The world is getting closer to a more sustainable model for pay-for-success arrangements. Reinvestment Fund, out of Philadelphia, announced a $10 million fund last year to support pay-for-success projects in a portfolio approach that would diversify investors from the risk of any single project.
Not sure what “pay for success” is? Check out this quick primer on social impact bonds, one common example of this practice.
Background
So far, this industry has seen a slow, but steady increase in the number of projects undertaken that will pay investors based on the success or failure of the program. The problem is that the expected results of any given program can never totally be known, so the risk of failure would wipe out the entire investment and discourage future investors from engaging in similar activities.
This makes the results of each individual project so critical toward advancing the industry.
Reinvestment Fund is an organization that has already taken part in two pay-for-success projects in Cleveland and Silicon Valley. They’re now taking the first step toward mitigating this “single project” risk by announcing a new fund for a portfolio of investments.
This approach is unique, because instead of selecting a single outcome to address, the organization may choose to invest across a wide array of social outcomes (e.g., housing, food, education, health). This combination of different investments may be more resistant to wider macro-economic exposures that can take down any given initiative.
Think about a social impact bond investing in some affordable housing initiative. If a sudden bubble happens over the next few years in real estate prices, it could dramatically impact the profitability, and success, of the bond.
But imagine, instead, of combining that affordable housing investment with others addressing different social outcomes. A second investment might address pre-k education, another prison recidivism, another healthy food, and so on
By combining these different outcome goals, despite the individual risk of each program, the overall investment’s risk is reduced due to different economic factors impacting each one. Sure, many social outcomes may be interwoven with similar macro-economic trends, but the risk is at worst the same, and at best highly mitigated.
Take Scenario A, which is a single investment into a program with a 50% failure rate, and compare it to Scenario B, which is investment in ten different programs, each with a 50% failure rate. Total loss in Scenario A is no better than a coin flip. Total loss in Scenario B is 0.1%.
Potential headwinds
Before creating this pay-for-success portfolio, Reinvestment Fund has operated both traditional pay-for-success arrangements (or social impact bonds) and traditional bond arrangements. The Fund’s AA S&P bond rating (which is higher than nine states) helps attract private dollars for more of these traditional bond setups — e.g., the $50 million bond issue earlier this year.
This high rating coupled with its status as a Community Development Financial Institution (CDFI) and the consequential funding it receives from the Federal government has the organization in position to reach a lot of programs and a lot of outcomes.
Pay-for-success funding has a built-in mechanism to pay back its investors—through the programs being invested in. However, the Fund’s standard bond issues (yielding around 3-3.5%) are theoretically paid back to investors from program revenues, outside sources, or any other resources at the organization’s disposal.
If CDFI funding from the Feds makes up any substantial portion of the payback to investors on these standard Reinvestment Fund bonds, and the Trump administration follows through in eliminating all CDFI funding from the Federal government, then many of the current deals could fail and the organization could be at risk of bankruptcy if it cannot meet its obligations.
Of course, without knowing how most of Reinvestment Fund’s bonds are structured to pay out, it is not appropriate to say this will happen if Federal funding disappears, but it certainly is reasonable to assume.
Optimistic Future
Regardless of what happens with its outstanding bonds, the fund has positioned itself as an early mover into an excellent idea of diversifying pay-for-success projects into a more viable option for profit-driven investors.
If any of the programs succeed, the whole fund will be able to pay at least something back, as opposed to a single investment failing and blowing up the whole investment.
It is a good idea that should be watched closely and improved upon to a point where the industry can build a more sustainable stream of capital into programs that help society.
Private investment in public service is a largely untapped profit channel that is just starting to be explored. Many attempts, often called “pay-for success” or “social impact bonds,” are designed to attract private dollars to meet public ends.
The concept is fascinating in that it could potentially solve a lot of social problems and provide return on investment to willing funders. However, many of the deals currently lack real quantitative outcomes—something that could stunt this industry’s growth for years to come.
