Volume 9, Issue 1 | April 18, 2013

April 2013


Ian Galloway*
Federal Reserve Bank of San Francisco

I first read about the social impact bond in Emily Bolton and Louise Savelle’s excellent 2010 report, Towards a New Social Economy: Blended Value Creation through Social Impact Bonds.1 In it, Bolton and Savelle predicted that the bond could someday be “a significant source of finance for effective services addressing a range of social issues, delivering attractive returns to a wide range of investors and improving people’s lives.” Their prediction proved prescient. Social impact bonds have become a global phenomenon—now being tested in the United Kingdom, Australia, Canada, and more recently in New York, Massachusetts, and Ohio.2 As they increase in popularity, however, it’s useful to position the bond in a larger context. The “big idea” behind the social impact bond isn’t actually the bond itself; it’s that the social sector should be held accountable through ex post payments for evidence-based results rather than ex ante payments for promising programs. This idea, encapsulated in the phrase “Pay for Success,” promises to transform the social sector into a competitive marketplace that efficiently produces poverty reduction.

This issue of the Community Development Investment Review attempts to do two things. The first is to serve as a comprehensive resource for the most current thinking on the origins, models, and potential implications of Pay for Success. The second is to encourage readers to weigh its exciting potential against its possible pitfalls. Pay for Success is a tantalizing idea but it raises important questions. Are we privatizing important government services that should remain under public control? How can we accurately measure and enforce “success?” Can we guard against fraud? Can we effectively balance our often-conflicting goals of equity, efficiency, and efficacy? Understanding and answering these, and other, questions is a crucial first step before widespread adoption of Pay for Success tools.

Thirty-nine authors contributed to this issue of the Review. This diversity of opinion allowed us to present Pay for Success as a constellation of important concepts—not just as a monolithic idea rooted in the social impact bond. Our hope is that this diversity will help policymakers, investors, service providers, and foundations better understand their roles in future Pay for Success transactions. The volume is loosely organized into three sections:
1) Background and Context, which highlights potential benefits and hazards, including ethical implications; 2) Roles and Responsibilities, which explores the participants involved in Pay for Success contracts and their respective responsibilities; and 3) Applications and Models, which profiles existing service interventions ranging from homelessness to foster care, and the various Pay for Success financing structures that support them.

As Daniel Stid points out in this issue, Pay for Success is not a panacea. Nevertheless, it offers an attractive alternative to the status quo of paying for programs instead of results. Despite our best efforts, the poverty rate today is roughly what it was when the War on Poverty began in 1964.3 We are winning important battles but losing the war. A new social policy paradigm is needed. Pay for Success financing has the potential to improve the social sector’s effectiveness by rewarding programs that work, encouraging innovation, validating progress, and attracting private capital to the anti-poverty cause. As George Overholser and Caroline Whistler write in this issue, it would “redirect and refocus our abundant resources, relentlessly, toward the innovations that demonstrate an ever-improving ability to deliver the results our communities need.” Certainly, important questions remain about Pay for Success. Equally important, however, is can we afford to pay for anything less?

* It takes a village to publish a journal. In particular, I would like to thank Caroline Whistler and Steven Godeke for their counsel from the outset and for introducing me to the rich community of practice that supports Pay for Success efforts around the world. I would also like to thank David Erickson, Scott Turner, Ellen Seidman, and Theresa Stark for their invaluable feedback and edits. This journal would not have been possible without their support.

1. Emily Bolton and Louise Savelle, “Towards a New Social Economy: Blended Value Creation through Social Impact Bonds.” Social Finance UK, March 2010.

2. Robert Hahn and Peter Passell, “Bonds, Social Impact Bonds.” US News and World Report Economic Intelligence Blog, November 15, 2012.

3. The official national poverty rate dropped from 17.3 percent in 1964 to 15 percent in 2011. U.S. Census Bureau, Annual Social and Economic Supplement (ASEC) to the Current Population Survey (CPS).

The views expressed are not necessarily those of the Federal Reserve Bank of San Francisco or of the Federal Reserve System. Material herein may be reprinted or abstracted as long as the Community Development Investment Review is credited.

