Since the world’s first pay for success project launched in the United Kingdom three years ago, the idea of governments “paying for success” using innovative public-private partnerships has sparked the development of pilot projects around the world. New York City launched the first project in the United States in 2011, Massachusetts will launch the country’s first state-level project (and the world’s largest to date) later this year, and President Obama recently proposed more than $500 million to support pay for success, or PFS, projects in the 2014 federal budget.
What are pay for success contracts, social innovation financing and social impact bonds, and why should government leaders care about this rapidly growing field?
An evolution in the pay for performance movement, “pay for success” is the general term for performance-based contracting between governments and social service providers, in which government only pays providers if target outcomes are achieved -- reduced recidivism or improved health outcomes, for example -- as opposed to providing cost reimbursements. Where traditional performance-based contracts merely delay cost reimbursements until governments are able to certify a service has been provided, PFS contracts delay government payment until success has been determined. In other words, PFS contracts allow government to invest in what is currently working to address our nation’s most pressing issues, instead of spending trillions of dollars on what may have once worked, or what we hope will work.
Service providers need to be able to fund PFS project implementation, however, and the timing gap between starting a project, proving project outcomes and receiving government success payments can be significant -- up to five or six years. Few providers have the cash to operate independently for this long. Social innovation financing, or SIF, arrangements allow organizations to access upfront working capital to provide their services. While such arrangements can take various forms, the most common SIF model is the social impact bond, or SIB, an arrangement which allows private investors, from foundations to commercial banks, to fund pay for success projects through various means, including grants, program related investments and low-interest commercial investments. Depending on the details of a specific arrangement, government success payments can eventually repay these investors or replenish working capital to support the project’s sustainability.
The idea of paying for success is not entirely new to the public sector -- highways, power plants, low-income housing and other infrastructure projects are generally built using outcome-driven contracts. But determining success in the social sector requires more than just counting outputs, it entails rigorous evaluation of providers’ real-time outcomes. This generally requires randomized control trials, complicated endeavors historically considered too expensive to integrate into general government contracts. In today’s age of big data, however, researchers are efficiently and inexpensively using existing administrative databases to produce low-cost, high-quality, rigorous and real-time social intervention outcome evaluations. Including reputable independent evaluators in a PFS project is essential to determining a project’s success.
Given the rigorous standards and multiple partners required for PFS projects, deals must be developed thoughtfully and collaboratively. This model is not appropriate for every social challenge, and no two projects are exactly the same. Early PFS pilots are small compared to most government social spending streams, currently ranging from approximately $5 million to $40 million, and are focused on specific outcomes for well-defined, measurable target populations. PFS projects require service providers with a track record of measuring outcomes, the capacity to scale resources and providers with cost-effective programming. They also involve a strong cost-benefit analysis, including the ability to achieve priority outcomes and cashable savings for government.
Despite these considerations, governments should not allow the complexity of PFS partnerships to prevent them from pursuing innovative projects. Indeed, the reason so many state and local governments, from New York City and Massachusetts to Chicago and South Carolina, have decided to pursue PFS pilots is because of the need to invest in high-impact, outcome-driven social interventions while maintaining fiscal responsibility. Governments cannot afford to keep spending money on programs that don’t work, and PFS provides the opportunity to invest in meaningful results using a fiscally balanced approach.
John Grossman is a partner and general counsel at Third Sector Capital Partners, a nonprofit advisory firm focused on developing and financing pay for success contracts between government and the social sector.