An Examination of Indirect Costs at Yale

Yale Science Policy Committee
October, 1996

The Science Policy Committee, commissioned by the Provost to examine issues and recommend policies regarding scientific research and education, concludes that:

Yale does not fully recover the indirect costs associated with sponsored research.

The amount of underrecovery has increased in recent years, and this trend is expected to continue.

The underrecovery has three major origins:

Recovery of the full cost of supporting research is not allowed under current federal guidelines (A-21).

In addition, the negotiation process with the Federal Government further reduces the recovery.

The negotiated rate is not paid by most non-federally sponsored research and some federally sponsored research.

The University must develop rational policies to control research costs and the underrecovery of indirect costs without endangering the research enterprise.

The Committee welcomes ideas from the faculty concerning policies that might be formulated to address the above issues.

Introduction

Indirect costs are once again the focus of much interest and controversy as competition for grants becomes more intense and as university budgets come under increasing pressure. During this past year, the Science Policy Committee (see Appendix I) has studied indirect cost recovery at Yale, resulting in this document. We hope to clarify for the Faculty the nature of indirect costs and the need for university policies in this area. Note that indirect costs have recently been renamed Facilities and Administrative Costs by the Federal Government. Although the new term is a better description, we shall continue to use the familiar term in this document.

Trends in Indirect Cost Under-recovery
We began our study with an analysis of the cost of supporting the scientific research infrastructure, (as calculated using federal guidelines) compared with indirect costs recovered. As is evident from the following graph, the University has been contributing to the cost of supporting research, and the trend since 1988 has been toward ever larger contributions. If extended to the future, the consequences of this trend are dramatic and possibly devastating.

[Note: Graph is currently unavailable on the web site]

The solid line indicates past experience and a probable course of future underrecovery, based on current trends. The upper envelope assumes 1% lower grant growth and a 1% lower indirect cost rate. The lower envelope is for a 4% higher indirect cost rate and 1% higher grant growth.

The graph shows the difference between the allowable indirect costs under A-21 and the actual recovery. Data are extrapolated into the future including a band of probabilities representing the uncertainties as we estimate them. The analysis includes the cost of planned or anticipated facilities improvements in the University and assumes no major change in current A-21 policy, such as a cap on total indirect costs.

The Committee, having examined the situation at some length, finds that the allowable costs actually underrepresent the full cost to the University of doing sponsored research. Our analysis shows a need to develop policies to avoid a severe financial shortfall in the future. In the following, we present a discussion of the information for the faculty, and we solicit ideas concerning policies that might be used to stabilize the Universitys finances in this area. The sciences, as with other scholarly areas of the university, receive a share of the Universitys support for research, so the objective we seek is not to reduce the Universitys contribution to zero, but to find a way to control both the growth of indirect costs, and of the Universitys contribution.

Historical Perspective:
Following the second world war, as federal sponsorship of research grew rapidly, it became evident that research universities were incurring significant costs through investments in the physical plant and administrative support systems required to carry out the research being funded. The funding agencies first responded by establishing fixed allowances for these costs, but shortcomings in this policy became apparent, and in 1965 a new policy was established calling for the negotiation of reimbursement rates that are specific to each institution. The basic idea underlying this policy was that institutions would fully recover costs connected with federally sponsored research. Since that time, there has been a steady erosion of consensus on the concept of paying full costs, despite the recommendations of senior advisory committees in several recent administrations. This is not surprising, since the subject is poorly understood, and engenders deep suspicion both within the academic community and in congress, and many feel the expenditures of these monies are not warranted. It is clear to this committee that the trends require a detailed consideration of the subject by the scientific community within the University and nationally.

1. What are indirect costs?
It is essential to distinguish between two types of issues that are often confused, namely 1. What are indirect costs and how large are they? 2. Who should be responsible for paying for these costs? We shall begin with the first question. Indirect costs are the additional expenses incurred by the university due to the sponsored research activity of its faculty, for example, the utilities, waste disposal, maintenance and depreciation costs of running a laboratory. In order to measure these costs, colleges and universities follow a process established under government rules (Circular A-21) for recovery of these monies.

