million in distributions in 2016-17, an increase of 5.6% over 2015-16. Of this $13.96 million, $779,000 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. With short-term rates continuing to languish at low levels and mixed indicators from the Federal Reserve on timing of rate hikes over the next year, this revenue source will continue to provide only a modest contribution to the revenue budget for the foreseeable future. These assets are currently yielding a minimal amount of revenue and expectations do not change substantively, so this line is budgeted at just $307,000 in 2016-17. These assets do, however, provide a natural hedge to the University's variable rate debt, which will be in excess of $29 million in 2016-17.
We anticipate aggregate investment income (endowment, trusts and short-term earnings) in 2016-17 to provide 39% 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 University operations. We are currently incorporating a 4.3% increase in the Annual Fund for 2016-17 over this year's budgeted levels. This increase puts the budget at $10.57 million, which is $370,000 greater than this year's public goal. This percentage increase reflects the outstanding performance of the Annual Fund over the recent years and additional investment into the support structure of the Annual Fund (more on that below). This component of the budget has shown tremendous growth through the Campaign, and it plays a significant role in the University's ability to fund programs and activities. Expendable gifts supporting both unrestricted operations and student financial aid provide 8% of our revenues, or $11.62 million.
It is worth noting that while not flowing through from an operations standpoint, the University benefitted greatly from Campaign gifts to fund capital projects. In the University's Strategic Plan, fundraising has provided the majority of the funds to renovate and restore the Colonnade, build the Center for Global Learning, construct a Natatorium, renovate Wilson Field, complete the Hillel House, and renovate Lewis Hall.
Over the course of the Campaign, 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 viewed as a positive development for the University and sets us apart from the majority of other higher education institutions. It is worth noting that at the outset of the Capital Campaign, philanthropy provided 38.4% of operating revenues while net student fees accounted for 54.3%. In 2016-17, we project those ratios as 48% and 48%, respectively. This reflects the strong impact of the Capital Campaign on operations as well as our efforts in recent years to improve access, which has effectively held net student costs flat for the past seven years.
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 2016-17 reflect changes in business practices, pricing changes and other operating environment changes. 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 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 certain specialty printing and improving turnaround time to maintain revenues. We expect auxiliary operations to grow by 1% in 2016-17 over the current year's anticipated result, contributing 5% of operating revenues.
Compensation, which consists of salaries, wages and fringe benefits, remains 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 but not necessarily very transparent. For the budget cycle for 2016-17, each Vice President and the Provost were canvassed relative to pressing staffing needs in each area along with possible financing alternatives to meet those needs. This process led to the recognition that the growth of facilities (Center for Global Learning, the upper division housing village and the Natatorium) would require additional staff investment in order to support the programs and maintenance needs. The 2016-17 budget includes new positions in Facilities Management, Student Affairs, Dining Services and a Building Coordinator for CGL to accommodate these space and program needs. Beyond these positions, the University has decided to make additional strategic investments in Admissions as recruitment strategies are refined and strengthened as well as Advancement where additional staffing in the Annual Fund office will lead to higher growth rates in that fund's support and Communications where a new writer/content manager will emphasize student-oriented communications. Finally, in the area of managing University risks, a new position for a full-time Cyber Security Officer has also been created. On the faculty front, the final two bridge positions have been authorized for budgeting purposes. This program, which has been phased in over a three-year period, may result in some rotation of faculty positions based on enrollment needs; however, it is important to note that the program has increased the faculty size by six. Within the Law School, the transition plan anticipates a decrease in both faculty and administrative and staff positions through normal attrition over the next four years. While timing for the reductions differs from the initial plan, there is confidence that the adjustments will occur during this transition period for the Law School.
Consistent with our goals of increasing compensation to the median levels of peers, we plan a salary pool increase of 2.0% for 2016-17. On the administrative and staff side, this pool will be administered consistently with the goals and objectives of the University's performance and compensation plan, which bases increases on a combination of performance and placement in the appropriate salary range. Beyond the general salary pool, funds are also set aside to further address the market adjustments for staff that were begun in 2009-10 and also to make the final installment of Lenfest adjustments for faculty (approximately 1% in the College and Williams School) as well as promotional increases. Within the Law School faculty salaries will be frozen over the next two years with adjustments only being made relative to promotions.
