In 2021, the General Assembly directed the State Council on Higher Education in Virginia to study higher education costs and funding needs of the Commonwealth’s public institutions and to submit a report with recommendations that “identify and recommend

1. methods to determine appropriate costs, including a detailed cost analysis, of Virginia public institutions of higher education and peer institutions.

2. measures of efficiency and effectiveness, including identification of opportunities for mitigating costs, increasing financial efficiencies, and incorporating current best practices employed by Virginia institutions and other institutions nationwide.

3. provisions for any new reporting requirements, including a possible periodic review of cost and strategies employed to implement efficient and effective operational practices.

4. strategies to allocate limited public resources based on outcomes that align with state needs related to affordability, access, completion, and workforce alignment, and the impact on tuition and pricing.

5. the impact of funding on underrepresented student populations; and

6. a timeline for implementation."

Pursuant to this charge, an interagency panel selected NCHEMS to assist with conducting this study through an RFP process. SCHEV identified four major deliverables as part of the review, which are listed below along with key findings from the project. Throughout the project, NCHEMS worked closely with SCHEV to produce and refine every significant element, and both consulted regularly with key stakeholders, particularly OpSix (a body established in Virginia statute to review institutional six-year plans consisting of the Staff Directors of the House Appropriations Committee and the Senate Finance and Appropriations Committee, the Director of the Department of Planning and Budget, the Director of SCHEV, the Secretary of Finance, the Secretary of Education, or their designees) and institutional finance officers but also other institutional leaders, the Council of Presidents, and important advocacy groups. This study was narrowly aimed at Virginia’s approach to funding its public institutions’ Education and General (E&G) operating budgets.(*1) While important, other aspects of state funding support to higher education were not within the scope of the study, including capital funding for higher education, state-funded financial aid, auxiliaries (e.g., housing, bookstore operations, athletics), and endowments.

Deliverable 1: Review of funding policies: Conduct a review of policies nationally and compare them to Virginia’s current funding model. For this aspect of the project, NCHEMS conducted research on Virginia’s financing policies, analyzed data provided by SCHEV, and developed, fielded, and analyzed a national survey of state finance policies (in partnership with the State Higher Education Executive Officers national association, SHEEO). The findings from this survey are that:

• States should strategically align funding with statewide goals. Above all, the funding approach should be deliberately designed and implemented in alignment with statewide goals.

• Base funding approaches in other states are rarely strategic. Researchers, funders, and policymakers have focused their attention in recent years on performance funding, resulting in few studies covering institutions’ basic funding needs. Most states use a Base Plus approach to funding public institutions, by which appropriations to institutions are set equal to the funding level from the prior year (or biennium) plus a percent increase that is either consistent across institutions or otherwise related to estimated additional expenses due to salaries or benefits. States that rely on this type of funding approach do not routinely reassess the “Base" component. Such approaches are rarely strategic or aligned with specific state educational goals even when states are able to specify what factors help determine the “Plus" part of the funding. Base Plus approaches assume historical funding patterns are appropriate and adequate, fail to strategically address significant changes in the circumstances of institutions, and can often lead to or exacerbate funding inequities across institutions (which typically lead to inequities in access to programs or adequate supports for students from targeted populations).? Formulas are a better basis for rational and strategic funding approaches. States with base funding approaches that are better equipped to make rational and strategic investments, and to respond to disruptions with a strong foundation of evidence, incorporate formulas. The best formula-driven approaches are sensitive to variation in institutional costs that are driven by differences in mission, program array, institutional size (including provisions that support the success of smaller institutions that are less able to benefit from scale economies), and characteristics of the student body. Formula approaches that are best equipped to capture and reflect that sensitivity in costs rely on the number of semester credit hours (SCH) produced by discipline and level, with a set of weights that account for the different costs of delivering those SCHs. Tracking SCHs is a common practice in use by institutions, and they can be related to a full set of the costs of instructional delivery that vary meaningfully by discipline and level—factors such as faculty and staff compensation, equipment requirements, curricular and student supports, clinical or similar experiences, and other differences deemed to be pedagogically sound (e.g., class size limitations).

• Virginia’s current base funding formula no longer serves as a strategic and rational mechanism for resource allocation. Virginia’s existing approach to funding public institutions uses a “Base Adequacy" calculation that relies on student-faculty ratios. No other state reported using this measure to establish base funding requirements. While faculty costs account for the majority of instructional expenses, they are not the only variable that will differ across disciplines and levels. Furthermore, once Virginia’s public institutions all reached the calculated base adequacy amounts (based on total funding from the state plus tuition revenue), the base adequacy formula no longer served as a rational or strategic approach to resource allocation. Instead, Virginia’s current funding approach functions like a Base Plus model.

