Student Loan Insurance

What happens when a student drops out of college without finishing his/her degree?

Well, nothing. However, there is a high percentage that said student will have to pay back thousands of dollars in student loans. This prospect is daunting even for those with decent jobs, let alone a college dropout. Student debts- a long term financial burden with no utility that is almost impossible to shed.

http://www.insidehighered.com/blogs/confessions_of_a_community_college_dean/dropouts_with_loans

The link above is from Inside Higher Education. The columnist proposed a possible solution to the growing number of people who drop out after taking student loans. He proposed for a change in public systems: that they charge less for the earlier semesters and more for the later ones.

Statistically, one-third of all college students drop out eventually. Some find it unenjoyable, others find it simply not worth the effort and also, commitment issues.

The possible solution: The creation of an insurance market that rewards students every year that they return to school to finish their degrees. A student loan insurance market would increase the number of undergrads finishing their degree by 3.8%, with greater effects for students who are currently more likely to drop out.

Now, there is a catch to this. It has the same problems that affect every insurance market, that is, people don't buy insurance unless they think they need it.


(Source: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1532391
Satyajit Chatterjee at the Federal Reserve Bank of Philadelphia and Felicia Anamaria Ionescu at Colgate University)

The authors acknowledge as much, writing:

Optimal insurance never encourages anyone who was putting in effort in college to stop putting in effort. Indeed, it encourages people who were not putting in effort to put in effort. The friction is simply that some students who were choosing to drop out may choose to continue on in college without putting in effort (there is no change in their college effort decision). Thus, insurance attracts students whose failure probability is 1.

 i.e. Insurance encourages people who were not putting in effort to put in effort, however some students who originally chose to drop out may continue their 'studies' without putting in any effort.

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Insurance is a form of risk management to defend against the risk of a loss. Agreeing to the terms of an insurance policy creates a contract between the insurer and the insured. Insurance is designed to protect the financial well-being of an individual or a corporation in a case of unexpected events.