Income share agreements: A solution to medical school debt?

Education income share agreements (ISAs) have grown in both popularity and applicability in recent years as a means for students to finance their college or trade-school education, whilst avoiding ever-growing student loans in the face of uncertain job prospects.

This form of ISA consists of a student agreeing to pay a set percentage of their future income to an investor for a fixed term in exchange for the investor financing the student’s education. This application of income share agreements is derived from the writings of economist Milton Friedman, who in 1955 proposed that investors should have the opportunity to buy a share in an individual's earning prospects. The investor would advance the student the funds needed to finance the training on condition that the student agrees to pay the lender a specified fraction of the future earnings.[1] He proposed these agreements as a solution for what he believed to be risky, fixed-rate education loans, which currently have a default rate of over 10 percent.[2] He believed that for private education loans to become a viable investment, “nominal interest rate charged on all loans would have to be sufficiently high to compensate for the capital losses on the defaulted loans.”[1]

This is exactly why private education loans today have interest rates, which are, on average, much higher than those offered by the federal government.

In contrast to fixed-rate education loans, ISAs reward investors by allowing them to share in the profits of a student’s future earnings, rather than creating a strict limit on return-on-investment (ROI), determined by a fixed interest rate. This model also creates value for students in many ways.

The Medical Education ISA

One area for which the application of income share agreements has yet to be explored is in medical education. To recognize how ISAs may be employed in this setting, the medical education timeline must first be understood.

Most commonly, students graduate from university with a bachelor’s degree and then matriculate into medical school, generally within two years. They subsequently spend four years in medical school, during which time they choose which specialty they intend to pursue. Each specialty then has a different length of required post-graduate training (residency), typically ranging from three to eight years. Upon completing their post-graduate training, they are finally able to practice medicine independently and make a salary that is realistically compatible with repaying fixed-rate loans.

In 2018, U.S. medical students graduated with a median education debt burden of $200,000.[3] With a fixed-rate federal student loan, the average newly minted MD will have loan payments of over $2,200 per month. As the average first-year resident salary in 2019 is $55,200, many are unable to make the standard monthly loan payment, and thus have to request a payment deferral until after they have completed their post-graduate training, or have to participate in an income-based repayment plan, allowing interest to accrue all the while.[4]

In contrast to this traditional loan model, medical education ISAs are a novel approach which grants physicians many otherwise financially untenable opportunities, while maintaining investors’ ROI.

The proposed framework for a medical education ISA is essentially identical to that of college and trade-school ISAs, in that a student would agree to pay a set percentage of their future earnings, for a fixed term, to an investor in exchange for that investor financing their education. However, while the structures are identical, there are many factors which differentiate medical education ISAs from others.

First, medical students have an attrition rate of 4 percent and a loan default rate of 2 percent, compared to 19 percent and 11 percent for four-year college students, respectively.[2,5,6,7] Second, there is a projected shortage of between roughly 50,000 and 120,000 physicians by 2032, and thus, medical graduates are sure to remain among the most employable professionals in any field.[8] Third, physicians have incomes which far exceed the projected incomes of those graduating college and not pursuing additional higher education.

In sum, these factors make income share agreements with medical students a radically different and safer prospect from the investor perspective when compared to those for undergraduate studies and even other graduate programs.

The Model

To effectively model income share agreements for medical education, it is imperative to account for the significant variation in income and required length of post-graduate training across medical specialties. For instance, pediatricians (three-year residency) have among the lowest average salaries ($225,000) for physicians, while orthopedic surgeons (five-year residency) have among the highest average salaries ($482,000).[9] Thus, the percentage of income required to be “shared” with investors will vary significantly.

Modeled below are income share agreements for six of the most common medical specialties chosen by graduating U.S. medical students. We have used $200,000 as the medical school debt burden for each, and have used the sum total paid on a fixed-rate loan to guide the percentage of income shared in each ISA.

Table 1: Fixed-rate loan of $200,000, 10-year term at 6% interest, compounded daily, repayment beginning post-residency

Table 2: Income share agreement for $200,000 education, 10-year term

For physicians pursuing fellowship training, adjustments can be made based upon the length of post-graduate training and expected annual income.

Furthermore, as with college and trade-school ISAs, there must be defined wage boundaries outside of which a physician’s income is not shared with the investor that financed their education. A reasonable lower bound for any specialty could be set at or near $100,000, as this figure precludes physicians from having to share their income during post-graduate training, as well as if they were to find themselves unemployed for one reason or another.

As for the upper bound for wage sharing, this figure will be much more specialty-specific, but could reasonably be set at or around 150 percent of the average annual income for each specialist.

Advantages for Physicians

If a physician attends medical school, completes their post-graduate training, and then secures a job earning the average salary for their specialty-all consecutively-there is admittedly no cost savings compared to the traditional fixed-rate loan. However, the ISA provides many advantages beyond potential cost-savings that are not detailed in the above table.

1. Psychological relief

There is a real psychological burden that accompanies having large education loans. An ISA has the potential to provide some relief from this burden, compared to the fixed-rate loan model.

