The University of Michigan remains financially healthy, despite the difficult economic conditions facing both the state and the nation. Our disciplined budget approach carefully balances the institution’s need to remain competitive against a challenging economic environment.
Our 36,000 faculty and staff are focused
on the university’s core missions and
are committed to finding innovative
ways to control costs and manage
resources more productively. Because
of this commitment,
we continue to
have the resources to make strategic investments in the facilities, programs,
and people that enable the institution
to remain one of the best public
research universities in the world.
The university, for example, continues to maintain the highest credit ratings from both Standard & Poor’s (AAA) and Moody’s Investor Services (Aaa). These ratings are important indicators of the institution’s strong financial health and outlook. U–M is one of only three public universities in the country to maintain both of these highest possible ratings.
Over the years, our commitment to moderate tuition increases as well as aggressive cost containment strategies, successful fundraising efforts, and relentless protection and enhancement of the world–class quality of the university’s research, teaching, and clinical care have combined with our long-term investment strategy to create a bright future for the university.
In summary, U–M’s total net assets (assets less liabilities) increased by $698 million in FY 2010 to $9.4 billion. This increase is primarily due to net investment income, which totalled $796 million. In the following sections, I will discuss the important contributors to the university’s overall financial health to provide context to the accompanying financial statements.
Revenue Diversification
Revenue diversification has long been an important strategy for the university to achieve financial stability in light of unpredictable economic cycles. In the 1960s, for example, almost 80 percent of the university’s general fund revenues came from state appropriations, compared to the projected 21 percent in the FY 2011 general fund budget. The current mix of revenue can be seen on the charts below, which show the FY 2010 operating revenue sources with and without the Health System and other clinical activities.
The General Fund Operating Budget Challenge
Although state appropriations have declined significantly since FY 2002, support from the state of Michigan remains an integral part of our strength. Base state appropriations have decreased $54 million, or 13 percent, from $416 million in FY 2002 to $362 million in FY 2010. In contrast, if appropriations had grown at the level of the Consumer Price Index, our state appropriations would have been $120 million higher in FY 2010. To put the state’s current support in perspective, it is useful to consider that in a stable economic environment, it would take an additional endowment of approximately $7 billion to generate a revenue stream that would equal the current level of support.
The general fund operating budget continues to balance our commitment to academic excellence and access with our ongoing cost containment efforts and the need to invest in our future, all against the backdrop of the state’s uncertain financial circumstances. The FY 2011 budget takes our commitment to students and their families to a new level during a particularly difficult period. At the same time, it demonstrates an unwavering commitment to the quality of the institution, both inside and outside the classroom. By focusing on innovative solutions and through ingenuity and hard work, we have limited tuition increases and provided more financial aid.
In adopting the budget for FY 2011, we anticipated a total state appropriation of $361 million, which reflects a 3 percent reduction from the amount we received in FY 2010 and we are planning for possible significant reductions in FY 2012 and FY 2013.
A disciplined approach to long–term cost containment is a driving force behind our ability to invest in teaching and research. The university’s deans, directors, faculty, and staff reduced and reallocated $135 million in recurring general fund expenditures from the Ann Arbor campus budget over the period FY 2003–2009. Further, we have made significant progress over the past year toward our goal of achieving an additional $100 million over the period FY 2010–2012.
The approved Ann Arbor campus budget for FY 2011 includes the lowest tuition increase in 26 years for resident undergraduates at 1.5 percent. The budget also includes moderate tuition rate increases of 3 percent for nonresident undergraduate students, and 2.8 percent for most graduate programs. Additionally, the Ann Arbor campus budget includes $126 million in centrally awarded financial aid, the largest investment in financial aid in the university’s history. Within that, centrally awarded financial aid for undergraduates is increasing by nearly 11 percent, which will help preserve access for our most financially vulnerable undergraduate students.
Over the last five years, Ann Arbor campus undergraduate tuition rates have increased on average by 5 percent while the annual increase in the budgeted amount for centrally awarded financial aid for undergraduates has averaged 10 percent.
The approved Dearborn campus budget includes a 3.9 percent increase in undergraduate tuition, a 2.9 percent increase in graduate tuition, and an 8.2 percent increase in institutional financial aid. At UM–Flint, the approved budget includes a 3.9 percent increase in undergraduate tuition, a 2.9 percent increase in graduate program tuition, and a 5.9 percent increase in institutional financial aid. At both UM–Dearborn and UM–Flint, the tuition increases for FY 2011 are the lowest in five years.