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Table of Contents

Community Reinvestment Act (CRA) Banks as Pioneer Investors in Pay for Success Financing

Steven Godeke, Godeke Consulting

Pay for Success (PFS) financing, sometimes known as social impact bonds (SIBs) or social innovation financing, has attracted much attention because it offers the promise of governments paying only for successful programs while increasing funding for prevention programs by accessing capital markets. To understand the emerging PFS investment landscape and determine the structures and investors that are most likely to attract incremental capital, we spoke with more than ninety investors and other stakeholders as part of an eight-month research project.

The Real Revolution of Pay for Success: Ending 40 Years of Stagnant Results for Communities

George Overholser and Caroline Whistler, Third Sector Capital Partners

Pay for Success (PFS) contracting, social impact bond financing, collective action, impact investing, human capital performance bonds–these are all fascinating and powerful ideas. But the big idea that unites them is progress.

Pay for Success is Not a Panacea

Daniel Stid, The Bridgespan Group

Our society needs Pay for Success (PFS) schemes to work. We are spending too much on social programs that do not generate results, too much on high-cost treatments, and not enough on lower cost and more humane prevention. Amid our deteriorating fiscal state, we must figure out how to do more with less.

The Promise of Pay for Success

Jonathan Greenblatt, White House Office of Social Innovation and Civic Participation and Annie Donovan, White House Council on Environmental Quality

The president’s fiscal year 2014 budget demonstrates that we can make critical investments to strengthen the middle class, create jobs, and grow the economy while continuing to reduce the deficit in a balanced way. Pay for Success (PFS) fits squarely in this strategy.

Social Impact Bonds: Lessons Learned So Far

Hanna Azemati, Michael Belinsky, Ryan Gillette, Jeffrey Liebman, Alina Sellman, and Angela Wyse, John F. Kennedy School of Government, Harvard University

Although Pay for Success (PFS) contracts have received widespread attention in the United States and abroad, there is nothing fundamentally new about governments paying for outcomes.

Pay for Success: Understanding the Risk Trade-offs

Kristin Giantris and Bill Pinakiewicz, Nonprofit Finance Fund

Pay for Success (PFS) financing is a relatively new concept in the United States, with great potential for improving the social sector and government efficiency.

The Ethics of Pay for Success

Jodi Halpern and Douglas Jutte, University of California, Berkeley

Every application of Pay for Success (PFS) financing (e.g., recidivism, health care utilization, special education) must meet clear, measurable goals to obtain “payout” funding. Much of this journal focuses on how to structure contracts to achieve these goals. But larger questions remain.

Learning from the Low Income Housing Tax Credit: Building a New Social Investment Model

Barry Zigas, Consumer Federation of America

In this issue, Terri Ludwig notes the parallels between the Low Income Housing Tax Credit (LIHTC) and social impact bonds (SIBs). She rightly points to their public-private structure, market-based pricing, and built-in program accountability measures as evidence of commonality. Importantly, however, the forces that led to the creation of the LIHTC program were rooted in a different set of priorities than those currently undergirding SIBs.

Using Social Impact Bonds to Spur Innovation, Knowledge Building, and Accountability

David Butler, Dan Bloom, and Timothy Rudd, MDRC

In this article, we propose a vision of a social impact bond (SIB) model that moves beyond just achieving cost-savings to spurring innovation, knowledge-building, rigorous evaluation, and, potentially, outcomes that go beyond cost savings.

Social Impact Bonds: Using Impact Investment to Expand Effective Social Programs

Luther Ragin, Jr., Global Impact Investing Network and Tracy Palandjian, Social Finance Inc.

To address the wide-ranging challenges facing the United States, collaboration among philanthropy, government, and the investment community is vital. Social impact bonds (SIBs) offer a new way to advance cross-sector partnerships and introduce innovative financing solutions to scale proven preventative social programs.

Innovation Needs Foundation Support: The Case of Social Impact Bonds

Kippy Joseph, Rockefeller Foundation

For more than 100 years, philanthropy has taken risks other sectors either would not or could not take to advance innovations benefiting poor or vulnerable people.

Pay for Success: Opportunities and Risks for Nonprofits

Laura Callanan and Jonathan Law, McKinsey & Co.

Across the United States, a variety of social sector stakeholders are looking to “pay for success” (also known as pay for results or pay for outcomes) approaches to enhance the reach and impact of social programs.