Because there is such a wide range of salaries between medical specialties, students undoubtedly feel, whether consciously or subconsciously, a draw toward higher-paying specialties because of their need to pay back six-figure loans. In fact, only 8 percent of residents said potential earnings did not influence their specialty choice, while 41 percent said they were “extremely or very influential” in making their specialty choice.[4]

In contrast, if a student knows ahead of time that regardless of specialty, she is going to share a percentage of her income for a fixed term, this could free her to make her specialty choice based on other important factors, such as personality fit, social impact, etc. Moreover, this is especially relevant for students who attend costly private medical schools where the cost-of-attendance can exceed $100,000 per year. With a debt burden of that magnitude, it can even more so seem cost-prohibitive to pursue a specialty with lower projected earnings.

2. Intellectual exploration

Many medical students during their studies encounter a research topic that interests them greatly. Because of this, some choose to take a leave from medical school in order to conduct research on that topic for a year or two. With the fixed-rate loan model, this is a very costly endeavor, as interest on their loans continues to grow during the year(s) taken off from medical school. In contrast, with the ISA percentage based primarily on the cost of a physician’s medical education and their length of post-graduate training, students can be free to pursue research opportunities without having to weigh the cost of mounting interest. Limits to time off from education will certainly be imposed by investors, but cannot be so stringent as to stifle intellectual exploration.

3. Academic medicine

When physicians complete their post-graduate training, they choose between two primary options for practicing medicine: remain in academia or move to a non-academic practice (physician- or hospital system-owned). One major factor in making this decision is the large difference in salary between academic and non-academic medicine, which oftentimes exceeds $100,000. As such, there is a common refrain said by resident-physicians as they near the end of their training: “I’m going to go private for a few years, pay off my loans, make some money, and then come back to academics.” Many are never seen in academia again (23 percent of residents report preferring to work in an academic setting, while just 14 percent of physicians currently work in academia).[10] While not attributing the comparatively small number of physicians in academia entirely to the salary divide, it certainly plays a role. With a medical education ISA, the influence of the salary gap may lessen. In an ISA, the percentage of income sharing is based on the average salary for each specialty, and those who make less than average are not penalized for their lesser earnings. As such, physicians who would otherwise feel inclined toward academic medicine if not for needing to pay their loans could choose to work in academia for the below-average salary, without concern for having to pay back large loans with less income.

4. Social impact

Many physicians early in their careers wish to work in settings where they feel they are providing a significant good for society. These include medical services for underserved populations (homeless, urban poor, Native Americans, etc.), as well as overseas aid organizations like Doctors Without Borders. Similar to the issue with academic medicine, such noble pursuits do not pay even close to the average salary for their specialty and are thus fiscally irresponsible and unwise to pursue with a large debt burden. However, with an ISA, if a physician wants to work in a setting that pays less than average, they are only bound to the set income sharing percentage, not a debt principal. What’s more, if a physician works for an organization where she earns less than $100,000 per year, she is not required to pay into the ISA that given year and can simply continue her term of income sharing once she takes a job that provides a salary above the lower income bound.

5. Unforeseen life events

Just as with college and trade-school ISAs, a medical education ISA can provide insurance for unforeseen life events that require a physician to take time off from practicing medicine, and thus from earning income.

6. Wealth building

When physicians finish their post-graduate training, the fiscally sound choice is most often to pay off medical school loans before beginning to build wealth. With an ISA, physicians would not find themselves net-negative upon completing their training and instead could immediately begin building wealth by investing in a home, stocks, etc.

Disadvantages for Physicians

In addition to the many advantages of medical education ISAs, there are some potential disadvantages and concerns worth addressing.

1. Loan forgiveness offers

Multiple loan forgiveness programs exist, through both government and private entities, which allow a physician to have some or all of their loans forgiven upon practicing medicine a set number of years in a particular setting. By pursuing an ISA, a medical student could potentially be forfeiting that future option, depending on the terms of the ISA.

2. Overpaying

If a physician completes their education and training consecutively without breaks, and then secures a job that pays more than the average salary for their specialty, they will be paying more for their education than they would have with a fixed-rate loan. This is a possibility a medical student must weigh before entering into an ISA.

3. Investor interference

It is certainly in an investor’s financial interest for a physician to take the most expeditious route through their training and then to take the highest-paying job possible, in order to increase their ROI. Thus, there is potential for investors to dissuade physicians from pursuing academic medicine, research, and lower-paying, humanitarian-focused jobs. As such, there must be regulatory measures put in place regarding investor and medical student/physician interactions in order to minimize any such influence. However, it is worth noting that as it pertains to taking time off in medical school to do research or during clinical practice to do volunteer work, physician salaries are currently rising at a rate such that delaying payment into an ISA will not as significantly impact an investor’s ROI compared to other education ISAs.[11]

4. Other concerns

There are additional, commonly stated concerns regarding college and trade-school ISAs, only two of which would pertain to medical education ISAs. First is the concern is that ISAs are essentially a form of indentured servitude. However, with the proper regulations in place regarding interactions between investors and physicians, it is clear that physicians would be indentured more so to their intellectual and social ideals than to any investor. Second is the fear that ISA investors would only fund elite institutions where the potential earnings are the highest. However, there is a unique democratization in medicine, in that a physician’s future earnings are not as significantly influenced by the institution they trained at compared to colleges and trade-schools. As such, the reverse concern may actually be the case in medicine, in that investors may preferentially choose to offer ISAs at less expensive medical schools rather than at the elite schools because the investment into each ISA would be lower and thus less risky.

