2019-20 Operating Budget and Parameters
I am writing as a follow-up to this morning's Town Hall Meeting on the budget, and to provide you with information on the 2019-20 operating budget for the university. For those unable to attend the meeting, a recording of the presentation will be available on this page later this week.
As the university turns its attention toward strategic plan implementation in 2019-20, the operating budget that has been under development will include a number of new positions and initiatives related to the early priorities that have emerged from the strategic plan. The commitments to these initiatives are in advance of significant fundraising. As such, when coupled with a very lackluster return on investments over the first half of 2018-19, the coming year reflects a challenging budget environment. This is not totally unexpected. We anticipated that the early years of strategic plan implementation would be financially trying as fundraising efforts ramped up. However, we will need to be mindful of this reality and careful to ensure that we do not act too fast on priorities in the coming years. The administration has developed the following parameters that inform this budget within this environment.
From a financial planning standpoint, the year is quite different from recent years. The operating revenue budget reflects moderated but continued growth overall, with an expected increase of 2.25 percent over the 2018-19 budget. This growth results from three primary factors: net student fees, endowment payout, and the Annual Fund. Of course, these additional revenues are offset by compensation costs as we continue to strive to offer competitive salaries and benefits and increase faculty and staff positions to assist with the implementation of strategic priorities. Overall, we anticipate a 5.0 percent increase in our expenditure base for 2019-20 over the 2018-19 budget. It goes without saying that while we can tolerate such a mismatch in revenue and expense growth in the short-term, over the longer term, these two lines will need to match up more closely.
Outlined below are the major assumptions and guidelines that we have incorporated into our 2019-20 budget. The overview of our revenues is followed by an overview of our expenditures. While in recent years, we have been able to fund transfers to reserves (an effort to move to industry best practices of funding depreciation), in 2019-20 we will likely need to draw from reserves to balance the budget. As a result, we will require continued discipline relative to expenditures and continued review of processes and services over the coming years to achieve our budget targets.
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 phased reduction of our total undergraduate enrollment. For the fall of 2019, we anticipate a first-year class of 461 students. This follows an entering class of 474 students (13 above the budget target) from last fall. Aggregate undergraduate enrollment continues its planned reduction, with opening enrollment set at 1,824 students in the fall of 2019. This assumes 60 students studying abroad. Study abroad is one variable that we are watching closely. In past years, the average number of student FTEs in study abroad has been approximately 55. In the current year, that number grew to 76. While these opportunities are wonderful for our students, they have a financial impact. If we continue to see growth in study abroad, we will need to make other adjustments in the budget. The aggregate undergraduate enrollment is down intentionally from the peak of 1,886 students in fall 2014. Our forecasts anticipate stable undergraduate enrollment, with an opening enrollment of approximately 1,800 students per year-with 1,740 of them on campus.
The School of Law has established an aggregate enrollment target of 394 for 2019-20, which is identical to the current year's opening enrollment. This reflects the large 3L class, estimated at 153, and nearly equal 1L and 2L classes of 120 and 121, respectively. While the national legal education marketplace has shown an uptick in the number of students applying to law schools, W&L's law school, even with a robust applicant pool, is challenged by a dip in the rankings in 2019. As a result, the law school expects improvement in GPA for the entering class but is not in a position to improve upon the median 163 LSAT. With the large class set to graduate in spring 2020, the law school's enrollment should stabilize at approximately 345 students.
Moderate tuition and fee increases continue to be the norm for most of the nation's selective liberal arts colleges. The combination of increased public pressure for colleges and universities to address the price of attendance and the federal government's emphasis on accessibility and outcomes in higher education has played a major role in this trend. This puts additional pressure on us to manage our costs, while still preserving the quality of the student experience.
With budget management in mind, we continue to examine ways to fund elements of our new strategic plan. Because W&L's comprehensive fee is approximately $3,100 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 and to utilize the additional revenues to underwrite elements of the strategic plan. In February, the Board of Trustees approved an undergraduate comprehensive fee of $69,675, a 4.96 percent increase, for 2019-20. This fee is composed of undergraduate tuition at $53,730, a room rate of $7,820, full board rate of $7,025, and mandatory student fees totaling $1,100. We have established Law School tuition at $49,075 (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 the economic and social 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 2022 were very encouraging, with notable improvements in class composition; however, these improvements were also accompanied by a significant overexpenditure of the first-year aid budget. While the strategic plan calls for us to maintain and progress on these fronts, we must do so within the context of what we can afford. As a consequence, we have targeted a financial aid budget of $48.7 million-$2.1 million greater than anticipated in 2018-19; however, the first-year budget of $11.9 million is approximately $1.1 million less than expended for this past year's enrolling class. Longer term, with additional endowment support through fundraising, it is planned that the university will shift to need-blind admissions for undergraduate candidates.
