What Congress Wants to Know About Endowment Principal and Returns

In early February, a joint letter from the Senate Committee on Finance, the House Committee on Ways and Means and the Oversight Subcommittee of the House Committee on Ways and Means was sent to 56 academic institutions. The letter asks a total of 13 questions dealing with such subjects as endowment management, endowment spending and use of funds, donations, and conflicts of interest. I have obtained a copy of the letter. In this post I will discuss question No. 7 and No. 8 dealing with endowment spending and use. In a previous post, I discussed the question No. 6 on this subject.

Question No. 7 is: Does your college or university have policies regarding spending the endowment principal? Has your college or university ever spent endowment principal? If so, under what circumstances?

This is a complex question. If your institution has a spending policy, then by default, it also has a policy regarding spending principal, although it may not be stated separately as such.

The Uniform Prudent Management of Institutional Funds Act speaks very clearly to endowment principal. It indicates that when the institution considers the purposes and duration of the endowment, the institution will give priority to the donor’s general intent that the fund be maintained permanently. Although the act does not require that a specific amount be set aside as “principal,” the act assumes that the institution will preserve “principal” (i.e., to maintain the purchasing power of the amounts contributed to the fund) while spending “income” (i.e., making a distribution each year that represents a reasonable spending rate, given investment performance and general economic conditions). Thus, an institution should monitor principal in an accounting sense, identifying the original value of the fund (the original donation(s)) and the increases in value necessary to maintain the purchasing power of the fund.

I believe that an appropriate answer to the first part of this question is a paraphrase of the above, together with reference to the spending policy as described in the previous post and your answer to Question No. 6.

The answer to the second part of the questionwhether your institution has ever spent endowment principal is a simple matter of fact. If the answer is “yes,” then an explanation is required. An appropriate answer is that the institution did allow spending to dip temporarily into endowment principal when the board (after careful consideration) felt that the current needs of the institution could not sustain a dramatic decrease in endowment spending and the invasion of endowment principal would be recovered through market gains in future years. The board monitored this situation closely and was prepared to reduce spending (even to zero) if it felt that the recovery of endowment principal was unlikely without a spending reduction.

Question No. 8 asks: How much and what percentage of the endowment's beginning balance has your college or university spent each year? How much and what percentage of the endowment’s return on investment has your college or university spent each year?

This question is very similar to the information requested in Question No. 6. In addition to asking your institution’s spending policy, it also specifically asks the dollar amount that the spending policy called for. If your spending policy contains a requirement for a three-year average of the endowment balance, that should be explained again here. That fact that you explained it in a previous answer may be irrelevant since Congress may have staffers analyze and summarize individual questions from multiple respondents. Therefore, you should not assume that one individual is reading all of your responses.

This question asks for a series of years without specifying the number of years. I believe that a five-year summary is sufficient. The IRS Form 990 requests multi-year information for only a 5-year period and that should be sufficient here also. The 5-year tabular response to this question might look as follows:

 

 

Year Ended

 

Beginning of Year Endowment Balance

Endowment Appropriation per Spending Policy *

Endowment Spending as a % of Beginning Balance

June 30, 20x5

 

 

 

June 30, 20x4

 

 

 

June 30, 20x3

 

 

 

June 30, 20x2

 

 

 

June 30, 20x1

 

 

 

* The institution’s spending policy is applied against an average market value of the endowment fund measured over a three-year period.

In this schedule, the fourth column is the information that is responsive to the first part of Question No. 8. This will likely be different from your appropriation amount if your institution follows a spending policy applied to an average endowment market value computed over time. Depending on the severity of the investment market fluctuations over the time period presented and the growth of the endowment due to new contributions, these percentages may be close to your spending policy amount.

The second part of Question No. 8—how spending compares to endowment return—is inappropriate. The long-term nature of endowment funds and the Prudent Management of Institutional Funds Act separate endowment return from spending except as these two amounts enter into the seven factors used in establishing a spending policy discussed in the previous post. However, one must answer this question.

Again, a period of five years appears appropriate for your response. A tabular response might appear as follows:

 

 

Year Ended

 

 

 

Endowment Return

Endowment Spending per Spending Policy

Endowment Spending as a % of Endowment Return

June 30, 20x5

 

 

 

June 30, 20x4

 

 

 

June 30, 20x3

 

 

 

June 30, 20x2

 

 

 

June 30, 20x1

 

 

 

 

Columns two and three contain actual dollar amounts. The percentage calculated in column four will likely vary considerably from year to year. Although I indicated above that asking this question was inappropriate, it is still recommended that you make an effort to educate and explain your results to the reader. The nature of your explanation will, of course, depend on your results. I cannot offer suggestions without see the result we are trying to explain.

The key to responding to all questions, but especially No. 7 and No. 8 is to remain positive (not defensive) and provide rational reasons why your policy is sound given the long-term nature of an endowment fund and your institution.