The FY 2011 budget is notable in that it was achieved during a period of unprecedented financial uncertainty. Multi–year budget planning, prudent management of resources, and our willingness to make tough decisions regarding priorities has enabled us to prepare for—and smooth out—the impact of the current tumultuous financial situation in the state and nation.
Growing Research
Research spending in FY 2010 grew 12 percent over the previous year to $1.1 billion, the second straight year the university has surpassed the billion dollar milestone. Research awards attained through the American Recovery and Reinvestment Act (ARRA) represented 5 percent of this increase, while the remaining 7 percent of the increase was attained through conventional funding sources. Thanks in part to ARRA research awards, federally funded research spending rose 15 percent over the previous fiscal year, accounting for 66 percent of total research expenditures.
One of the year’s largest ARRA grants was a $19.5 million, five–year award from the Department of Energy to establish the Center for Solar and Thermal Energy Conversion in Complex Materials. Researchers at the center will study complex materials on the nanoscale, searching for new ways to convert sunlight and heat into electricity.
The North Campus Research Complex
Moving forward, the North Campus Research Complex (NCRC), which was acquired from Pfizer in June 2009, will play a strategic role in the university’s critical expansion of its research enterprise. The NCRC has 30 buildings with nearly 2 million square feet of sophisticated laboratory facilities and administrative space situated on 174 acres. Beyond accelerating the institution’s research efforts, it positions us for a future that will feature greater scientific collaboration among faculty, staff, students, and industry partners.
During FY 2010, we activated nine buildings on the complex property. With some 300 employees now on site, the first of an expected 3,000 faculty and staff are now working at the NCRC.
All of the groups chosen for the initial move are involved in supporting university research, whether by providing services to researchers or raising money to fund research. As more researchers move to the NCRC in coming months and years, they will benefit from having these research support functions close by.
We anticipate that the NCRC investment will provide a number of long–term benefits, including jobs, spin–offs, incubator space, and public–private partnerships. Rather than move too quickly, we are focused on deliberate, strategic growth to achieve our vision of a multifaceted hub of research and innovation—one that helps transform our economy in Michigan and beyond.
This development is a once–in–a–lifetime opportunity for the institution, and we are enthusiastic about the potential of research and innovation to deliver meaningful benefits to society. Over the next several years, thousands of current and new faculty, staff, and students will pursue groundbreaking research initiatives involving disciplines across campus and industry partnerships.
Other Physical Plant Improvements
The university’s facilities serve a wide range of needs, from patient care to academics, and we are mindful of the importance of investing in our future by carefully choosing which facilities should be renovated or replaced.
To support this effort, the university has invested an average of $461 million per year, over the past decade, for renovation and replacement of buildings and related infrastructure. FY 2010 was no exception as the university completed 345 projects across campus, an investment of $617 million. Many facilities to support the university’s academic, research, patient care, and athletic functions have recently been completed or are currently under construction to meet the university’s changing needs.
North Quad Residential and Academic Complex, one of the largest construction projects in university history, and the university’s first new residence hall on the Ann Arbor campus in 40 years, will be home to 450 upper-level students in fall 2010. The new structure will serve as a hub for learning and collaboration and will also be home to the School of Information, and four academic units of LSA—Screen Arts and Cultures, Communication Studies, the Language Resource Center, and the Gayle Morris Sweetland Center for Writing.
The facility features 19 state–of–the–art classrooms and three labs, television/video production studios, faculty offices, a dining center, and abundant common areas shared and utilized by all of the building occupants. The Media Gateway provides individual and collaborative study alcoves and rooms equipped with display screens and workstations where students can connect with each other and the world. North Quad is a cornerstone of the university’s Residential Life Initiative, a multi–year plan to revitalize and expand student residential halls and dining facilities.
Work is also continuing on another of the largest construction projects ever undertaken by the university—the replacement for the C.S. Mott Children’s Hospital and the Women’s Hospital, the latter of which will be known as the Von Voigtlander Women’s Hospital. The new facility, which is slated to open in FY 2012, will total 1.1 million square feet and include nearly 350 beds. It is designed to bridge inpatient and outpatient services within the same medical disciplines to create a seamless approach to patient care.