The Law School has shifted its focus toward managing net tuition revenues within a range that allows for long-term financial stability. With larger entering classes in recent years and an ability to recruit those classes at lower discount rates than originally budgeted, net tuition revenues have exceeded expectations. This has provided flexibility to improve entering-student qualifications over recent admission cycles. While we do not anticipate that we will improve the median LSAT score this year, we expect to improve the median GPA from 3.5 to 3.6. To generate this improvement, the law school anticipates a discount rate of 60 percent for the entering class. Coupled with the budgets for returning students, this results in an $11.9 million budget for 2019-20, an increase of $900,000 over the current year.
The combination of undergraduate and law tuition rates multiplied by enrollments, less student financial aid, yields net tuition revenues. For 2019-20, undergraduate net tuition revenues will grow by $850,000 to $45.2 million, an increase of 1.9 percent. On the Law School side, net tuition revenues will be $29,000 greater than budgeted in 2018-19. In aggregate, net tuition revenues are expected to increase by 1.7 percent to $52.6 million.
Fees from housing, dining and other sources (technology, health services, etc.) yield an additional $20.5 million in revenues. The 2019-20 academic year will mark the sixth and final year of a planned reduction in the Greek membership fee, from $200 to $0. With this phased out, the university has aided in lowering the costs of Greek life participation for all students, especially those on need-based aid. Overall, these other fees will grow by $1.24 million in 2019-20 over the 2018-19 budget, or 6.4 percent. Net student fees are expected to total $73.08 million, or 48 percent of the total revenue budget. This is an increase in the budget of $2.11 million, or 3.0 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. Overall, the last decade has surpassed our forecast for rate of return (8.1 percent through January 2019 versus an assumption of 7.5 percent); however, it has been a decade with strong returns one year followed by stagnant returns the following year. Of course, this is the decade that comes on the heels of the largest decline in markets since the Great Depression. We expect volatility to be a factor in the endowment, so we allocate the investment portfolio across multiple asset classes that do not normally trend evenly in the same direction. Our endowment spending formula is one in which we increase payout annually by inflation plus one percent and test this against a 5 percent cap of the endowment value. This formula, coupled with new gifts to the endowment, has allowed us to grow endowment payout significantly above inflation over the last decade. While our decade-long return is considerably improved from this time last year, the general forecast from our consultant, Makena Capital Management, and other investment pundits suggest that a lower return environment is likely to pervade across asset classes for the foreseeable future. As a result, the possibility of hitting the 5 percent cap constraint of our endowment spending policy is a legitimate concern.
In the current fiscal year, the portfolio has an estimated return of just 0.05 percent. If this number does not improve by the end of the fiscal year, we will hit the 5 percent cap on payout allocation for 2019-20. Currently, we anticipate that endowment payout will increase on a per unit basis; however, it will be less than the 2.9 percent increase that we would plan under the normal formula. Because endowment payout has become an increasingly large share of the revenue stream, we must look for ways to mitigate payout volatility in our policies and practices. The Finance Committee has been discussing this issue in recent meetings, and we are honing in on possible changes in the spending formula that should mitigate some of the challenges of the hard 5 percent cap. 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 $44.28 million in support of operations. This is an increase of $1.115 million, or 2.6 percent over the current year's budget. With conservative return assumptions in our multi-year 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 revenue forecast becomes far more robust.
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 trusts will provide $16.1 million in distributions, an increase of only 2.0 percent over the 2018-19 budgeted target. Of this $16.1 million, we will allocate just over $1.0 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, which meets an important best-practice objective. However, the slowing of the growth rate in the Evans distribution in recent years may require us to revisit how we achieve this important long-term financial objective.
The final component of investment income, and by far the smallest, is short-term investment earnings. An increasing interest rate environment over the last several years has begun to yield better results from our cash holdings. While it appears that rate increases are likely paused for the foreseeable future, this element of the revenue budget has grown more rapidly than others. With a full year of the higher rates in place for 2019-20, we anticipate that this revenue source will grow to $579,000, a 31 percent increase over the current year's budget. These assets provide a natural hedge to the university's variable rate debt, which is $15 million.