A brief case study
The United Way of Salt Lake and its partners including StriveTogether are doing good work funding early childhood education through a pay-for-success program. They have reasonable numbers to suggest significant cost savings to the State of Utah while demonstrating a strong business case to scale the program further.
Of the 110 students attending this pre-school program who were “likely to need special education later on,” only one ended up requiring it in kindergarten. This translated into a cost savings of $2,607 per child—the marginal cost of providing special education in Utah.
These results suggest immediate outcomes of $281,550 in total savings that very next year. Because of the way the deal was structured, investors were to receive 95% of these savings after the one year, amounting to $267,473, leaving the state with a presumable profit of $14,077. Not bad for an immediate return.
However, after taking a quick look into Utah state budget documents, the actual results are quite different:
Increased total expenditure from $22,432,300 in 2013 to $24,376,400 in 2015. This equals a compounded annual growth rate of 4.2%, which is higher than the total student enrollment growth rate of 2.4%.
Increased per-unit expenditure from $2,607 per student in 2013 to $2,837 (compounded annual growth rate of 4.3%).
There are possibly very valid reasons for these increases. First, the need for special education could be growing generally and this trend could have at least been slowed by this program, thus making it a success in real terms. Also, the cost of providing this service could be going up generally, another trend that might have been slowed by the program – again, making it a success.
By these accounts, this program really is doing great. And that’s the point. The United Way has put together a legitimate program to help improve outcomes for early-age students. Almost every single program student in danger of needing special education ended up not needing it by kindergarten. That is a success.
Note: For simplicity in this analysis, we are avoiding things like selection bias and other aspects that might skew a program toward success to the detriment of potentially more needy program recipients.
However, because of this success, the State of Utah paid $267 thousand to investors after one year, despite seeing zero actual nominal savings on special education over that same period.
How does that inspire future governments to make these types of deals? How is this anything other than a public service, funded like everything else—with budgeted tax dollars?
The program works, but the deal doesn’t
A good program is one that generates positive outcomes—like the Utah program. A good deal, however, is one that generates positive financial rewards as well—something that is lacking so far.
The major problem with the way the Utah deal works is that it assumes the social outcomes are tied to lower spending on special education. The theory makes some sense, but practically speaking, this “outcome” could be achieved by slashing special education budgets, reducing amount of enrollees, or any number of additional manipulative tactics. And it is easy to see that these are not the same as actually improving the lives of those needing special education.
So how could we improve on a deal like this?
1. Identify the real outcome
Reduction in special education spending is not a social outcome, but reduction in special education need is. But how do we quantify this?
For one, it is probably safe to say that the more advanced our children are, the more ready for the world they become and the more successful they become as participants in the economy (getting good jobs, paying taxes, buying things, etc.).
If this is truly the sought-after outcome—creating productive citizens—then we have a much longer time horizon to wait than one year (more like 15-30 years). Instead of chasing incremental drops in special education spending, the state should focus on creating the best possible version of each student beyond just that first year after pre-school.
Who’s to say that the same reasons causing kids to “likely need” special education in the first place don’t resurface once they leave this rehabilitating pre-school program?
2. Determine the value
A Utah student in 2013 needing special education had a marginal additional cost of about $2,600, according to the Utah State Board of Education. However, these cost reductions were not achieved. There are probably legitimate reasons for this, including a proportion of fixed costs that we cannot immediately slash after one year (e.g., reducing the amount of students by 10% does not allow us to lay off 10% of a teacher).
If we take a step back and look at the real long-term outcome of such programs, we can identify educational attainment and career earnings as more valuable metrics. It is fair to say that educational attainment level contributes heavily to an individual’s earning power.
In 2014 for example, those with a high school diploma earned a median weekly income of $668 and unemployment rate of 6.0%. Those with a bachelor’s degree earned $1,101 with an unemployment rate of 3.5% (according to the U.S. Bureau of Labor Statistics).