The Athletic Department, through sound financial management and additional revenue sources such as those from the Big Ten Network and donor contributions, continues to make significant investments in its facilities. The renovation of Michigan Stadium, home to the football team since 1927, was completed in FY 2010, in time for the start of the 2010–11 football season. Additionally, the Al Glick Field House, a new indoor practice field for the football program, and the Bahna Wrestling Center, a new 18,000–square–foot facility, were completed in FY 2010.
Controlling Health Care Costs
Organizations across the country continue to be challenged by escalating costs of employee and retiree benefits. This is an ever–present challenge, with total university health care spending for employees and retirees reaching almost $297 million in FY 2010.
In previous years, the university drew upon the combined expertise of top clinical and health policy faculty and financial experts to design a new health benefits premium structure that increased the overall contribution toward health care coverage made by employees, dependents, and retirees. Half of the changes became effective in January 2010, and the remainder will take effect in January 2011. These changes will provide a reduction in university health care expenses of more than $31 million annually. A system of salary bands for active employees helps determine the contribution amount to lessen the impact on lower paid employees.
During FY 2010, we again called upon some of the university’s national health care and health policy experts to form the Committee on Retiree Health Benefits to help us address the acceleration of benefits costs projected for current and future retirees and their dependents. The committee’s work, now underway, will result in a long–term plan to keep the university’s retiree benefits competitive with peer institutions while producing significant short– and long–term annual savings.
The university has also completed its first dependent benefits eligibility audit. About 20,000 U–M employees cover at least one dependent in university–sponsored health plans, and they were required to document the current eligibility of their dependent(s) in order to continue coverage. More than 400 ineligible or unsubstantiated dependents were removed from coverage during the audit process, which will provide an expected savings for the university of about $650,000 in the first year and a recurring savings in subsequent years.
Prevention, early intervention, and wellness also help to reduce the pressures on the health care system and promote overall control of costs. The university’s health and well–being program, known as MHealthy, addresses these important factors. MHealthy offers a spectrum of programs designed to support healthy lifestyles, and uses health data to ensure that those programs are targeted to the greatest needs of faculty and staff.
MHealthy completed the second university–wide health risk assessment in FY 2010. This assessment provided measures of our community’s health as compared to the first assessment completed in the previous year. The data gives the university a rich opportunity to understand our greatest community health risks in ways never before possible, and to use the data to design targeted programs and interventions that invest in health improvement and thereby reduce the costs incurred by the university’s health plans.
The Endowment
Our long–term diversified investment strategy is designed to maximize total return, while our spending rule policy is designed to protect and grow the endowment corpus in real terms and provide dependable support for operations.
The Long Term Portfolio’s 12 percent return in FY 2010 follows a –23 percent return in FY 2009 and a 6 percent return in FY 2008. The Long Term Portfolio’s annualized five–year return of 6 percent was 1.7 percentage points above the custom market benchmark designed to capture the university’s long–term diversified investment strategy and 5 percentage points over the undiversified benchmark consisting of major equity and fixed income indices in an 80/20 ratio. The return of the S&P 500 stock index was –0.79 percent over the same five year period.
The table above shows the endowment’s favorable investment performance relative to its benchmarks. Utilizing a diversified investment strategy has limited the loss of capital in the more challenging years.
The university’s endowment spending rule smoothes the impact of volatile capital markets by providing for annual distributions based on a percent of the moving average fair value of the endowment. The spending rule, along with the growth of the endowment, allowed for distributions to support operations of $255 million in FY 2010, for a total of $1.1 billion over the past five years.
The payout from our more than 7,100 separate endowment funds enables us to serve a diverse population, ranging from patients in our Health System to students. For example, approximately $1.5 billion, or 24 percent, of our $6.4 billion endowment is restricted for use by our Health System, where nearly 1.9 million patient visits take place each year. The portion of the endowment available for U–M operations supports the education of more than 58,000 students. About 20 percent of our total endowment, or $1.3 billion, has been set aside for student aid, with 70 percent of our undergraduate students who are Michigan residents receiving some form of financial aid, which includes grants, work–study, and loans. Endowment income also provides key support to the university’s research efforts, which have made countless contributions to our global society in areas ranging from medicine and law to the arts and sciences. The average effective annual spending rate from our endowment over the last 10 years, including spending rule payouts and withdrawals from funds functioning as endowment, primarily for strategic capital investment, was 5.8 percent.