Full costs of research:
Before describing the A-21 process, we note that there are many types of costs associated with research that are not included in the A-21 calculation for organized research. Among the most important are a portion of salaries of faculty engaged in departmental research, certain graduate student stipends and fellowships, and a sizable fraction of the library budget that is assignable to research (see appendix III). These costs are routinely borne by the University, in much the same way as it bears the cost of research that is not externally sponsored, e.g., in the humanities. The above items contribute to what we call the "full" costs of research.

How does the A-21 calculation work?
The A-21 calculation is described in more detail in Appendix II. It is based on the following simple formula:

_{INDIRECT COSTS INCURRED}

_________________________________ = INDIRECT COST RATE ALLOWABLE UNDER A-21
MODIFIED TOTAL DIRECT COSTS (MTDC)

The numerator consists of three main cost components:

• administrative: university-wide; school-based; department-based.
• facilities: operation and maintenance of buildings; depreciation.
• library.

Each of these components contributes to the numerator an amount based on the total actual cost that is assignable to sponsored research (see Appendix II).

The denominator (MTDC) consists of all direct costs of organized research modified by excluding categories such as permanent equipment, subcontracts greater than $25,000, and tuition.

In 1993-94, for example, the components of the on-campus rate in Yales calculation were:

• administrative 24%
• facilities 39%
• library 4%
• Total allowable rate under A-21 67%

Negotiated costs (the federal rate):
In discussions between the University and the federal government, a negotiated rate that is usually lower than the above "allowable" rate is set. From 1992-93 to 1994-95 the negotiated rate was 64% and in 1995-96 it rose to 65%, pending renewed negotiations.

An important consequence of the above method of calculation is that each sponsored project is assessed an average cost based on organized research expenditures incurred throughout the university. It is thus necessarily true that some projects will incur higher indirect costs than this average and some projects will incur lower ones.

What are the numbers for Yale?
In 1993-94, for example, Yales modified total direct costs were $125 million. The relevant indirect cost figures were:

Total $

• full costs of research* -- $100M
• allowable indirect costs under A-21** -- $76M
• negotiated indirect costs -- $74M
• actual indirect cost recovery -- $60M
• unrecovered allowable costs (adjusted to 96/97 dollars in figure above) -- $16M

*allowable indirect costs plus costs in appendix III.
**includes on- and off-campus research at different rates.

The problem of grants with low indirect cost recovery:
Apart from the discrepancy between the "full" costs, the "allowable" cost rate and the "negotiated" rate, a sizable fraction of grants fail to recover at the lowest of these, the negotiated rate. This is even true for some federal grants and it is prevalent for research grants from charitable foundations and from private industry. It is important to understand that such underrecovery has two interrelated problems:

(i) the grants generate real indirect costs connected with the research they support and these costs must be paid from other sources;

(ii) if the indirect costs are low, the direct costs of these grants contribute to the MTDC in the denominator of the rate formula, so they reduce the total by lowering the indirect cost rate in future years.

The "marginal" grant:
An argument that needs examination is that some grants may be "at the margin", since the incremental cost of supporting the research involved is perceived to be small. Three points need to be recognized in this context.

First, the cost calculations for research include an averaging of costs among all projects.

Second, the cost of additional projects is often underestimated. There is a real and significant shortfall at present. Economies of scale are small; in fact, there are always costs involved with additional research. Administrative effort needs to be in place to monitor the finances, services need to be provided for waste disposal, radiation safety, and other purposes. Furthermore, space that might be used for research paying higher indirect costs is occupied.

Third, as explained above, any grant that pays direct costs influences the equation for the recovery of indirect costs, in effect reducing the global recovery under A-21.