Assuming all residents stay within the same community, the cost of unemployment insurance can be calculated (identifying cost savings) and the incremental gains in total tax dollars can be calculated (identifying increased revenues).
These are two major benefits and exclude any other secondary benefits such as increased buying power in the local economy, likelihood to raise children of higher caliber, and improved property values due to more desirable school districts (all of which can contribute greatly to social impact).
3. Match payments to benefits
Utah paid investors 95% of the “cost savings” after one year. These cost savings were not actual dollars, but underwritten savings at the time of the deal being signed.
Instead of doing this, Utah should have tracked special education need to things like graduation rates and educational attainment. From there, baseline costs of special-needs children into adulthood can be approximated.
If these children were subsequently tracked all the way through school and beyond, real costs and benefits can be tracked on a unit level and the benefits can be repaid based on when they are achieved.
For example, a child we will call “Timmy” has been identified as likely to need special education sometime during his school years so he participates in the pre-school program. The program works to significantly reduce the likelihood of him needing special education, so he progresses through school at a faster pace than previously expected.
He graduates high school and attends some college but leaves to work a full-time job earning $741 a week. This is compared to a special-needs baseline of someone not obtaining a high-school diploma and earning $488 a week. Assume both incomes fall in a state income tax bracket of 5%. This generates an additional $13 in tax income per week, or $658 per year. Plus, Timmy is 33% less likely to become unemployed and drain tax resources from that program.
Multiply the $658 over 10 years of working and the state earns an additional $6,578 in revenue on top of any cost savings from reduced need for special education. But because residents’ salaries are not budgeted the same way program funds are appropriated, it is easier to track expense progression and transfer some of these earnings back to the investors as they come in.
Here is a table outlining the net cash flows for the program investment ($ in thousands):
A couple disclaimers on these charts:
First – Let’s assume the program runs for the first five years, with equal $1m installments each year. Let’s also assume the $72k tax income increase starts when a class of students turns 18. So for a 4-year old in a pre-k program, this implies by year 14, he will be 18 and starting to earn more money than he would expect without the additional education.
Second – Inflation of 2% is assumed for the cost of program. The $1m invested right away would now cost $1.08m by the fifth year. Wage growth of 4.5% is assumed for earnings and tax increase, implying a jump from $72k to $133k by year 14 (when the first class turns 18).
As you can see, the major benefits of this program are not likely to be achieved until many years after the program is initiated, making immediate return to investors a very difficult challenge to achieve.
In fact, using these assumptions and only considering increased tax revenue, the program doesn’t break even until the 26th year. When factoring in ONLY the impact of increase tax receipts from higher earnings, the five-year program earns 2.6% annual ROI over a 50-year period.
To get a full picture of the program’s social impact, other outcomes should be quantified in this manner and payouts tied to specific years they are expected to take place. Without doing so, the program loses its pay-for-success nature.
Conclusion
To successfully construct a pay-for-success program, multiple projects should be pooled. Their results, on a combined basis, have the power to offer payback to investors at various times during the contract.
As illustrated above, a program like pre-school obviously wouldn’t warrant payment until closer to the end of such a contract. However, a program like prisoner reintegration might be more able to pay back investors on the front end of the deal.
The key is to diversify the types of programs and outcomes being achieved to stagger payback in a more realistic and reasonable manner to investors. Because after all, it’s their appetite for risk and reward that has the potential to drive capital toward the growing sector.
Around the world, innovative financing methods are being used to tackle social issues. Programs and organizations typically funded by grants are constantly at the mercy of governments who have trouble thinking past the next election cycle.
As a result, when spending cuts need to be made governments typically look for the quickest fix – cutting social services.
What’s wrong?
Think about it. In your city, you may have a $100 million budget allocated primarily to:
– Schools: $60 million
– Emergency services: $15 million
– Public works: $15 million
– Human services: $10 million
Tax receipts are expected to decline by 10% next year. What do you do?
The majority of the first several categories (schools, emergency, and public works) are used on an as-needed basis. They are there to serve public needs in the moment.
