I’ll be at the Fifth National Summit on Quality in Home Visiting Programs in Washington DC on May 7, 2015 participating on a panel discussing social impact bonds and pay-for-success financing. I’ll be joined on the panel, moderated by Lauren Schumer, The Pew Charitable Trusts, by:
David Juppe, Department of Legislative Services/Maryland General Assembly
Elizabeth Lower-Basch, Center for Law and Social Policy
Rhett Mabry, The Duke Endowment
Risk and Reward
Social impact bonds (SIBs) represent a form of pay-for-success financing.
In the Pay for Success model, governments partner with private sector investors who provide up-front funding to promising service providers. Investors only receive a repayment from the government if the service provider’s work is measurably successful. Because governments pay only if the programs work, the PFS model has the potential to more effectively allocate taxpayer dollars while increasing funding for programs that deliver improved social outcomes. – The Social Impact Bond Technical Assistance Lab (SIB Lab) at the Harvard Kennedy School
While SIBs provide for a mechanism in which governments can shift the risks of “unsuccessful” programs to the investors, they generally do so at the cost of paying more for “successful” programs. Typical profit-motivated investors will presumably develop strategies to mitigate the risks to maximize their opportunity for profits. Accordingly, SIBs must be seen as not merely a form of public-private partnership in which the interests of the government and investors are aligned to produce a favorable social outcome, but also one in which their respective interests are competing at selecting appropriate programs, metrics, parties, and payments.
For example, it would make little sense for governments to pay more for low-risk, high-social return programs that they should have simply funded directly. In contrast, it would make more sense for governments to pay more for high-risk, high-social return programs. Typical investors, on the other hand, will look for low-risk opportunities and/or mitigate the investment risks by negotiating metrics, terms, and conditions that favor their interests over the public interest. What will be required initially for the overall success of SIBs as a social financing strategy are true social investors who are willing to take on more risk for a less-than-market-rate return relative to such risk in exchange for advancing a social good.
What You Should Know About Social Impact Bonds, Gene Takagi
Social Impact Bonds: Overview and Considerations, Elizabeth Lower-Basch
Testimony of Dr. David B. Juppe, U.S. House Committee on Ways and Means, Subcommittee on Human Resources Hearing on Social Impact Bonds, September 9, 2014
Transcript for Pay for Success Social Impact Finance: South Carolina Home Visiting to Improve Health and Early Childhood Outcomes, March 11, 2013 (including comments from Rhett Mabry)
Quotes from Additional Resources
PFS contracts introduce several potentially valuable components: performance measurement, performance-based pay, an intermediary with management talent, financial resources for successful nonprofits to expand, and new program models. A subset of these components may be sufficient for, or may explain a large portion of, an intervention’s successful outcome. If the model is successful, we may not be able to tell the relative contributions of each.
Consider investments in prenatal health care. Such investments may produce short-term benefits such as improved infant and maternal health and lower health care costs, but they may also produce longer-term benefits such as reduced special education spending, reduced crime during teenage years, and increased adult earnings. While it would not make sense for a SIB contract to pay out over two decades as results become apparent—the feedback loop between management practices and results would be too long to be useful—it might be possible to design a SIB that paid out based upon short-term results that are predictive of longer-term benefits. It will be interesting to see whether any governments are willing to make payments based on these potential longer-term benefits.
How Will Governments Scale Pay for Success Contracts That Work?
In designing initial PFS contracts, it is important to have a vision for what will happen at the end of the contract if the project is successful. Clearly, it would be a bad idea to have the contract conclude, have services shut down, and then start the process of figuring out what comes next. But it is also not remotely possible to specify a plan for scaling up a successful intervention several years ahead of time since what is learned along the way will be critical to designing any follow-on plan. In practice, a sensible approach may be to write explicit deci- sion dates about contract extensions and scaling into the original contract with sufficient lead time to allow for effective expansion. For example, if the initial contract is for six years, then by the end of the fourth year a decision would be made about years seven and eight. Another question is whether follow-on contracts should assume the same PFS model or whether the government could simply contract directly for the now-proven program model. Ideally, the government will maintain capacity to measure impacts rigorously during successor contracts regardless of their setup.