Points of comparison
It may be asked whether Yales indirect costs are high or low compared with other universities. The costs vary among institutions because of differences in the size and character of the research portfolio, the age of the physical plant, the severity of the climate, local wage rates, and other factors. It turns out that many private research universities have negotiated rates comparable with Yales, whereas public institutions have lower negotiated rates due to subsidies from state governments. A number of public universities have sought to increase their negotiated rates in recent years, in part because of a slowdown in state funding.

Yale is not unusually high in its level of indirect costs.

2. Who should pay indirect costs?
The committee believes that the University should make every effort to negotiate an indirect cost rate close to the federally allowed rate under A-21 for grants and contracts. In practice, this still leaves a signficant amount of cost sharing by the university to cover the "full" costs of research. As for the remaining underrecovery, i.e., the difference between the actual costs recovered and the federally negotiated costs, we need ideas from Yales scientific community as to the best strategies for containing the growth of underrecovery while sustaining excellent research in the future.

As with most enterprises, the best planning will involve both prudent management of costs for facilities, labor and goods, and strategies to improve cost recovery. In the coming year, we will, as a committee, attempt to develop policies to contain the growth of underrecovery. This does not mean we will have the objective, as has already been noted, of bringing the underrecovery of indirect costs to zero; rather, commensurate with the mission of the university to support scholarly activities in general, we wish to find ways to support science. We should expect some support from the University, but must be responsible in containing the growth of expense shortfalls.

Appendix I:

Membership of Science Policy Committee

Chair:
Donald M. Engelman, 432-5600, fax: 432-6381
Professor, Molecular Biophysics & Biochemistry
266 Whitney Ave., Bass Building
Email: don@paradigm.csb.yale.edu

Members:
Janet H. Ackerman, 432-1337, fax: 432-7165
Assoc. Vice President for Finance
451 College Street
Email: jan.ackerman@yale.edu

D. Allan Bromley, 432-3082, fax: 432-3522
Sterling Professor of the Sciences & Dean of Engineering
Dunham Laboratory, 10 Hillhouse Ave.
Email: d.bromley@yale.edu

Thomas Carew, 432-4545, fax: 432-7172
Chairman and John M Musser Professor of Psychology, Professor of Biology
Dunham Laboratory, 2 Hillhouse Ave.
Email: thomas.carew@yale.edu

Donald M. Crothers, 432-5204, fax: 432-6144 (on leave, Fall 1996)
Chairman & Alfred E. Kemp Professor of Chemistry,
Professor of Mol. Biophysics & Biochemistry
Kline Chemistry Laboratory, 225 Prospect Street
Email: donald.crothers@yale.edu

Richard A. Flavell, 785-3048, fax: 785-7561
Professor and Chairman Immunobiology, Professor of Biology
Farnam Memorial Building, 310 Cedar Street
Email: richard.flavell@yale.edu

Pierre C. Hohenberg, 432-4448, fax: 432-7107
Deputy Provost for Science and Technology
Hall of Graduate Studies, 320 York Street
Email: pierre.hohenberg@yale.edu

Richard Jacob, 432-4949, fax: 432-7960
Director, Federal Relations, Office of General Counsel
451 College Street
Email: richard.jacob@yale.edu

Vincent T. Marchesi, 737-2263, fax: 737-2267
Anthony N Brady Professor of Pathology, Professor of Cell Biology and Biology
Boyer Center for Molecular Medicine, 295 Congress Ave.
Email: vincent.marchesi@yale.edu

Suzanne K. Polmar, 432-2460, fax: 432-7138
Director, University Grant and Contract Administration
12 Prospect Place
Email: suzanne.polmar@yale.edu

Dorothy K. Robinson, 432-4949, fax: 432-7960 (on leave, Fall 1996)
Vice President and General Counsel
451 College Street
Email: dorothy.robinson@yale.edu

Carolyn W. Slayman, 737-1770, fax: 785-7227
Assoc. Dean & Sterling Professor Genetics, Prof. Cellular and Molecular Physiology
Sterling Hall of Medicine, 333 Cedar Street
Email: carolyn.slayman@yale.edu