Human services, on the other hand, typically comprise both rehabilitative (immediate things like food banks or homeless shelters) and preventative (down the road things like job training for unemployed or after-school activities for at-risk youths) benefits.
Now back to our problem of decreasing tax receipts. Aside from broad reductions, you’re not typically going to close a school, or cut back on your police force – they’re much too important to a town’s immediate value (not to mention the unions involved…).
As a result, you would turn to social services as an area to cut. And all things being equal, the preventative services are viewed as a relative “luxury” compared to rehabilitative services…again, because they provide benefits down the road, as opposed to right now.
So you’d cut those preventative services. After-school programs, job training, and collaborative work spaces would get the ax before food banks, homeless shelters, and unemployment benefits. They’re simply easier things to cut.
Now imagine this scenario playing out in thousands of cities and dozens of states across the U.S. each of the past 8 or 9 years. Naturally, many health and human service organizations struggle due to lack of funding. So despite the fact they do quality work, they are unable to provide the full potential value of their work.
Bottom line: Results are determined not by the quality of the organizations doing the work—but by the amount of funding governments are able to grant them.
Governments fund short-term services over long-term ones. They favor less complexity to more. And they reward risk aversion at the expense of seeking out truly innovative and high-quality programs.
They offer value in a down-the-road or not immediately profitable manner.
Take a business that sells computers. It makes a product. People need the product. They pay immediately for that product. Value is created instantly upon receipt of the computer. And because that value is created instantly, it is easily quantified and paid for by a customer, making the value realized by both seller and buyer at the same time.
Now take a mental health organization. It provides a service. People need that service. They often can’t pay for that service, even though society deems it necessary for the overall good (through increased tax revenues, lower prison costs, etc.). Value is provided instantly to a patient but not realized instantly by society. It happens “down the road.”
Naturally, investors flock toward ideas that provide easily quantifiable returns. There are demonstrable data that prove the returns they can reasonably expect, corrected for risk of course, even though some investments are extremely long-term in nature (think of real estate or long-term bonds).
The further an investment is from concrete, quantifiable returns, the further it is from attracting funds. Something like mental health service is extremely hard to quantify. We know there are tangible benefits to providing this service. But who exactly benefits financially from it?
This creates the great divide in funding. There needs to be a way to bridge the gap from social returns to commercial returns on investment.
How do we solve this?
Traditional methods of funding lead to services delivered in isolation from each other, with inadequate focus on preventative services known to produce better outcomes.
Coupled with inadequate resources and rising need, many cities and states are seeing rising poverty, growing need for job training, and a host of other negative social outcomes, many of which could be prevented with adequate investment in prior stages of these problems’ development.
Introducing: pay for success.
Also known as pay for performance, this describes service payment models that offer financial reward to providers who achieve or exceed specified quality, cost, and other benchmarks. In other words, you only get paid if you do good work.
These models offer a blended return, accomplishing both financial and social payback.
Return on taxpayer investment
Governments spend billions of taxpayer dollars each year on crisis-driven services. These programs help a great number of people, but fail to make much headway in solving social problems that have become too complex for one-dimensional, prescriptive solutions. Although they recognize the economic and social benefits of prevention, government agencies generally cannot afford early intervention services as their funds are already committed to high-cost remediation programs.
Even if they fund prevention, governments risk having to pay for both prevention and remediation if their chosen prevention programs fail to improve participants’ outcomes. The short-term imperatives of the election cycle exacerbate this tendency to shy away from potentially risky, longer-term preventative investments.
Economic recession and shrinking budgets have forced governments to cut many programs providing prevention services, and as a result, nonprofit providers and their clients are struggling to survive.
The social impact bond
The social impact bond (SIB) is a financial device that integrates the needs of governments, service providers, and charitable investors under one concept: pay for success.
The bond is an outcomes-based contract in which government officials commit to paying private service providers for significant improvement in social outcomes (such as a reduction in offending rates, or in the number of people being admitted to hospital) for a defined population.