• State funding should address foundational costs, be sensitive to institutional missions, and embed incentives linked to state goals. In addition to a formula that rationalizes institutional costs, states with strategically aligned funding models also include elements that account for a minimal set of foundational costs, intentionally consider the differences in public institutions’ roles and missions, and include a performance component that directs funding to institutions based on their ability to make progress toward state priorities.

• State funding policies should be mindful of differences in institutional capacity to generate tuition revenue. Although Virginia is among a few states that have formally described cost-sharing targets, its approach to such targets fails to recognize important differences in institutional role and mission, particularly those related to differences in institutional capacity to raise tuition and other non-state revenue.

Deliverable 2: Efficiency and effectiveness review: Inventory Virginia institutions’ practices and research those in other states to identify opportunities for mitigating costs and increasing efficiencies for incorporation by Virginia institutions. NCHEMS reviewed reports from other states on institutional and system-wide efforts to improve operational efficiencies and institutional effectiveness. Typified by reports from Texas and Ohio, these reports catalogued the various ongoing efforts being undertaken at their institutions. NCHEMS also developed, fielded, and analyzed a survey of Virginia’s public institutions related to similar efforts currently underway or recently implemented. The following are findings from the multi-state review and Virginia institution survey:

• Virginia’s institutions are active in seeking efficiencies, most commonly by making improvements internally (versus collaboratively) and with a focus on administrative services. They consistently look for opportunities to operate more efficiently and creatively implement them. They are less likely to reach across institutional boundaries to find efficiencies that can scale beyond their campus. And there is less attention to efficiency gains related to academic delivery. The latter can be more difficult to implement in most settings, due in part to the necessity of engaging faculty productively in making changes to the curriculum.

• Multi-institutional collaborations can yield substantial savings. The most significant savings from efficiency activities have come from collaborations of multiple institutions related to purchasing and library services. These tend not only to free up money for other priority purposes, but they also enhance the quality of services to students, faculty, and other institutional stakeholders.

• Activity in Virginia is similar to those in other states. These observations are consistent with the findings from other statewide efforts to drive greater efficiencies: most successful efforts lead to the reinvestment of resources in improving institutional quality or student success, initiatives are more commonly aimed at improving administrative services rather than in the academic arena, and multi-institutional collaborative activity is even more likely to address the delivery of administrative services.

• Savings are reinvested in institutional priorities, which can include better service to students. It is difficult to ascertain the extent to which efficiencies were passed on to students and families in terms of slowing the pace of tuition increases or through financial aid awards or otherwise helped students and families save money by improving the likelihood of graduating or time-to-degree. Perhaps just as often, however, are savings used for more institutionally focused reinvestments in academic quality, new programs, or other opportunities that may or may not yield a payoff directly for an institution’s current students.

Deliverable 3: Identification of trends in costs and determination of estimated costs for higher education: Gather and analyze data on funding and costs for higher education and create benchmarks for evaluating revenue and expenditures of Virginia institutions. Using Virginia-specific data supplied by SCHEV and national data from various sources, especially IPEDS, NCHEMS developed new peer groups for Virginia’s institutions and benchmarked financial data of Virginia’s institutions in comparison to these peers. In generating data to support the funding model, NCHEMS conducted research on costs analyses that have been done by other states or systems. In summary:

• While total education operating revenue per student was nearly identical to the national median, state funding of public institutions in Virginia is well below the national average. Virginia’s educational appropriations per student was lower than 37 other states in FY 2021 (excluding financial aid, research, and medical education). Tuition revenue, which, on a per student basis, exceeds the national average has made up the difference. In the first two decades of this millennium, the share of educational costs borne by students in Virginia has climbed by nearly 24 percentage points, a cost shift exceeded by just 10 other states.