The fringe benefit budget has been built with the assumption of a 7.5% increase in the University's costs for health insurance. In developing the renewal rates in March, the University elected to increase the base share of the premium covered from 72% to 75%. In exchange for this increase, employees will pick up a co-insurance level on certain services in 2016-17. Overall, these changes reduce employee premiums by 8.4%. Employees can reduce their health insurance costs through incentives earned in the Wellness Program. It is worth noting that based on data that the University has collected on its peers, benefits are quite comparable to those offered by peers in both scope and magnitude. Other benefits reflect only marginal changes, and so the bulk of the balance of the increase in benefits costs is driven by the higher aggregate salary numbers. Benefits do represent 36.9% of salaries.
As a result of these budgeted changes, total compensation is anticipated to increase by 4.0% in 2016-17 to $91.9 million, 65% of all operating expenses.
Departmental budgets have been managed very well over recent years with efforts across departments to reallocate, when needed, to higher priorities and to look for and generate savings where possible. Some of this effort has been aided through technology (lower print volumes as electronic media have become a preferred distribution method as an example), but a significant portion has been 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 with electricity usage dropping by 26% and natural gas usage falling by 32% over recent years. Even with the addition of new facilities, the utility budget is expected to tick up only modestly in 2016-17. ITS has worked to consolidate and manage software licensing and maintenance which has yielded savings through either negotiated contracts or identification of vendors who provide similar or better functionality at lesser costs. This level of attention and discipline to budget management has allowed the University to increment departmental budgets marginally. 2016-17 is not materially different from prior years with the exception of the operational costs associated with new facilities. The majority of departmental budgets increased by 1.1% while the aggregate adjustment, which includes the additional operating costs for new facilities, grows 3.4% to $31.04 million. At $31.04 million, departmental budgets represent 22% of the expenditure budget.
Capital Budget and Debt
The Annual Capital Budget is one of the important sources ensuring that facilities and equipment are renewed and maintained on a regular basis. It is scheduled to grow to $4.29 million in 2016-17, a 6.4% increase over the current year's allocation. 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 $25.8 million in facilities and equipment in 2016-17. The renovation of Tucker Hall and Stemmons Plaza - phase 2, the completion of the Natatorium and design and creation of temporary space for the Indoor Athletic and Recreation Facility renovation are the major projects that will be visible on campus over the coming year.
As noted above, the University periodically utilizes debt to supplement funding for capital projects. Last spring, the University issued $45 million of new bonds to fund the Upper Division Housing project along with other various mid-level capital projects (those ranging from $500,000 to $4.0 million). This issuance increased the University's debt service costs by $1.9 million in 2015-16. However with the retirement of the 2006 bonds during this year, debt service will actually decline modestly in 2016-17. Our debt payments for 2016-17 are anticipated at $13.35 million with $4.48 million allocated toward principal repayment and $8.86 million toward interest costs. This does represents 10% of the budget, which is the maximum debt burden that we can carry under the University's debt policy.
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 and do so with each new issue. With the 2015 issue, Moody's rated the University as an Aa2 credit and S&P issued an Aa rating. Both ratings were accompanied by a stable outlook. Within the higher education industry, this is an enviable financial rating and is a clear sign of the strength of both the University's financial picture and prospective student demand.
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 practice models. However, in an environment of tight revenue growth coupled with increased debt burden and operating expenses, transfers will be limited in 2016-17. It is anticipated that we will only allocate to the Capital Reserve in 2016-17, and in fact may need to modestly draw down the Trustee Reserve to cover a portion of the reduction in the Law School endowment payout as a result of the decline in the investment markets. Based on our current planning assumptions, reserves will be increased by only $617,000 in 2016-17. Over the long-term as the University realizes the expected return on endowment, there will be greater ability to make additional investment in the reserves to ensure that we remain well-positioned from a financial perspective.