Funds are raised by charitable investors looking to make a difference, and their return on investment is defined by the degree of success in the program invested in. If a program is successful, the government repays the investment plus a variable rate of return based on performance. If the program fails, no payment is earned.
The government repays investors only if the interventions improve social outcomes, such as reducing homelessness or the number of repeat offenders in the criminal justice system. If improved outcomes are not achieved, the government is not required to repay the investors, thereby transferring the risk of funding prevention services to the private sector and ensuring accountability for taxpayer money.
By leveraging SIBs, governments can transfer the financial risk of prevention programs to private investors based on the expectation of future recoverable savings. They also provide the incentive for multiple government agencies to work together, capturing savings across agencies to fund investor repayment.
– Common belief that prevention is less expensive AND more effective than remediation
– Prevention also takes longer to realize tangible benefits and is naturally harder to measure
– SIBs transfer the risk of funding preventative programs from the government to private investors – government (and taxpayer) payment is contingent on success
1. An intermediary issues the SIB and raises capital from private investors.
2. The intermediary transfers the SIB proceeds to nonprofit evidence-based prevention programs. Throughout the life of the instrument, the intermediary would coordinate all SIB parties, provide operating oversight, direct cash flows, and monitor the investment.
3. By providing effective prevention programs, the nonprofits improve social outcomes and reduce demand for more expensive safety-net services.
4. An independent evaluator determines whether the target outcomes have been achieved according to the terms of the government contract. If they have, the government pays the intermediary a percentage of its savings and retains the rest. If outcomes have not been achieved, the government owes nothing.
5. If the outcomes have been achieved, investors would be repaid their principal and a rate of return. Returns may be structured on a sliding scale: the better the outcomes, the higher the return (up to an agreed cap).
How it works
Future State wants to invest in programs to reduce prison recidivism – the number of people who re-offend and end up back in prison once released.
The obvious benefits include:
– Lower prison costs. Obviously fewer prisoners means lower expenses spent on prison facilities, staff, services, etc.
– Increased income tax revenue. Fewer prisoners means more people available in the workforce. Ultimately this benefit is realized only if the majority of those released from prison do in fact re-enter the workforce, instead of staying unemployed.
While not necessarily easy to quantify, you can ballpark it. Say each prisoner has a variable unit cost of $25,000 per year when behind bars. Say also that Future State loses out on $1,000 a year in income tax with each prisoner not working. These figures alone equal a net $26,000 per year cost of a prisoner.
The state releases 2,000 of its total 10,000 inmates each year. Those released have a 50% chance of re-offending and ending up back in prison within 3 years. Reducing one year’s released inmates’ recidivism rate to 40% would reduce the number of people returning to prison by 200 by year 3.
This carries with it an additional 200 people eligible for work in the state. Assume in this case that everyone who remains out of prison becomes employed.
JobTraining Corp has a program that promises to reduce recidivism by the nominal 10% described above. This includes job training and re-integration services for prisoners. The annual cost to run such a program at the scale required to achieve this 10% reduction is $3,000,000.
Every 10% reduction ends up benefiting the state $5,200,000 over three years. That equals a 20.1% annual return on a $3,000,000 investment.
What this means
In this example, the net benefit to society, or in this case the government, is 20.1% per year.
These benefits are tangible from a financial perspective. They just take multiple years to materialize. That’s why these programs are typically funded by governments in the first place.
Take an outside investor now. Say they want to invest $3,000,000 into this prison recidivism program. For a social investor like this one, they may be enticed by a 5% return on investment for their funds.
By year 3, with Future State realizing $5.2 million in total benefits, it can afford to pay out an investor the 5% annual return plus initial investment for their efforts. This equals $3.5 million.
This leaves $1.7 million net profit (in the form of higher tax revenues and lower prison costs) to the government.