• Funding levels have been volatile in recent years; the resulting unpredictability inhibits good institutional planning. New money provided by the General Assembly and supported by federal stimulus funding has helped Virginia’s institutions weather the pandemic. As welcome as this infusion of funding has been, Virginia’s institutions (not unlike others elsewhere) have experienced funding inconsistency from one year to the next over the past decade, making it challenging to predict support levels and to plan effectively. In the wake of the Great Recession, state General Fund (GF) support per instate-student dropped from $9,103 in FY2009 across the public four-years and $4,371 in the two-year sector to respective low points of $6,528 and $2,957 in FY 2012 (adjusted for inflation). Thereafter the institutions collectively saw gradual improvements through FY2017, which resumed after a one-year dip in FY2018. Due to a combination of state budget increases and declining enrollment in the two-year sector, per student funding in the two-year sector has recovered to pre-Recession levels, but remains 16 percent below pre-Recession levels in the four-year sector. Moreover, because they are less able to raise tuition revenue and thus more dependent on state funding, the institutions that are typically most affected by unpredictable state funding support are those that primarily serve higher proportions of low-income, under-represented students—those populations that Virginia’s strategic plan identifies as in need of special focus, especially in light of anticipated demographic changes. This volatility can severely impede the achievement of state goals.

• Virginia's public institutions spend fewer E&G dollars per student. In FY2019, Virginia’s public institutions spent 4.3 percent less on core administrative and instructional costs. If spending on auxiliary enterprises (housing, athletics, bookstores, etc.) is included, Virginia’s institutions spent 11.6 percent more per student, but this report is focused on E&G revenue and expenditures. Further, consistent with statewide figures, looking at Virginia’s institutions in comparison to institution-specific comparison groups of similar institutions across the country reveals that Virginia’s institutions collect more revenue from tuition and less from state appropriations. These comparison groups play no direct role in the funding model design that this report recommends, though they are expected to provide additional data to help validate the funding amounts the model generates for each institution, especially as the state transitions to the use of a new model. Moreover, the comparison groups are important and valuable for benchmarking purposes more generally—both for assessing institutional financial resources and spending and for assessing student outcomes.

• Affordability for resident students remains a significant problem. On average, first-year resident students from median income households attending public four-year institutions full-time had to pay the equivalent of almost 20 percent of their annual income to attend college, even after accounting for grants. For students in the lowest income quartile, that proportion was 72 percent. Both figures were notably higher than the national average.

• Differences between Virginia’s institutions are substantial. Aggregated revenue and spending levels obscure important variation across the institutions. Virginia is home to both well-funded public institutions and institutions that operate much closer to the margins. This shows up in many ways important to state goals, especially in terms of the students each institution tends to serve. For example, the proportion of Pell Grant recipients in the undergraduate student body ranges from 68 percent at Virginia State University to just 15 percent at the University of Virginia in 2020-21. Similarly, the non-White population at Norfolk State University accounts for roughly 97 percent of all students, while at Christopher Newport University, that share is just 24 percent. Any adjustments to the funding model must be carefully calibrated with a full awareness of these key facts about which institutions serve what audiences.

Deliverable 4: Recommendations for a new funding model: Create or modify a funding model or models for use in Virginia. Drawing on the work conducted for the other three deliverables and from its experience working on postsecondary finance through the nation, NCHEMS developed a preliminary new cost and funding model for use by SCHEV to estimate plausible costs of higher education and recommend appropriations levels to the legislature. The model builds from a conceptual framework that is novel in its design and application to data, one that is appropriate not only for the specific Virginia context, but also balances the alignment of funding to state needs and accounts for real operating costs incurred by institutions.

• Design principles guided development of the funding model. Early in the project, NCHEMS, with consultation from SCHEV, developed a set of principles for the design and eventual implementation of a funding model. This set of principles, which is detailed beginning on page 43 of this report, was intended to serve as a guide to the difficult decisions that inevitably accompany the revision of a funding model. It received considerable feedback and overall acclamation from key stakeholders, including institutional representatives.

• A typology of institutional costs provided a sophisticated yet straightforward framework for the cost and funding model. The proposed new funding model is closely linked to a conceptual framework that is both coherent and adapted to address statewide goals, while being sensitive to differences in institutional mission and capacity for acquiring tuition revenue. It does this by organizing estimates of costs that begin with a minimum, “frugal" level of administration sufficient to preserve the value of the institution as a state asset (the bottom two elements of the basic form of the framework depicted in Figure 1 - see numbered page 7), before factoring in costs that vary by academic program array and characteristics of the student body (scale, scope, and audience). The framework next addresses costs of creating and sustaining performance improvements, adding new capacity, and supporting various activities that are effectively purchases of services. The top two categories are activities important to the institution but are funded externally or by the institution itself.

