Supersedes Working Paper 10-31 - Insuring Student Loans Against the Risk of College Failure

But many students who take out a loan do not earn a degree (the dropout rate among college students is between 33 to 50 percent). The authors examine whether insurance, in the form of loan forgiveness in the event of failure to complete college, can be offered, taking into account moral hazard and adverse selection. To do so, they develop a model that accounts for college enrollment and graduation rates among recent U.S. high school graduates. In their model students may fail to earn a degree because they either fail college or choose to leave voluntarily. The authors find that if loan forgiveness is offered only when a student fails college, average welfare increases by 2.40 percent (in consumption equivalent units) without much effect on either enrollment or graduation rates. If loan forgiveness is offered against both failure and voluntary departure, welfare increases by 2.15 percent and both enrollment and graduation are higher.