The beauty of this arrangement
Circling back to the earlier concept, pay-for-success, this kind of deal only gets paid out by the government if the program succeeds. No matter what happens, the investor fronts the money to a service provider (in this case, JobTraining Corp). The service provider has no other obligation in the financial workings of this deal—merely to provide a service.
The government then reimburses the investor if, and only if, success is achieved.
Because in this case success was defined by hard outcomes with real financial rewards attached to them, it is easy to see that the government will realize the gains in its own bottom line.
The government can subtract from these gains and pay out the service provider a cut of the “profit.”
If on the other hand, the outcome isn’t achieved (in this case, recidivism doesn’t drop 10%), then the government is off the hook. Nothing is returned to the investor. The funds remain with the service provider.
The service is still provided, which means positive outcomes could still be achieved, but probably at a lower rate of return. In this case, the government still earns some financial benefit without being required to reimburse the investor.
The investor is on the hook for any risk associated with delivering on these outcomes.
In other words…a government can fund a public service with no up-front capital. Additionally, it needs only to actually pay for such a service if the financial reward it sees is tangibly greater than the cost. A classic win/win.
Looking ahead
This example is a very simplified form of a social impact bond. It assumes a straight yes/no basis for successful outcome triggering repayment. In reality, a social impact bond will have a scale of returns an investor can achieve based on a sliding scale of outcomes.
As more of these deals pop up across the United States, it is important to determine how effective they are at not only providing a social service, but also providing a return on investment.
Governments, if planning properly, can fund outcomes completely risk free. If they have good data to support the financial impact of social outcomes, they can prove to investors a financial return on their end.
Until data exist in the quantity and quality that support these outcomes though, investors will bear a greater risk in funding these types of deals. In these early stages of this industry, it is more likely to be seen as a donation than an investment. But once deals start proving financially viable for all sides, the social impact bond industry has the chance to really take off and make a difference across the world.
Despite all the criticism, negativity and reports of failure, the Peterborough social impact bond may prove to be a disrupter in the way we fund social services and invest in impact. Plenty has been written and said about the Peterborough prison social impact bond, so there is no need to go into detail here.
Why is this program unique?
This deal represents the first social impact bond in the world, one designed to leverage private dollars for use toward public services. Private investors provide cash up front to service providers—nonprofits, for example, who may have difficulty accessing traditional capital—and receive repayment of principal and possibly interest from a government based on the service’s outcomes. The final return to investors is based solely on the outcomes delivered and may amount to zero repayment if the programs are unsuccessful.
Complex investor motives
Being a participant in the first deal in the world (and actually, any of the first several deals in the world) offers a number of opportunities for interested “investors.” Beyond merely hoping for positive outcomes from the services and reaping a financial reward on the backend, early investors may be noted donors or fundraisers who normally fund programs such as these in the first place on a grant or unrestricted donation basis. The attachment to a social impact bond allows them more notoriety by way of appearing on every short list of active social impact bonds in these critical early years of their formation, while continuing to allow them to fund programs meaningful to them.
The reason for skepticism on the part of early investors is the lack of any substantive data proving these upstream programs work to influence outcomes in a financially tangible way. Early investors may as well just be donors at this point, and any additional return on their investments may help to build a case for future real profit-driven investments.
What does measuring outcomes mean?
Investment and repayment in the Peterborough deal were based solely on reducing recidivism rates among the cohorts compared to a national baseline. If reoffending rates in the first year after release dropped by at least 7.5% for all cohorts the investors would receive a return on their investment—if not, then they would receive nothing.
The OneService program gets funded in the beginning, regardless, via private dollars from investors. Meanwhile, the British government is on the hook for repayment only if this recidivism goal is reached. Governments can agree to deals like these because the outcomes desired—in this case, lower recidivism—theoretically provide some sort of financial value for them, either through lower costs or increased tax revenues. But looking at the Peterborough deal, there is no concrete dollar calculation tied to 7.5% recidivism reduction.