The Health System
The Health System, which integrates the Hospitals and Health Centers, the Medical School, the clinical operations of the School of Nursing, and the Michigan Health Corporation under the direction of the university’s executive vice president for medical affairs, had a stellar year financially despite the economic times, and continues to receive national recognition for its academic and clinical excellence. We take great pride in the fact that the Hospitals and Health Centers have experienced 14 years of positive financial margins, while also improving the quality and safety of the care we deliver to patients.
In FY 2010, the University of Michigan Hospitals and Health Centers (UMHHC) beat its own budget predictions by achieving an operating margin of 3.3 percent ($61 million) on revenues of $2 billion—surpassing the original target of 1.7 percent.
This year’s success can be attributed to a combination of more patients, more efficiency, more teamwork, and more attention to every factor that affects the bottom line. More specifically, UMHHC saw 5 percent more patient activity, in terms of adjusted cases, and productivity improvements of 4 percent in FY 2010 when compared to the previous year. UMHHC, however, must perform even better in the new fiscal year in order to prepare for a future of health care reform.
Strong financial performance now will help the Health System prepare for the opening of the new C.S. Mott Children’s and Von Voigtlander Women’s Hospitals, scheduled for FY 2012, and major investments in clinical information systems and other clinical infrastructure.
The continuing struggles of the Michigan economy, which in turn have led to double–digit increases in the amount of charity care and uncompensated care that the Health System provides, also pose a significant challenge. UMHHC experienced a 17 percent rise in uncompensated care in just the past year, with increases in both the number of patients who qualify for charity care, and those who cannot pay bills for care they’ve already received. At the same time, a higher percentage of health system patients are covered by Medicare, Medicaid, and county health plans, which do not reimburse at the same rates as private insurers. In FY 2010, UMHHC was reimbursed $350 million less by these plans than it would have been if the same patients had been covered by private insurance.
Commitment to Sustainability
We take our responsibility to protect and preserve resources very seriously. In our educational programs, our goal is to inspire students to acquire the knowledge and insight that will empower them to address the many complexities of sustainability in their chosen careers. In our research programs, we are drawing on our multidisciplinary strengths to attack major sustainability problems at local–to–global scales. And in our operations, we aim to set the standard for excellence in achieving a green campus.
For the past several years, teams of Planet Blue energy and environmental specialists have been deployed throughout campus to improve energy efficiency within facilities while engaging building occupants to "think and act green." So far, in the first 35 buildings, energy utilization has been reduced by 11 percent for an annual savings of over $3 million.
In FY 2010, the university created a new Office of Campus Sustainability as well as a new position—Special Counsel to the President for Sustainability. The special counsel reports directly to President Coleman and is charged with coordinating existing efforts by students, faculty, and staff across the entire campus in education, research, and operations for maximum impact, and inspiring new initiatives.
U–M adopted LEED Silver certification as its standard for major new construction projects in FY 2010. LEED, which stands for Leadership in Energy and Environmental Design, is a standard created by the U.S. Green Building Council. This new policy builds upon an existing commitment to exceed by 30 percent a widely recognized energy efficiency standard, giving U–M one of the most rigorous construction standards among higher education institutions in the nation.
Financial Controls
FY 2010 was the sixth year that each unit on campus was required to complete an annual internal control review and certification of internal controls and financial information. More than 40 senior executives from both academic and administrative units completed this process, which leverages best practices from the Sarbanes–Oxley Act and focuses on areas such as financial stewardship, information technology security, conflict of interest, and identity theft prevention.
A variety of tools and guidance are provided to units on key risk areas such as employment, purchasing cards, cash handling, journal entries, and gift card usage. Future plans call for adding new areas for certification, including employee travel and expenses, human subject incentive payments, and donor stewardship.
Conclusion
It is, once again, satisfying to receive an unqualified opinion from the university’s independent financial auditors (PDF). This opinion signifies that the financial statements present fairly the financial position of the university. The Management Responsibility for Financial Statements (PDF) is my certification of management’s responsibility for the preparation, integrity, and fair presentation of the university’s financial statements.
Please read Management’s Discussion and Analysis (PDF). It describes how the university’s financial strength, prudent financial policy, and the institution–wide commitment to sustaining the highest level of excellence come together to ensure the university’s mission is fulfilled in the years ahead.
Timothy P. Slottow
Executive Vice President
and Chief Financial Officer