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A Financial Surplus—and Some Surprises

11.7.14


The University completed fiscal year 2014, ended last June 30, with a modest surplus, following two years of modest deficits. According to the annual financial report, published today, Harvard closed its books $2.7 million in the black, as operating revenue increased 4.8 percent ($203 million) to $4.409 billion and operating expenses rose 3.9 percent ($167 million) to $4.406 billion. In fiscal 2013, Harvard was $33.7 million in the red. The improvement this year is in fact understated because it includes a one-time expense of nearly $46 million related to the accounting for defined-benefit pension obligations; excluding that charge, the operating surplus was about $49 million—a goodly improvement from the prior year. The report appears here.

Tuition Income and Benefits Expenses

Before examining the year as a whole, a few nuggets merit highlighting.

• Tuition and other income derived from students was up sharply, rising nearly $60 million (from $817.8 million to $877.6 million)—6.6 percent. The financial report highlights continuing and executive education, up a robust 10.6 percent. Undergraduate revenue rose 4.9 percent, and graduate and professional degree programs yielded 5.1 percent more revenue. More interesting than the latter two gross figures is the net one, with tuition and fee revenue after financial-aid awards rising robustly: up 7.3 percent in the aggregate. Scholarship awards applied against tuition and term bills increased just 3.7 percent, or $13.5 million (from $359.5 million to $372.9 million), meaning that more of nominal tuition in fact remained in the University’s accounts. Since tuition is the largest source of unrestricted funds for the Faculty of Arts and Sciences (FAS), it has been campaigning hard to raise endowment support for its expanded financial-aid program; but if financial-aid spending itself is growing more moderately, that increases the faculty’s financial flexibility even more.

There is evidence that some such shift is happening. In fiscal 2012, for example, undergraduate revenue rose about 4 percent, and, University-wide, scholarship spending increased at nearly twice that rate. Any factors that narrowed that gap would, in effect, improve Harvard’s margin from tuition receipts.

Close analysis of FAS’s undergraduate receipts—up just 1.8 percent in fiscal 2013, and then 4.9 percent in the most recent year (when the term bill increased just 3.5 percent)—may be complicated by an unusual circumstance: the 2012-2013 withdrawal from the College or disciplining of a large number of students involved in academic misconduct, and then their return to campus the next year. Dean of administration and finance Leslie A. Kirwan writes in the 2014 FAS annual report:

Revenue sources that increased over the prior year included net tuition (+7.1 percent, driven by a 3.5 percent increase in the tuition package increase for undergraduate and graduate students, increased enrollment and revised estimates of financial aid program costs)….

She subsequently observes, “Net tuition increased more than planned for the reasons described”—perhaps the intersection of the fluctuating enrollment and changing tuition margins discussed. (Publication of FAS’s detailed financial report follows release of the University report each year.)

• Employee benefits. In recent annual reports, Harvard’s senior financial officers have repeatedly emphasized rising employee-benefit costs as a subject of concern. They emphasized the theme again just before the public launch of the $6.5-billion Harvard Campaign in September 2013—and the University has introduced several cost-saving changes in health insurance, retiree health coverage, and its administration of those programs in recent years. The new annual report speaks of efforts “to evaluate the University’s benefits offerings relative to both peers and the local market.” Optimistically, at least in this regard, it talks about “difficult choices, such as recently announced changes in Harvard’s health plan offerings” that “Harvard’s community of faculty, students and staff has risen admirably to the challenge thus far….”

In fact, changes in health insurance for nonunion employees announced in early in September—including the introduction of significant coinsurance and deductibles for certain medical services beginning in 2015—came under bitter criticism, and a unanimous protest vote of disapproval, at the November 4 FAS faculty meeting. During that meeting, professors were told that University spending on healthcare and dental costs had compounded at a 6.8 percent annual rate from fiscal 2008 through fiscal 2013. (This is an aggregate figure, not a per capita figure, adjusted for growth in the workforce. It encompasses both active and retired covered Harvard faculty and staff members, and those enrolled in both the nonunion faculty-staff plans and the more generous plans negotiated by Harvard unions for their members; union members are not affected by the pending coinsurance and deductibles.) In fiscal 2013, those costs amounted to about 3.9 percent of Harvard’s operating expenses.