It could be argued that lower recidivism is not even an outcome at all, but merely an output of the service. Outcomes are the net results of activities, whose results are measured by outputs. For lower recidivism to impact the U.K. government in some tangible way, we would expect cost of prison operations to decrease, tax receipts to increase from having a higher tax-paying (i.e., non-institutionalized) population, damages from crime to decrease, etc. Simply reducing recidivism does nothing financially for the government if these greater impacts are not achieved.
Further disconnect between program and outcomes
The Peterborough program, as designed, rewards investors with taxpayer dollars based not on a net return on taxpayer investment, but rather based on a specific number of short-term offenders not reoffending within a one year period. This means, that the program may work wonders in the first year of contact with inmates, but after that, who cares? Several publications document the drop-off in contact between case workers and inmates after the first few months anyway. Add to this, the fact that while a good indicator of future behavior, initial behavior after walking out the doors does not adequately equate to long-term financial value for a government.
The one-year post-release measurement period should tie to outcomes received in the first year of repayment. Assume recidivism does drop 10% or so against a national baseline—what does this mean?
How many incremental taxpayers are added to the system? Are any prison wings shut down? How many fewer staff are required after that first year? What is the resulting drop in crime rate? And most importantly, what do these dollar amounts equal?
These are much more tangible results that should be looked at, or at least mentioned in any of the write-ups of this program.
Is this such a bad thing?
Even if the government entered into this arrangement without having even the roughest of estimates for these real types of outcomes, the deal still adds value.
First, the programs are clearly good ones. OneService has achieved some success and seemingly the more dollars thrown at it, the greater the scale the impact could be. At the very least, this deal serves as a public initiative to improve the system (which, ironically, that’s all it was, as proven by the fold-up into the criminal justice initiative Transforming Rehabilitation.
Second, and more importantly, this potentially paves the way for future deals around the world—and this certainly has been the case. It serves as a template of sorts and proof that private dollars can be brought into public services. Ignoring the fact that payments weren’t made back to investors (kinks that still need to be worked out in these systems), we have something to learn from and move forward with.
Moving forward
There are certain things to take away to make better deals in the future. Most critical is having a concrete understanding of the outcomes desired. Outputs such as recidivism are great for tracking progress, but broader measures of societal impact need to be measured and improved. If there is any disconnect between the two, then these types of programs will not ever achieve what they were intended to: bring in private capital.
As more of these deals are created, it is critical to track the progress of the programs. If these programs can start to prove outcome results that tie to real dollars on the government side, investors will naturally take notice that there is money to be made. And once this starts to happen, donors will be supplemented, but not replaced, by profit-driven investors—adding volume to the social impact investing marketplace.
If that is the primary result of the world’s first social impact bond in 2010, then that would be a tremendous success, no matter what the analysts say.
It is very easy to look at pay for success as the next great innovation in public service. It’s also easy to look at it as the next great weapon of Wall Street greed. That’s the problem. There are still far too many unknowns about the real potential of these projects, and it is far too easy to write off early failures as proof that these concepts will never work. And while the concept is interesting, the current process of studying and marketing these opportunities is being executed in a wrong way.
Small number of deals
Although they are certainly gaining traction, the limited volume of pay-for-success deals in this country (and the world) is an issue. Since they were introduced in 2010, there have been roughly 10 social impact bonds created each year, and have now expanded to 15 countries. Each deal takes months of planning, feasibility studies, and collaboration among at least three different parties. Much of this planning goes around underwriting the actual services and how their results will lead to financial rewards—results based on very specific programs offered by very specific organizations. While appropriate for a piloting process for this mechanism, this is a massively inefficient way to build momentum for a scalable model.
Additionally, most of these deals take 3-7 years to provide any sort of finished program data. So even if all these initial deals become major successes, it would take years to prove that this mechanism should be scaled up (not to mention the potential disaster if even some of them fail). At this pace, it will take decades to build any substantial database around program outcomes that can be leveraged on a larger scale. Successful programs will submit their program data and performance metrics, as well as how they map their activities to outcomes, but no two service providers necessarily records results in a uniform manner. There is no GAAP for nonprofit activities, which will make any comparison among programs time consuming, if not impossible.