Lastly, we have thus far used the generic descriptor ‘investor’ when detailing the framework of a medical education income share agreement. In reality, there are multiple types of investors-not just for-profit groups-that may benefit from offering this novel kind of ISA.[12] For instance, a nonprofit fund looking to invest in certain populations, such as women and under-represented minorities, could offer ISAs to these specific medical students. By receiving a percentage of these future physicians’ salaries in the subsequent years, these funds could create a sustainable model for investing in the success of these particular groups of physicians. Additionally, many medical schools have associated foundations that seek to further the interests of their specific institutions. Such a foundation could directly invest in students at their own institution and thus also provide a sustainable model for investing in the success of their students. This could potentially be doubly beneficial for these foundations, because if a medical student were to take advantage of the ISA and do a year of research or choose to pursue a career in academics, there is a considerable chance that those endeavors would be undertaken at that same institution, and thus align with the mission of the foundation.

Conclusion

Education income share agreements, while still in their infancy, have been implemented successfully at multiple institutions across the country. However, they have yet to be applied to medical education. There are many factors that make ISAs an attractive opportunity for potential investors, just as there are many advantages for physicians, compared to traditional fixed-rate loans. As such, we believe medical education income share agreements are an economically viable option for financing medical education and could be offered by both private and special-interest investment groups as an alternative to federal student loans.

Jordan Hughes is a fourth-year medical student at the University of Texas Southwestern Medical School. His professional interests include quality improvement, medical economics, and global health. He is pursuing a career in emergency medicine.

References

1. Friedman M. The Role of Government in Education. New Brunswick, NJ: Rutgers University Press; 1955.

2. Official Cohort Default Rates for Schools. U.S. Department of Education. https://www2.ed.gov/offices/OSFAP/defaultmanagement/cdr.html. Updated October 17, 2018. Accessed July 31, 2019.

3. Medical Student Education: Debt, Costs and Loan Repayment Fact Card 2018. Association of American Medical Colleges. https://store.aamc.org/medical-student-education-debt-costs-and-loan-repayment-fact-card-2018-pdf.html. Published October 2018. Accessed August 22, 2019.

4. Martin K. Medscape Residents Salary & Debt Report 2019. Medscape. https://www.medscape.com/slideshow/2019-residents-salary-debt-report-6011735#1. Published July 19, 2019. Accessed August 22, 2019.

5. Johnson D. Rational Lending: Demystifying Medical Student Loan Debt. Becker’s Hospital Review. https://www.beckershospitalreview.com/hospital-physician-relationships/rational-lending-demystifying-medical-student-loan-debt.html. Published December 7, 2019. Accessed August 22, 2019.

6. Graduation Rates and Attrition Rates of U.S. Medical Students. Association of American Medical Colleges. https://www.aamc.org/download/492842/data/graduationratesandattritionratesofu.s.medicalstudents.pdf. Published October 2018. Accessed August 22, 2019.

7. Undergraduate Retention and Graduation Rates. National Center for Education Statistics. https://nces.ed.gov/programs/coe/indicator_ctr.asp. Updated May 2019. Accessed August 22, 2019.

8. 2019 Update: The Complexities of Physician Supply and Demand: Projections from 2017 to 2032. Association of American Medical Colleges. https://aamc-black.global.ssl.fastly.net/production/media/filer_public/31/13/3113ee5c-a038-4c16-89af-294a69826650/2019_update_-_the_complexities_of_physician_supply_and_demand_-_projections_from_2017-2032.pdf. Published April 2019. Accessed July 31, 2019.

9. Kane L. Medscape Physician Compensation Report 2019. Medscape. https://www.medscape.com/slideshow/2019-compensation-overview-6011286. Published April 10, 2019. Accessed July 31, 2019.

10. 2019 Physician Practice Preference & Relocation Survey. The Medicus Firm. https://www.themedicusfirm.com/pdf/TMF_2019_Physician_Practice_Survey.pdf. Published 2019. Accessed August 26, 2019.

11. Shryock T. Physician Compensation on the Rise. Medical Economics. https://www.medicaleconomics.com/news/physician-compensation-rise. Published June 4, 2019. Accessed July 31, 2019.

12. Palacios M, DeSorrento T, Kelly AP. Investing in Value, Sharing Risk: Financing Higher Education Through Income Share Agreements. American Enterprise Institute. http://www.aei.org/wp-content/uploads/2014/02/-investing-in-value-sharing-in-risk-financing-higher-education-through-inome-share-agreements_083548906610.pdf. Published February 2014. Accessed July 31, 2019.