Joseph Warshaw, 785-4638, fax: 785-7194
Assoc. Dean & Professor and Chairman, Pediatrics
Laboratory for Medicine and Pediatrics, York Street
Email: joseph.warshaw@yale.edu

Appendix II:

A guide to the calculation of indirect costs under A-21

The formula:
A simple formula is used to calculate the rate:

_{INDIRECT COSTS INCURRED}

______________________________ = INDIRECT COST RATE ALLOWABLE UNDER A-21
MODIFIED TOTAL DIRECT COSTS (MTDC)

The indirect cost rate is an average of indirect costs incurred by all organized research projects, both federally and non-federally funded. Thus an individual project is assessed an average cost based on research expenditures throughout the institution.

What are MTDC? (Denominator)
All direct costs of sponsored research with some exceptions such as permanent equipment, tuition, and subcontracts exceeding $25,000. These and other costs are specifically excluded in OMB circular A21 either because they are thought not to be good measures of the demand for indirect services or because they are unallowable under the federal cost principles (student financial aid, entertainment, advertising, cost of goods sold, patient care costs, building rental and alterations, fund raising, lobbying, gifts).

How are the indirect costs calculated and what are their components? (Numerator)
The first step in this process is the identification and quantification of costs to be treated as indirect. Next these costs are aggregated into several general classifications or cost components. The costs in each component are then allocated to the primary "functions" of the university (organized research, instruction, other activities) so that each function is assigned a part of the costs.

Listed below are general descriptions of cost components included in the current version of the government regulation. The percentages indicated are the portions of the current provisional negotiated indirect cost rate of 65% for 95-96.

Facilities:
Operation and maintenance (26.1%): Utilities, janitorial services, maintenance and repairs, grounds, hazardous waste disposal, etc.

Depreciation or use allowance (9.9%): the depreciation of capital costs for buildings and equipment. Note that depreciation is 20 years on laboratory interiors and 40 on buildings.

Library expenses (3.0%): both books and library staff are included.

Administrative (capped at 26% total):

General and administrative (6.0%): includes a portion of the costs of offices serving the entire university such as accounting, payroll, purchasing, general counsel, and senior administrative offices.

Department administration (16.7%): administrative costs at the departmental and school levels. Note that expenses paid as direct charges on sponsored projects are subtracted before this pool is allocated.

Sponsored project administration (3.3%): includes the cost of personnel and other expenses of the offices whose responsibility is the administration of sponsored projects, for example, the offices of grant and contract administration and grant and contract financial administration, animal and human subject committees.

How is the rate determined?
The University calculates a rate (the "allowable rate") for each component based on its interpretation of A-21 applied to the actual costs. These costs are audited by Coopers & Lybrand and are subject to audit by the government.

In a subsequent discussion a representative from the Department of Health and Human Services representing all agencies of the federal government negotiates with university officials to establish the "negotiated" rate. Historically, the federal negotiator has had interpretive differences with the University over which costs are allowable under A-21, or has set ceilings on costs in certain areas, resulting in the lower negotiated rate.

Appendix III:

Research related costs not included in "organized research"
(as defined in A-21)

There are several costs that are not included in the organized research calculation under Circular A-21, but that relate to the overall research enterprise of the University. These costs include, for example:

Faculty compensation costs (primarily in the Faculty of Arts and Sciences) that are paid on General Appropriations but which relate to time spent on research activities, assuming half of ladder faculty effort is devoted to research.

Graduate student costs for fellowships and stipends for students performing research activities, assuming the first two years of graduate study are assignable to education and the remainder to research.

Library costs in excess of the 3% that is recognized by the DHHS negotiators.

While precise calculations have not been done, the Committee estimates that these three examples alone added up to $24 million in 93-94 (expressed in 95-96 dollars).

Web site version
6/97