We anticipate aggregate investment income (endowment, trusts and short-term earnings) to provide 40 percent of our operating revenues.
Annual support from alumni, friends and parents-primarily through the unrestricted Annual Fund-continues to be an important source of support for operations. In recent years, annual Funds across the country have faced headwinds as donors increasingly seek to restrict their gifts toward a purpose of the donor's choosing. W&L's Annual Fund has held up relatively well, reaching an all-time high in 2017-18. In the current year, the fund has been trailing last year's results modestly. Reaching the public goal of $11.075 million (another new record) will be a challenge. We currently estimate a $10.82 million result-the second-highest on record. With challenging external and internal factors, some of which will not likely abate in the short term, we anticipate more conservative assumptions for the Annual Fund going forward. Our current scenario for 2019-20 anticipates a 2.0 percent increase from this year's expected result. I should note that our Advancement group continues to look at new ways to grow the fund and provide support of the university's operations through this important revenue source. Of course, the unrestricted nature of this support plays a significant role in the university's ability to fund programs and activities. When included with expendable gifts supporting student financial aid, annual giving provides 8 percent of our revenues, or $12.3 million.
It is worth noting that we continue to benefit greatly from gifts for capital projects, even though these funds do not directly impact our operating budget. The Richard L. Duchossois Athletic and Recreation Center will be funded primarily through gifts supporting the indoor athletic and recreation facility initiative. The CARPE project will also be funded through gifts, and many other capital initiatives associated with the strategic plan will rely on donor support in the coming years. This illustrates the critical 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 an equivalent role. 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 represented 38 percent of operating revenues, and net student fees accounted for 55 percent. In 2019-20, we project these ratios to be 48 percent philanthropy and 48 percent net student fees. In many respects, this growth in philanthropy provides the greatest financial contribution to long-term economic sustainability at the university, and we believe that this will only strengthen through the strategic plan and the upcoming capital campaign that will be associated with many of those initiatives.
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 2019-20 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, etc.). The store has altered its practices in recent years to provide students more options for required texts, with the objective of retaining a portion of this business while also providing students with additional options on prices where possible. Likewise, in Printing and Copying Services, the use of electronic media has replaced many of the printed materials that were once the foundation 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 2.75 percent in 2019-20 over the current year's estimated outcome, contributing 4.0 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, our stated approach has been to restrict the addition of new positions. In fact, we have added both faculty and staff members, typically through cost-neutral arrangements. However, with the initiatives identified in the strategic plan along with the transition to WorkDay, a new enterprise resource planning system, and the efforts associated with planning for a new capital campaign, adding positions in a variety of areas is critical. For 2019-20, we have planned for three new undergraduate faculty positions (Environmental Studies, Computer Science and Art History); three positions supporting WorkDay implementation with two of the three being term positions for the duration of the project; and four administrative positions in Development and Advancement Services in support of fundraising efforts. Beyond these, we will add the Director of Institutional History, the Director of CARPE, an additional Counselor position in Student Health Services, an Assistant Director for Student Leadership and Engagement, an additional staff member in Campus Recreation and Intramural Programs, a Director of Marketing for Admissions and Financial Aid, a Director of Fellowships and an additional Maintenance Technician focused on the university's rental properties.
While many of these will be funded through the operating budget, the administration has been creative in finding ways to fund certain positions through restricted funds or operating savings where practical. Most of these positions relate to strategic planning initiatives, and many will be supported over time through new gifts.
With budgeted undergraduate faculty at an all-time high of 217 (exclusive of athletics and the library) and the enrollment reductions over the past five years, the student-to-faculty ratio is projected to be 8.1 to 1 in 2019-20. This benchmark is consistent with the mean of the top 10 liberal arts colleges.
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 assisted 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 have not yet seen data on our peers for the current year, but we believe that the pools utilized will allow us to hold our position relative to the peer group.
We evaluate the most recent information to assist in establishing the annual salary pool. For 2019-20, the operating budget includes a salary pool that will allow most employees to receive a 2.0 percent increase. Beyond this base amount, merit and promotion pools will add approximately 0.5 percent each, making the aggregate change to continuing salaries and wages at 3.0 percent. These pools will be distributed based on our practices and guidelines for salary administration.