Success Begins with a Feasibility Study

Robert H. Dugger, ReadyNation

Pay for Success (PFS), a form of social impact financing, is receiving international attention as a way to pay for scaling up high-return interventions, ranging from prisoner rehabilitation to infant health. It is attractive because risk of failure is shifted from taxpayers to the private sector; if programs don’t work, government doesn’t pay. Government pays for success by rebating a large portion of the savings from programs that work to private investors in those programs. If there are no savings, that is if interventions do not reduce government costs, there is nothing to rebate to investors. In this article, I review contracting and time-to-completion considerations with particular attention to feasibility studies, the critical first stage of establishing a social impact finance program.

Government’s Role in Pay for Success

Kristina Costa, Center for American Progress and Sonal Shah, Case Foundation

Pay for Success (PFS) financing mechanisms, including social impact bonds (SIBs), provide opportunities for multiple stakeholders with different expertise—government, private investors, foundations, and service providers—to work towards common goals. For government agencies at all levels, PFS mechanisms create opportunities for the public sector to reward “what works” or expand access to evidence-based preventive social interventions without requiring taxpayers to shoulder all of the financial risk upfront. But in order for these new mechanisms to work, government must retain a central and important position.

Rikers Island: The First Social Impact Bond in the United States

John Olson and Andrea Phillips, Goldman Sachs

In August 2012, Goldman Sachs Bank’s Urban Investment Group (UIG) announced the first social impact bond (SIB) in the United States, a $9.6 million loan it would make to support the delivery of therapeutic services to 16- to 18-year-olds incarcerated on Rikers Island.

Human Capital Performance Bonds

Steve Rothschild, Invest in Outcomes

The concept of the “new normal” has infiltrated the thinking of policymakers, employers, and service providers. Brought about by demographic and technological changes, the new normal demands change: business as usual will no longer work.

Pay for Success: Building On 25 Years of Experience with the Low Income Housing Tax Credit

Terri Ludwig, Enterprise Community Partners, Inc.

Pay for Success (PFS) has been touted as the hot new innovation in social investing. Over the past year, investors and governments across the country have committed millions of dollars to exciting new tools like social impact bonds (SIBs), which deliver a financial return only when specific social goals are met. But this approach is not new.

Can Pay for Success Reduce Asthma Emergencies and Reset a Broken Health Care System?

Rick Brush, Collective Health

In this article, I look at a path forward for one chronic condition, childhood asthma, and the potential for spreading this approach to the broader health system.

Supporting At-Risk Youth: A Provider’s Perspective on Pay for Success

Lili Elkins, Roca Inc.

Roca is currently negotiating with the Massachusetts Executive Office for Administration and Finance to establish one of the first Pay for Success (PFS) pilot projects in the United States.

Tax Increment Finance: A Success-Driven Tool for Catalyzing Economic Development and Social Transformation

Toby Rittner, Council of Development Finance Agencies

In the wake of an economic downturn, many cities are left with sites, projects, districts, or entire urban cores requiring redevelopment. The need for social improvements such as community centers, school rehabs, and parks has also become a critical development challenge. However, the ongoing risks of the development market require communities to be even more diligent and aware when entering into the use of public financing mechanisms such as Pay for Success (PFS) financing. One such mechanism, tax increment finance (TIF), has the potential to forge a new path for communities to fund development projects on the basis of their success.

Bringing Success to Scale: Pay for Success and Housing Homeless Individuals in Massachusetts

Joe Finn, Massachusetts Housing and Shelter Alliance and Jeff Hayward, United Way of Massachusetts Bay and Merrimack Valley

Valentino became homeless after struggles with gambling and alcohol addictions left him with nothing. For more than a decade, Valentino stayed in shelters in the Greater Boston area—or in the hospital. Valentino had three heart attacks while he was homeless, each one worse than the last. He was unable to take care of his health without a stable, safe place to live. Now, Valentino lives in permanent housing through the Massachusetts Housing and Shelter Alliance (MHSA) Home & Healthy for Good (HHG) program, which is a partnership between MHSA and its member agencies like Pine Street Inn, where Valentino lives.

Making Performance-Based Contracting Work for Kids and Families

Patrick Lawler and Jessica Foster, Youth Villages

Done right, performance-based contracting (PBC) offers a win-win-win to government, providers, and, most importantly, the people being served. Government spends funds more effectively, higher-quality providers thrive, and recipients get better services. Take Tennessee’s experience introducing PBC to its child welfare system.