At this early stage, SIBs are most appropriate for areas in which:
* Outcomes can be clearly defined and historical data are available
* Preventive interventions exist that cost less to administer than remedial services
* Some interventions with high levels of evidence already exist
* Political will for traditional direct funding can be difficult to sustain
The foundation staff also pointed out that potential collaborators should not assume foundations are exclusively interested in using any one type of capital: They have the ability to make grants, which require no payback; program-related investments, or PRIs, which are investments that focus on a charitable mission and range from 0 percent to below-market rate returns; and mission-related investments, or MRIs, which intend to achieve a market-rate return while advancing the foundation’s mission. Internally, most foundations split investment and grant-making functions into separate departments, which might mean different decision-making processes and priorities.
As conversations about social impact bonds continue, it is helpful to understand what drives potential collaboration among investors. Since each institution has multiple ways in which it could participate, it is not useful to make assumptions about whether or how any one organization would want to collaborate. Taking time to get to know an organi- zation’s mission, staff talent, available capital, appetite for risk, relationship with gov- ernment, and sustainability goals can help bridge the perception gap among potential investors. Participants at our discussions highlighted the role of networks in identifying expertise and understanding the bigger picture beyond the individual SIB transaction. Beyond access to financial capital, investors have intellectual and often community capi- tal that can be helpful in assessing whether to enter a deal.
These challenges mean that the agreement itself—the contract signed by the government agency and the external organization—is critically important to the success or failure of a Social Impact Bond. Among other things, the contract will define the relationships and responsibilities of all the parties in this unusual arrangement, will set out the circumstances under which the external organization can expect to earn their payment, and will determine when either the government or the external organization can terminate the agreement. Writing the agreement well will help guarantee transparency and cooperation between the government and the external organization, help protect the vulnerable populations that the agreement serves, and make better outcomes possible.
The contract should also place some restrictions on the government. In most SIB agreements this will include clauses prohibiting the government from exerting control over the external organization’s strategy or day-to-day operations. The contract should also prevent the government from intervening in the external organization’s selection of subcontractors and investors, though subcontractors will be held to the same standards as the external organization itself.
Pay-for-success contracts are not appropriate for bleeding-edge innovation; they typically work best to scale up proven, battle-tested interventions.
For social service providers, social impact bonds represent a sea change not only in the amount, but in the kind of available capital. Payment in advance eliminates the challenge of meeting expenses while waiting for government reimbursement. Since investors are repaid based on outcomes, not inputs, unrestricted funding is not tied to specific program components and can be spent on what works best. With costs covered in full, providers can focus on services, not fundraising. All of that is intended to help high-performing nonprofits with proven interventions thrive, not merely survive.
The record on SIBs reveals several implications of the financialization of urban policy, that is, of aligning urban policy with the requirements of the funding mechanism. First is the pitfall of program selectivity. The tendency to fund programs that correspond to the underlying logic of SIBs is evident in the emphasis to date on programs designed to stem juvenile and adult recidivism and reduce use of healthcare and homelessness services. The aim of these programs is to reduce “subprime” behaviors that increase costs to governments and to use the cost savings to repay private investors and program needs that do not correspond to this logic are unlikely to be funded. A second and related problem is the monetization of outcomes. Because the aim is to reduce the cost of government programs rather than to address social issues per se, program success is defined in terms of cost reduction rather than the substantive effect on the underlying problem. As a consequence, programs that address a pressing social need but can’t directly be linked to cost reduction won’t be funded through SIBs. Third is the measurement problem arising from the assumption that changes in outcomes (e.g., reduced recidivism, lower healthcare costs) can be directly and causally attributed to the program intervention—a confidence in social science methodology that may be seriously misplaced. Ironically, given the logic of program evaluation, a positive outcome in the target population must exceed outcomes in the comparison population, so an improvement in the comparison population that could reasonably be considered a success for society as a whole would be deemed undesirable for investors. Fourth, SIBs’ reliance on independent evaluators to certify program success is likely to engender the same market-based pressures that bedeviled the bond rating agencies that certified the credit-worthiness of mortgage-backed securities prior to the economic collapse of 2007.