This basic form of the conceptual framework fits within a larger version (Figure 2 - see numbered page 8) that details the relationship between these categories and their role in accounting for institutional costs (the Cost Model), investments in institutional and state priorities, the portion of the state General Fund appropriation that is to be allocated based on the Funding Model, and where the responsibility for providing financial support for each category rests. Feedback from stakeholders concerning this conceptual framework was generally positive as an organizational scheme for providing guidance to the legislature on resource allocation decisions.

• The funding model is dynamic and can adjust to changing conditions. A significant component of the funding approach is the use of a dynamic simulation that allows SCHEV to quickly and easily assess the effects of adjustments in the parameters of the funding model itself. As data are updated and conditions change over time, this tool can also help SCHEV continue to develop and advance funding recommendations to the Governor and General Assembly that are aligned with state priorities and political and budgetary realities.

Recommendations

Virginia has a strong, vibrant public higher education infrastructure. Collectively, the institutions spur innovation and economic development, work to assure the Commonwealth’s workforce needs are appropriately met and attract talent from elsewhere to settle in the state. They are clearly an integral part of the state’s strategy to retain its position as a national leader in economic prosperity and societal health. But they will struggle to continue to fulfill this duty without sufficient funding strategically allocated to them in concert with clear goals and in full awareness of the roles each institution plays individually and as part of a broader collective. Virginia’s approach to funding institutions is in need of a new model that restores rationality, coherence, and strategic alignment with the state’s goals, all of which have eroded since the last major revision to those policies. This report develops a conceptual framework that lays the foundation for an improved funding model that meets these criteria. As this report is released, additional elements remain under review. Several factors—delays in the 2022 General Assembly session and budgeting process, changes in administration that occurred partway through the project, and the need for ongoing review of data inputs and metrics—have slowed progress toward the complete adoption of a new funding model. The following provides recommendations on the deliverables and notes where additional work remains to be completed.

1. Adopt the conceptual framework and continue to refine the parameters and data sources for use in the model. Virginia should make it a goal to allocate General Fund support to public institutions in accordance with this conceptual framework and with the recommendations for specific appropriations levels that SCHEV will make using the framework and the model. While additional work is needed to further refine the data sources and funding parameters, the conceptual framework that details a strategic approach to funding has general consensus among key stakeholder groups. NCHEMS provided recommended parameters and an interactive model that are under review and should continue to be refined over the next six months.

2. Adopt differential cost-sharing targets. Virginia should adopt differential cost-sharing targets to aid in prioritizing the allocation of state support to public institutions in alignment with state goals and in recognition of the differences in mission. While Virginia’s current base adequacy model accounts for the mix of in-state and out-of-state students in assessing whether or not the state’s support level met the cost-sharing target, it does not have a formal method of determining an institution's ability to raise tuition and fees given the variation of income levels of in-state students. In addition, the Commonwealth should consider excluding the “frugal" base funding requirement from the cost-sharing calculation.

3. Implement an incentives and performance component of the conceptual framework that rewards institutions for making progress toward state goals. Further development and testing of metrics for the incentives component of the framework are needed. Such a component should allocate sufficient funding to steer institutional decisions, yet limit competition among them that is not productive. The incentives and how achieving them translates into dollar amounts should also be transparent and predictable. A system built on fixed dollar amounts per point, paired with a thoughtful approach to making strategic adjustments when Virginia’s institutions collectively earn more funding than the legislature appropriated for the incentive funding pool and when they collectively earn less than that amount, can address these criteria. Additionally, the Institutional Performance Standard (IPS) funding should also be reevaluated for its impact and relevance, particularly for the six education-related measures. Once a more fully developed incentive model is ready, it is not logical to maintain the IPS process separately from the more robust and integrated approach to be built.

4. Use the model to prioritize the funding components. Ensure that funding needs related to the cost estimates (fixed and variable costs) and incentives and performance are met before allocating funds to new capacity building initiatives.

5. Adopt a phased-in approach to using the new funding model. Too abrupt a change in institutional funding can be disruptive and counter-productive to the achievement of state goals. As Virginia shifts to a new funding model, it should take a deliberate approach over several years by implementing a stop/loss strategy in the transition. A stop/loss strategy means that the state will implement some limits on how much an institution’s budget can be affected during a transition to the new funding approach. Usually, such provisions include a specific schedule. For example, a stop/loss provision might specify that institutions will not be subjected to changes that exceed a percentage greater than plus or minus one percent in Year 1, plus or minus three percent in Year 2, and plus or minus five percent in Year 3. In Year 4, the new funding model would be fully implemented with no stop/loss in effect.

