One price index helps officials forecast budget needs and shows why colleges’ actual costs rise faster than inflation. The other is the Consumer Price Index.    

TO SAY THAT TRUSTEES HAVE A LOT ON THEIR PLATES these days risks serious understatement. Board practices are being scrutinized on everything from independent audits to financial transparency to whistle-blower protection and much more. And these are just the challenges that are out in the open.   

There looms another long-standing issue that is more insidious but no less of a risk:  inflation. It’s a problem with both external and internal facets.   

Externally, colleges and universities are on the defensive to explain why tuition rates continue to rise faster than inflation, as measured by the federally compiled Consumer Price Index (CPI). Internally, trustees become aware  that the problem is acute as they wrestle with  the increasing costs associated with faculty  salaries and benefits, energy, information technology, physical plant maintenance, and other  expenditures mandated by the institution’s  mission. Such costs considerably exceeded the 3 percent increase in the CPI for 2005 and every other year in recent memory.   

One tool trustees may find useful in fighting the inflation wars is the Higher Education Price Index, or HEPI. This inflation index—the only one if its kind—is designed specifically for higher education and is a more accurate and custom-tailored indicator of cost changes for colleges and universities than the CPI.   

Released each July, HEPI has been calculated every year since 1983; in fact, on its original release it included historic inflation data back to 1961. (Commonfund Institute took over the compilation of HEPI last year and plans to evaluate and refine the index over time. It has formed an advisory board of experts to advise it on management of HEPI and to determine future enhancements to its annual report, the latest of which is available free of charge at www.commonfund.org.)   

Currently, HEPI is used by some 19 percent of the 729 institutions responding to the “2006 Commonfund Benchmarks Study Educational Endowment Report,” Commonfund’s annual nationwide survey of educational endowment policies and practices. This is an increase from 14 percent the previous year. Notably, institutions with large endowments—$500 million and larger—report using HEPI at a significantly higher rate than their smaller counterparts.   

Although HEPI’s reach is growing, it has lived for too long in the shadow of the CPI.  Traditionally, CPI is the index that commands the headlines, but it’s not an accurate yardstick for measuring the consistently higher costs that colleges must bear and that drive increases in tuition. In addition to being a better indicator of the factors that contribute to college costs, HEPI is a far superior tool for such key board and administrative functions as projecting the need for budget increases. So the question is how can boards and senior administrators make more and better use of HEPI?   

What HEPI Measures. Compiled from data reported by federal agencies and higher education organizations, HEPI measures the average relative level of prices in a fixed basket of goods and services typically purchased by colleges and universities each year through current-fund educational and general expenditures, excluding research.   

The index is organized around eight categories that cover most campuses’ current operational costs. These include faculty, administrative, clerical, and service employees’ salaries and fringe benefits; miscellaneous services (such as computer programmers and auditors); supplies and materials (such as office supplies); and utilities (such as fuel and electricity).   

HEPI measures price levels from a designated reference year in which budget weights are assigned. The base year is fiscal 1983 (using a July-to-June fiscal year) and is assigned a price value of 100 for index compilation. Comparing one year’s index value with that of another year reflects relative change. Thus, an index value of 115 represents a 15 percent price increase over 1983 values. This change also can be expressed in monetary terms. The price of $100 worth of goods and services purchased in 1983, for example, could be said to have risen to $115.   

Movements of the index from one year to another usually are expressed as percentage changes by dividing a later year’s value by that of any earlier year and subtracting 1. Thus, an increase in index values from 125.6 in 1987 to   134.4 in 1988, for example, would have been a yearly increase of 134.4 ÷ 125.6 = 1.07, or +7.0 percent.  

The tool of a price index measures the effects only of a price change, as reflected by differences in the price of a fixed group of items. The procedure in calculating the index is to measure the price level of purchased items each year, comparing the aggregate amount paid with that of the base period. The amount and quality of the selected commodities that make up the market basket remain constant so that only the effects of price changes are reflected in the index.  

Under these restrictive conditions, the annual change in price-index values may be interpreted as the change in dollars required to offset the effects of inflation in buying the same kinds and amounts of goods and services purchased from one year to the next.   

Contrast With the CPI. To appreciate the value of HEPI, it’s useful to compare it with the CPI. The price of goods and services purchased by colleges and universities from 1980 to 2000 rose 154 percent, according to HEPI measurements, while inflation measured by the CPI increased 118 percent.   

Another significant difference between HEPI and CPI is how the indices treat changes in quality (the point mentioned earlier about holding quality constant). HEPI is a straight   forward measurement of costs, whereas CPI is a measure of “quality-adjusted prices.” For example, let’s say it costs $2,000 to replace an old computer that originally cost $1,500. The new computer, however, is twice as fast as the old one. HEPI would report that as a $500 increase, while CPI would report the new computer as a $500 price decrease due to the “quality adjustment.”   