All results are not created equal
The most influential factor of a program’s success is the provider’s execution. But throw in any number of external variables and the numbers can be thrown off and outcomes not achieved—even if the results are still better than a baseline scenario. You never know when the economy is going to turn upside down—or when riots will erupt in the streets—or when a new virus spreads across the country. But when any of these things happens, they can influence results for any types of programs or activities.
Imagine a health initiative designed to decrease the number of hospital stays in a local community. The program performs as expected, closing in on the desired numbers. Suddenly a new virus sweeps across the community, wreaking havoc on the reported numbers. Despite the program’s real success (real being defined as net difference between reality and a baseline scenario, which in this case must be altered to include the virus), the deal will be designed to not reward investors.
Who gets the credit?
When pay-for-success initiatives succeed, the provider is often recognized as the reason. Future funders will look to fund this same provider because: A) they’re clearly effective at what they do, and B) they have experience measuring a very specific set of outcomes now (reducing the need to pilot more studies and set up another organization for similar data capture). This newly deemed “successful” provider essentially owns a monopoly over an outcome and will be able to scale up; but it gets no easier for similar organizations to do the same unless they copy the methods of the first one, which may divert them away from activities they traditionally excel at. Does program success merely lock in future funding to a specific set of providers?
Alternatively, when these initiatives fail, it is often an indictment of the flaws found in these types of financing mechanisms altogether. It is much easier to blame the mechanics of the deal than to blame the execution of the program or flaws in data analysis. This creates a discouraging environment to pursue these types of arrangements, further contributing to the long timeframe of putting together a solid base of data and understanding needed to scale these things up.
There must be a better way
Instead of waiting for some magical database to be populated decades from now, what if we started with a more generic outcomes database? The fundamental goals of most nonprofits (and governments for that matter) are similar in nature, and they all strive to achieve similar outcomes. There is no reason these outcomes can’t be defined in a way that maps them to specific activities. These activities, in turn, can be mapped to resources that can perform them. This simple map allows the alignment of activity performers to outcome providers.
The hard part is quantifying the relationship between activities and outcomes. What sort of graduation rate improvements can be achieved if 50% more kids went to pre-school? What sort of recidivism rate improvements can be achieved if 50% more prisoners went to job-training programs? And so on…
Basic government budget and audit data provide some baseline of resources expended on public activities. Other public records such as labor, census, public health, and crime data provide some baseline of outcomes. Connecting the dots between activities and outcomes becomes simpler when you look at it this way. Simple statistical analyses could possibly provide correlations between resources spent and outcomes, allowing for some sort of predictive calculation to be done (e.g., 10% more per-pupil spending leads to 10% better college enrollment rate).
Fund outcomes…not organizations
Assuming some database like this was created, nonprofits could be publicized on a more universal basis. Their activities will be on display and attached to outcomes without even providing any program data. Of course, as program data becomes more available, their inclusion in this sort of database would only add to the calculations’ accuracy, making it an even more powerful tool.
If a potential social investor wanted to fund a health initiative in his hometown, he could search this database for specific outcomes (life expectancy, quality of life, etc.) and a list of activities will show up (extracurricular education, preventive screenings, etc.). The investor could then select whichever activity fits his mission and a list of possible providers will appear. This process allows funding to flow through to outcomes rather than specific organizations—not the other way around, as is the case in setting up a traditional pay-for-success deal.
Looking ahead
Building a database is not easy. Sure, there are plenty of public data sources, but they are often inconsistent or outdated. An activities-to-outcomes map is very conceptual in nature and may require assumptions and arbitrary values in the beginning. But as programs pile up and more data become available for inclusion, the accuracy of the database will improve. And then it can truly be a sustainable and useful tool for providers, governments, and funders alike.