It’s a public policy bet that has legislators of both parties and at the national, state, and local levels hopeful that private capital will somehow discover and fund public policy solutions that wouldn’t come to the fore without SIBs. It is a bipartisan dream built on a belief in the efficacy of the free market system that hasn’t borne much social progress fruit in recent years and rooted in a disparaging view of public servants, who have accomplished more than most free market true believers might ever guess.
Social impact investment can potentially provide new ways to more efficiently and effectively allocate public and private capital to address social and economic challenges at the global, national and local levels. While these innovative new approaches will not replace the core role of the public sector or the need for philanthropy, they can provide models for leveraging existing capital using market-based approaches with potential to have greater impact. However, given that social impact investment is a nascent field, concrete evidence is needed in terms of its impact to date. In particular, further work is needed to demonstrate the gains from the social impact investment approach compared to existing social service delivery models.
While the social impact investment market has been growing significantly and has drawn increasing interest and attention, it is still in the early stages of development (Kohler et al, 2011) and is only a small share of the global capital markets today (Saltuk et al, 2014). While difficult to measure for a variety of reasons including the lack of clear definitions and the diversity of sectors and approaches across geographies, the social impact investment market potential has been estimated to be significant. This is due to growing interest among foundations and mainstream investors as well as an intergenerational transfer of wealth, estimated at USD 41 trillion that is expected to take place over the next 50 years with nearly USD 6 trillion of that expected to be directed towards social issues (Rangan et al, 2011).
Social impact investors, as well as targeted policies, can play a role in improving the effectiveness of social ventures (Jackson and Associates, 2012). Social impact investors can help social delivery organisations by providing not only financing but perhaps more importantly, support on strategy, management and growth (Bannick and Goldman, 2012). [Ed. Query the problems this can pose as well.] Helping social entrepreneurs grow their ventures to scale is the key to maximizing impact (Koh et al., 2012). The success of social impact investment is reliant on the long term sustainability and performance, both social and financial, of the impact organizations, for-profit and not-for-profit, in which the investments are made (Bannik and Goldman, 2012).
Despite the increased interest among institutional investors, securing commitment from traditional investors continues to be a challenge. The approach to institutional investors needs to be structured in way that works for them and in a language they can understand. Initiatives, such as GIIN, ANDE and SOCAP, which build links between mainstream and social impact investors, can help to create awareness and increase interest. Institutional investors also have certain legal requirements which can create barriers to social investing (Wood et al, 2012).
The lack of efficient intermediation in the social impact investment market translates into higher transaction costs caused by fragmented demand and supply as well as complex deal structuring (Freireich and Fulton, 2009). The early stage of ecosystem infrastructure development impedes the dialogue between investors and social ventures, which makes it difficult to break down historical barriers between philanthropy and investment (Freireich and Fulton, 2009). Platforms are needed to provide accessible distribution systems and offer comparable product performance (Jackson and Associates, 2012). This will also allow better matching of investor and investee risk/return profiles.
I fear that even skilled nonprofits and intermediaries will have trouble translating great ideas into contracts that really provide the right incentives. When you look at how the parties do the accounting, how they measure “savings,” how they decide what the return should be and to whom at various break points, it gets inelegant, to say the least. – Clara Miller, President, F.B. Heron Foundation
But financial savings are not our primary motivation, nor are they what brings our government, nonprofit, and investing partners to the table. Rather, progress toward social outcomes is the key motivator — supporting people in their efforts to get and keep jobs, build healthy families, improve educational opportunities; in short, finding ways to help our society’s most vulnerable reach their potential. Yes, the potential cost savings for government in the long term are compelling, but only because it offers a path to meaningfully solve or reduce problems that have stubbornly persisted even in the face of decades of effort. – Tracy Palandjian, CEO, Social Finance