According to the new annual report, the broad category of employee-benefits expenses (health, dental, pensions, disability insurance, payroll taxes, and so on) decreased about 4.5 percent ($23 million) to $484 million, excluding the $46-million charge noted above. That decrease reflected both accounting factors (changes in future benefit assumptions in response to interest rates) and the real, lowered costs of retirement health costs resulting from prior changes in benefits.

For current employees, the report notes, Harvard’s health-plan expenses increased about 5 percent. In a Harvard Gazette interview on the annual report, executive vice president Katie Lapp provided something of a per-capita adjustment: “[W]hen we looked at the cost of health benefits, they actually increased 5 percent, primarily due to an increase in enrollment and health-care cost inflation.” She also noted that of the 6 percent increases in wages and salaries, “A little less than half of that went to new people….” So it appears that about half the increment in higher health-plan spending for employees represents a larger workforce (and perhaps some enrollment of people who found their spouses’ plans less generous than Harvard’s, or additional dependents), and the other half reflects higher costs.

A recalculation of the figures shared with FAS faculty members on November 4 shows a slight deceleration in University costs. The compound annual growth rate for spending on healthcare and dental costs is now 6.5 percent for fiscal 2008 through 2014.

The Year in Review

Writing the overview letter for this year’s report, a new senior financial team—Lapp (in place of departed vice president for finance and CFO Dan Shore) and University treasurer Paul J. Finnegan (who succeeded James F. Rothenberg)—note that just as the fiscal 2013 deficit “was not a cause for undue alarm, so is this year’s surplus not cause for excessive optimism.” They foresee “ongoing foundational financial pressures.”

Revenue. In addition to the $60-million increase in student income, already discussed, gifts for current use (spurred by the capital campaign) increased $80.6 million (24 percent), to $419.2 million. The endowment distribution rose a modest $40 million (2.7 percent)—in line with a spending rule that now reflects a rolling three-year average of investment returns—to $1.53 billion. (For the current fiscal year, the distribution is budgeted to increase only about 3 percent; thereafter, reflecting recent, improved endowment returns, financial deans may look forward to brighter prospects.) Separately, “decapitalizations” from the endowment, apart from the distribution for the operating budget, rose to $241 million from $157 million in the prior year; FAS and Harvard Medical School, which have the largest endowments, are the units best able to tap endowment appreciation this way (for FAS, to support House renewal and the operating budget, where it can). Both schools have been reporting operating deficits in their separate annual reports.

The miscellaneous category of “other” income increased $36 million (more than 6 percent), to $601 million; notable contributors were robust sales by Harvard Business School Publishing, and the worldwide bestseller status of Thomas Piketty’s Capital in the Twenty-First Century, published by Harvard University Press in the United States and several nations abroad.

Offsetting these gains was a worrying decline in funding for sponsored research— down $13 million (about 2 percent) to $819.2 million; this category, long the University’s second-largest source of revenue, after the endowment distribution, was eclipsed this year by tuition and related student income. Looking in greater detail, direct federal sponsored support decreased by almost $21 million (4.5 percent). That reflects the expiration of the American Recovery and Reinvestment Act stimulus spending on research, constraints on the budget of the National Institutes of Health (the University’s largest source of sponsored support), and the effects of the budget sequester. Non-federal direct sponsored funding, largely from corporate sources, rose $12 million—about 7 percent.