6. Regularly review the funding model. Ensure that the funding model is reviewed on a periodic basis—more regularly for technical issues and once every 8-10 years for adherence to policy priorities.

7. Create and regularly convene a technical funding model workgroup. Ensure that all institutions and their leaders have an in-house technical expert on how the formula works, and so that there is a sense of shared ownership for the technical aspects of the model’s implementation. A standing workgroup consisting of experts on the technical aspects of the funding model design and its implementation, one for each institution, would ensure a sense of shared ownership among the institutions over the accuracy and performance of the model. Not only would this group help SCHEV with highly technical issues (e.g., the number of years to use as an average, the assumptions that may need to be reassessed) and comprise the core team for the regular technical reviews mentioned above, its members would also be well positioned to use the model and its simulation tool in assessing the impact on funding of decisions under consideration by institutional leaders.

8. Identify strategies to mitigate tuition and fee increases that may result from state supported salary increases or other state required mandates. Due to the split funded approach to higher education costs where the state pays a portion of costs (roughly 50%, but varies by institution), state supported increases in salaries often result in an increase to tuition and fees. While investments in salaries are a shared interest of the state and the institution, strategies should be considered to mitigate the concerns related to tuition and fee growth when this occurs.

9. Create incentives that encourage institutions to collaborate for greater efficiency in administrative services and in academic delivery. Virginia’s institutions are active in seeking ways to streamline their operations, but typically do so on their own. Major savings and reinvestment opportunities are available through collaborative activity, as demonstrated by the Virginia Higher Education Procurement Consortium (VHEPC) and the statewide library consortium (VIVA). Collaborations are difficult to implement and sustain, especially in academic delivery, but a compelling financial reason can induce participation by institutions on a voluntary basis. Funding that can seed and support the development of collaborative activities will likely be an investment strategy that states throughout the country will turn to more often, especially those seeking effective responses to converging enrollment and financial pressures. Efficiency gains to be derived from such efforts must be measured based on all the participating institutions and in terms of costs avoided by students and the state, and by the enhanced services collaboration can generate, rather than being viewed simply as benefits accruing to individual institutions.

10. Monitor progress toward greater efficiency and effectiveness using metrics. SCHEV should seek to more regularly measure institutions’ individual and joint efforts to improve efficiency and effectiveness. These efforts should rely on existing data as much as possible so as to avoid adding reporting burdens to institutions. Even if these data are already reported to SCHEV, it remains valuable to gather data from IPEDS for benchmarking purposes. Metrics that are relatively straightforward to calculate include: state and tuition revenues per graduate, degrees relative to enrollment, and expenditures relative to enrollment.

11. Revise the approved group of comparison institutions. After completing a review of candidate institutions for comparison groups—NCHEMS provided an initial group of national comparative institutions and, following a request to add to the number of institutions in the groups, particularly for some of the institutions, a second group of comparison institutions. These groups are important for benchmarking Virginia institutions in terms of their finances and their student outcomes. NCHEMS selected the comparison groups based on similarities in the mission they serve expressed primarily in their program array, research activity, student characteristics, and size, as well as some other important features (whether they operate a hospital, are a Land-Grant institution or HBCU, their geographic location, etc.). Notably, none of the selection criteria included data about their funding levels or student outcomes. The same groups should be used for all benchmarking analyses in order to avoid selecting institutions on the basis of the outcome they are examining. Details about the comparison groups and the process used to select them are provided in Appendix F. Comparison Groups. While NCHEMS’ original comparison groups were named in the interim report, the expanded groups have not yet been shared with the institutions; there is a need to gather feedback from the institutions before they are finalized.

12. Develop an implementation plan to identify next steps and policy changes that need to occur to support the recommendations included in this report. As noted, there are several elements of the model that need to be adopted by stakeholders to meet the requirements outlined in the budget language for this review. Revised comparison groups for each institution to be used for benchmarking and to assess the fitness of the funding model also need to be adopted, as are metrics for assessing institutional effectiveness and efficiency. SCHEV, in partnership with stakeholders, should develop a plan to continue this work and identify policy changes in code or budget language that need to be implemented to support these elements, with a target of completion by the 2023 General Assembly session.
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(*1) Education and General (E&G) funding and expenditures refer to the core activities related to the institution’s instructional mission such as faculty salaries, institutional support, student supports, libraries and other academic support costs, etc.