The fringe benefits budget will continue to grow in 2019-20. The increases in our health insurance plan, which are higher than expected, drive much of this change. The current year has been difficult for our health plan. Claims experience through February is significantly greater than anticipated at renewal. While the university will be able to utilize reserves to fund this overage, this year's experience plays a major role in forecasting experience and premium equivalents for 2019-20. We are modeling an 8.0 percent increase in premiums and will evaluate potential plan changes to secure a renewal within this range over the coming month. This follows a period of relatively modest increases in our health premiums. It is our hope that the current year is an anomaly; however, there is enough evidence to suggest that this issue will not resolve quickly. As a reminder, employees can reduce their health insurance contribution through incentives earned in the Wellness Program, which was substantially altered last year and led to an increase in participation. Based on data from our 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 37.2 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 5.5 percent in 2019-20 to $103.6 million, or 68 percent of all operating expenses.
Management of departmental budgets continues to be a strength across 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 simply through 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 recently, with double-digit declines in consumption over the last decade. This has continued in the current year, with all but one month reflecting consumption that has fallen below that of 2017-18. This was accomplished even though the university's campus footprint has increased by more than 10 percent over the decade.
Within the College, the dean's office is working on a budgeting approach that will better allocate service contract costs and generate savings to fund needed repairs and replacements that occur during the year. ITS continues to take advantage of centralized purchasing for software, licenses, and maintenance. This level of attention and discipline to budget management has permitted a marginal increase to departmental budgets. The fiscal year 2019-20 is not materially different from prior years, as the majority of departmental budgets will increase by 1.2 percent. Certain areas of the budget grow by inflationary or greater than inflationary levels (dues and memberships, property insurance, etc.), and the university will be accommodating the costs of WorkDay licenses while still needing to maintain the operational aspects of the Ellucian system during the transition. As a result, the aggregate adjustment of 3.9 percent accommodates these areas within the budget. At $33.9 million, departmental budgets represent 22 percent of the expenditure budget.
Annual Capital Budget and Debt
Within the operating budget, the annual capital budget ensures that facilities and equipment are renewed and maintained on a regular basis. It will grow to $5.14 million in 2019-20, a 6.2 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 campus. We anticipate investing approximately $30.5 million in facilities and equipment in 2019-20 with the bulk of those dollars supporting the Duchossois Athletic and Recreation Center project, final renovations to the Woods Creek Apartments, and the first phase of the CARPE construction in Leyburn Library.
The university periodically uses debt to supplement funding of capital projects. Including debt taken in the summer of 2018, we enter 2019-20 with long-term debt of $205 million. Of course, the additional debt comes with a cost, and we anticipate that we will underwrite debt service from operations with $5.22 million allocated to principal repayment and $9.52 million allocated to interest payments (this assumes that the average variable-rate debt cost will be 3.25 percent for the year). At $14.74 million, debt service represents 10 percent of the operating budget, which places this element at our policy cap of 10 percent.
Both Moody's Investor Services and Standard and Poor's provide ratings for our debt. In the most recent review, Moody's and S&P issued Aa2 and AA ratings, respectively. Both ratings were accompanied by a stable outlook and outlined the strong financial resources and student demand in support of the ratings. These are enviable financial ratings within the higher education industry.
Transfers and Adjustments
Over recent years, we have been fortunate to build reserves to assist with future periods of uncertainty and economic hardship or to facilitate important projects. As you know, we have worked diligently to adopt these best practices and build healthy reserve balances to assist with volatile investment markets, underwrite capital projects and cover unexpected operating expenses. It is important to note that on occasion the use of reserves allows the university to advance ahead of certain fundraising efforts. In 2019-20, we anticipate such a scenario. While we plan to allocate more than $1 million to capital reserves from the Evans distribution, we will need to draw down the Trustee Reserve by an estimated $3.8 million to help underwrite a number of the early strategic priorities. In fact, the capital reserve will be drawn down by approximately $7.9 million as we complete the Duchossois Athletic and Recreation Center and invest in the WorkDay implementation. Such draws on reserves are not sustainable over the long term; however, under the right circumstances and because of the tremendous financial strength built over the years, the university can accommodate these for 2019-20. As we look forward, we will need to be cognizant that other new strategic investments will require support through gifts, and, in some cases, debt. We will have to be careful and thoughtful in our planning to ensure that we do not exhaust our reserves but can rebuild those balances.
I hope this summary of the Recommended 2019-20 University Operating Budget provides a level of clarity to the assumptions, policy and past practice that guide the budget process, as well as investments in the continued excellence of Washington and Lee.