Welcome though those corporate funds are, they conceal another source of anxiety for budget officers. Federal research grants are accompanied by indirect funding, at rates ranging in some cases to 60 percent or more, to pay for the laboratory buildings, libraries, and Internet connections professors and their teams need to conduct their grant-funded research. The $446.3 million in direct federal sponsored funds received in fiscal 2014 was accompanied by $164.3 million in indirect support: an average rate across all grants of 37 percent. Non-federal direct grants of $177.4 million were accompanied by $31.2 million in indirect support: an average rate of 17.6 percent. From a financial-management perspective, the shift from federal to corporate sponsorship helps to sustain research per se, but poses worrisome problems of how to pay for the surrounding, expensive University infrastructure.

Expenses. As noted, salaries and wages rose 6 percent. Employee benefits, including the nonrecurring $46-million charge, rose about 5 percent. Together, the two categories made up 49 percent of Harvard expenses in fiscal 2014, and accounted for about two-thirds of the overall increase in expenses of $167 million. The catch-all “other” category rose by nearly $44 million—some of that reflecting adjustments as projects such as House renewal require accounting entries to capture the early retirement of building improvements carried on Harvard’s books over a longer anticipated lifetime. Nowhere does it say so, but certainly costs associated with the capital campaign—University and school launch events, extensive travel to alumni functions around the world, and collateral materials—affect the expense figures as well. Interest costs declined about $14 million, as the University benefited from prior restructuring of some debt obligations, and maintained overall borrowings at about $5.6 billion.

Capital spending. The University is doing its best to keep Boston-area contractors and construction workers fully occupied. Capital spending was $465 million, up about 15 percent from fiscal 2013. Notable projects include Harvard Art Museums, opening November 16; Harvard Business School’s Tata Hall—completion of which figured in boosting executive-education activity; and the continuing undergraduate House renewal.

The annual report notes, intriguingly, that Harvard “engaged in no new debt issuance over the past fiscal year, and is currently limiting the use of new debt in order to allow for future flexibility in the financing of major initiatives.” Ever-hopeful fundraisers would be loath to show their hand as they appeal for support of House renewal and the new School of Engineering and Applied Sciences complex planned for Allston—for which, in the aggregate, hundreds of millions of dollars are being sought. But it is certainly conceivable that the University will tap the capital markets to complete the financing for such huge projects.

A Campaign Document—in the Best Sense

In many senses, this annual report is a capital-campaign document—and more broadly, an early prospectus for the University’s future business model.

President Faust begins her letter in the report by observing that the close of the fiscal year “marked the anniversary of the public launch of The Harvard Campaign, which energized and engaged Harvard alumni around the world, with more than 100,000 people participating to date.” Supporters and prospective donors are among the important intended readers of the report, and Faust names, respectively, “transformative” and “extraordinary” nine-figure gifts.

Lapp and Finnegan, too, emphasize the campaign, and no wonder. Beyond that leap in current-use gifts, the report details the previously announced $1.5 billion in giving during the year. Among the pertinent items: the $419 million in gifts for current use; $513 million in endowment gifts (up an eye-popping 130 percent from the prior year); and an increase of more than one-third of a billion dollars (to $1.59 billon) in pledges for future gifts.

More broadly, they point to the campaign’s role in yielding “fundamental improvements in the University’s finances and financial prospects.” In addressing those “foundational financial pressures,” they are pointing the way toward at least an evolution in Harvard’s business model. It would be better insulated from “continued volatility in capital markets,” less reliant on federal support given the darkening prospects there, and better prepared to cope with “increasing pressure on grant aid expenditures”—given families’ economic circumstances.

That suggests continued reliance on means to boost philanthropic support, during and between capital campaigns; “meaningful growth in continuing and executive education” (including finding ways to monetize investments in online education through HarvardX, the business school's HBX, at the Extension and medical schools, and elsewhere); and further “encouraging growth in corporate-sponsored research,” of “particular importance” given the problems in the public sector.

Coincidentally, or perhaps not, the cover of the annual report (shown above) looks over Lowell House and down the Charles River, showing both Cambridge and Boston—and in particular, the site in Allston where Harvard hopes to erect an innovation and enterprise zone combining academic and commercial interests.

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