Overall, in only nine of the 45 years that HEPI has been calculated has it been exceeded by the CPI. Looking back over the past ten years, the rate of price change for HEPI has averaged about 3.6 annually versus 2.4 percent for the CPI. The point is that HEPI demonstrates that costs for higher education historically run at a rate substantially higher than the CPI. For the public—or equally important, the media, regulators, and lawmakers—to believe otherwise is a perception problem that higher education officials need to correct.  

To help more colleges and universities anticipate inflation and respond to concerns about rising prices, the Commonfund Institute has modified how it publicizes HEPI data. The U.S. Bureau of Labor Statistics updates CPI statistics monthly and provides six-month and 12-month average changes for the periods January to June, July to December, and January to December. In January 2006, the Commonfund Institute began publishing monthly HEPI forecasts on its Web site during the last week of each month. This is an important step forward because many colleges and universities formulate budgets in the second calendar quarter and cannot wait until the annual HEPI report is released in July. In addition, the institute issues a final report in July so it can include official July-to-June CPI numbers as a basis for comparison.   

Just how important monthly posting can be is illustrated by the fact that one category— utilities—soared more than 27 percent in 2006 over the previous year. Supplies and materials showed a rise of more than 8 percent, and administrative salaries rose 5 percent. These were the first categories to be reported, and they provided trustees with a portent of things   to come. Once cost changes in the remaining five categories were determined and added in the overall 2006 increase in HEPI was 5 percent, compared with 3.5 percent for 2005.  Now that’s significant inflation.   

Projecting Budget Increases. Budgets for fiscal 2007 are already in place. But given such a significant increase, trustees and business officers will need to examine current budgets for possible overages and be especially watchful as they budget for the future. This addresses what is perhaps the most important application of HEPI—projecting the need for future budget increases required to preserve purchasing power. If next year’s inflation affecting current operations is expected to be 6 percent, for example, the budget must be increased by this amount if a college or university intends to purchase the same level and quality of goods and services.   

A discussion of this nature at a budget hearing requires a publicly defensible inflation forecast. Unfortunately, the basic nature of price indices in reflecting yearly percentage changes cannot be “projected” in the traditional manner. Incremental changes seldom exhibit “trends” that can be used for reliable extrapolations. A two-year or three-year average increase in an annual percentage change of 3 percent is not evidence that this phenomenon will continue into the future.   

The soundest means of estimating next year’s inflation is to slightly adjust the rate of the recent past to account for expected changes in the economy. An equivalent three- year compound interest rate establishes the recent history, and it can, of course, be fully documented. This unadjusted rate itself may be selected as the estimate, or if an inflationary economy is expected, the average can be “forecast” upward slightly (or downward if there is evidence of the opposite). Note, however, that any departure from the recent average requires supporting documentation, whereas the compound interest rate is a fact.   

In addition, in general terms a price index compiled and published regularly can serve at least three other major purposes:

1. Index values may be projected into the future to estimate the degree of change in expenditures that will be necessitated by anticipated price changes. If price increases are expected, the projected index values are used to “inflate” expected “real resource” needs to equal future funding requirements in actual dollars. Usually, these real resource needs are expressed in user-unit terms—for example, constant (inflation-adjusted) dollars per full-time-equivalent student. Budget requests based on a HEPI projection account only for inflation—that is, the  provision of additional funding sufficient to  purchase the same resources as acquired in the  previous year. Additional funding for greater course loads for students, program expansion, and quality improvements would need to be separately requested and justified.

2. Past expenditures may be compared with movements in a price index to ascertain whether spending has kept pace with changes in prices.  Adjusting expenditures by an appropriate price index to convert “actual” or “current” dollars to “constant” dollars permits officials to compare the real purchasing power of various funding levels over time. Similarly, revenues in dollar terms may be “deflated” by a price index to identify trends in the level of real purchasing power of funding by various sources.

3. Price indices may be used to provide automatic “inflation adjustments” of various administrative and contractual transactions. The price charged for a particular service, for example, may be “tied” to input prices or the “cost of labor” as measured by an appropriate price index.  

Finally, the investment committee and board may wish to use HEPI in formulating endowment spending policy and distribution rates.   

The Value of an Index. What makes an  industry-specific price index so valuable  is that by reporting only price  increases, without quality or quantity changes, it is possible for officials to document the additional revenues required to continue  “business as usual.” Few financial supporters of the college or university would deny that funding should at least maintain if not improve the status quo. Thus, price indices such as HEPI can reliably report increased funding requirements that officials can defend as essential if the institution is to maintain the same level of services.  If quality changes were included in HEPI, as they are in the CPI, then the force of the argument would be lost, because justification of the added costs to improve operations is seldom obvious.  

HEPI has been widely recognized as the only benchmark to effectively monitor changes in a college or university’s purchasing power, and many institutions have found it to be a practical tool in establishing important policies. At a time when colleges and universities are under public scrutiny to be accountable for the price of tuition and for their governance policies and practices, HEPI is a great public-information tool to help key constituencies understand the higher costs institutions must absorb in the process of fulfilling their missions.