Pay For Success

Pay For SuccessPresident Obama’s 2012 budget includes an innovative proposal called Pay For Success that has the potential to revolutionize the way the government provides funding for social services. The program creates a framework for government payments to be contingent on positive program results rather than paying for program delivery. Pay For Success is a nonpartisan program that should be embraced by politicians from both sides of the aisle who want to see better results from social programs and more cost effective use of government funds.

The US government frequently provides social services such as kindergarten readiness programs for disadvantaged children or employment services for welfare recipients by paying social service providers to deliver a program. The results of these types of programs are often not assessed and when they have been, their effectiveness has often been called into question.

Under the Pay For Success model, the government would contract with an intermediary for the delivery of specific results. The intermediary would then contract with one or more social service providers in a bid to create the results in question. If, and only if, the results were actually shown to have been achieved after rigorous evaluation by independent evaluators, the government would make payments to the intermediary.

While performance based contracts have existed for a while, Pay For Success adds another important layer – private or philanthropic capital that funds the intermediary during the time prior to them receiving success based payments from the government. Unlike a grant, in the Pay For Success model, the funders would have the potential to recapture their initial invested principal plus a rate of return. While it is expected that philanthropic funders will be the first entities willing to provide such funding, if the Pay For Success model is shown to work, impact investors or profit-seeking investors may become sources of capital as well.

The core innovation of this model is a transfer of the risk that a program will actually work from the government to the intermediary and its funders. Once the programs demonstrate their effectiveness, the government can reallocate its spending to now proven solutions.

While this model would be attractive to the government in a variety of cases, it is particularly compelling when program success will result in cost savings for the government, such as when employment training for welfare recipients reduces future welfare payments. Some government officials refer to Pay For Success as an opportunity to shift government spending towards preventative programs and thereby reduce the need for very expensive safety net services.

For funders, Pay For Success provides a new investment option, one where the financial return is directly dependent on social results. While many impact investment options exist that offer both a financial and social return, the two are rarely directly linked. Microfinance investors for instance earn a return based on the rate at which borrowers repay their loan. Microfinance may very well be a useful tool for creating social benefits, but the social and financial returns are two separate outcomes of the investment rather than the financial return being a result of the level of social benefits.

In other words, with most impact investments, the financial return can be realized even if the social return fails to materialize. Pay For Success funders on the other hand would receive financial returns that were directly dependent on the realization of social returns.

The Pay For Success model opens the doors to a wide range of capital – from market rate investment capital to philanthropic support – being used to finance innovative social programs that produce better results at lower cost to tax payers.

But at its heart, Pay For Success is not just a financing or cost savings program. Its success hinges on whether the intermediaries and nonprofits that participate in the program are able to deliver measureable results that are superior to current government programs. Pay For Success offers an opportunity for the social sector to showcase the potential of the current push towards results based philanthropy. If the program succeeds, the payoff will be a dramatic increase of funding for effective nonprofit programs.

The Pay For Success model will not be appropriate for all social services. For the model to work, the government and intermediary must be able to accurately track the results of the program. In areas like school readiness or employment services, the government is already tracking much of the data needed to determine the level of program success. But there are many areas in which program results are difficult to accurately track or the benefits are so long term in nature that it would not be feasible for the intermediary to finance the program since government payments for success would not be triggered until far into the future.

The Pay For Success proposal is a pilot program and we need to learn much more about the model before it can be determined whether the concept will work well in practice. In the early stages, Pay For Success programs should focus on areas where nonprofit programs have already undergone rigorous evaluation to prove their effectiveness and where positive program results would produce significant cost savings to the government.

The government is by far the largest funder of nonprofit services. Today, those funds are rarely dependent on the effectiveness of a given program. The Pay For Success model offers a promising approach to directing government funds so that they achieve better social results at lower cost to tax payers.


  1. Jacob M says:

    I have real mixed feelings about such a proposal. Certainly the upside (as Sean lays out well) is that this sort of scheme has to potential to create a more efficent market for social services provided by government funds. Perhaps even more promising to tax payers is the ability of the government to learn what the “true value” of an outcome is and adjust the price its willing to pay over time. This might help allocation issues if the government either under/overestimates the “true cost” of achieving its desired outcomes.

    While all this sounds great, to me the question whenever anyone sets up an incentive-based system that uses outcomes is a question of monitoring. No Child Left Behind’s effect on state education standards is probably the best recent example of this – when the Feds asked the states to hold their schools accountable for passing State tests, most states just dumbed down their tests so students would pass.

    There’s a similar issue at play here. If the intermediaries get compensated for the outcomes which they fund, there better be some independent entity that is collecting the data and ensuring quality. Otherwise, there will be strong pressure, especially if investors get involved, to deliver on those outcomes.

    While some of this pressure might lead to program efficiencies, it also will encourage people to game the system. Outright lying about outcomes might be possible to catch, but other more subtle methods such as “creaming” for the least needy may prove more difficult. And even if on paper outcomes may look good, the neediest people may become more likely to be overlooked.

    In sum, I’m hopeful…. so long as their is sufficent resources and thought put into designing monitoring systems for data quality.

    • You make a very important point Jacob. Hopefully I’ll be publishing a counter argument on Pay For Success from another author. After that, I’ll tackle some of the critiques with yours being an important one.

  2. Melinda Tuan says:

    Pay for Success is an interesting model, akin to the Social Impact Bond experiment in the UK. I think Jacob M’s warnings about “creaming” as well as appropriate monitoring are spot on. In addition, I think very careful attention must be paid to the projected positive outcomes of a program and whether those are intended to generate cost savings for the government.

    In my experience with social return on investment (SROI) at REDF, where we tried to calculate the social savings to society generated by nonprofit social enterprises that employed formerly homeless individuals, I clearly recall at least one important finding from that work.

    We funded a fabulous nonprofit called Youth Industry that tried to get homeless youth off the streets and into wage-earning jobs in social enterprises such as a thrift store, bicycle repair shop, neighborhood restaurant, etc. The positive outcomes achieved in the lives of these homeless youth were remarkable. Based on follow-up interviews conducted two years after youth were hired at a Youth Industry enterprise, 72% of youth were still employed, and 45% were living in a stable home (as opposed to 81% at time of hire).

    However, the youth were also using more social services at two-years after hire than they were at the time of hire — which meant they were costing more to society than they had previous to being employed in Youth Industry social enterprise. Their “SROI” numbers were not good.

    But the real story is that these were youth who were largely disenfranchised from society at the time of hire: 76% had used illegal substances, 68% had mental health issues, 41% had a previous criminal conviction; and as a staff members said, “they were not working the system, they wanted to get out of the system.”

    The youth outcomes showing an increase in usage of social services provided by the government were a positive outcome for the youth. For example, they were re-engaging in society, accessing much-needed mental health services, and obtaining food stamps to feed themselves (as opposed to scrounging in the streets). In the case of these formerly homeless youth, costing more money to society was a step in the right direction towards their ultimate greater self-sufficiency and well-being.

    Sean, I was glad to see that you cautioned any Pay for Success program be piloted using effective programs with evidence of success AND where positive program results would produce cost savings to the government. It would be a huge mistake to simply assume that cost savings are tantamount to positive outcomes in individuals’ lives.

    • Thanks Melinda. I agree completely that lower government costs is not the only measure of social impact. In fact, I would argue that since philanthropy and government have different goals and roles, measuring philanthropy via government’s goals is misleading.

      However, Pay For Success is a government program. The goal of the program is making government spending more effective. That can be done via better outcomes per dollar spent, or lower costs for the same outputs.

      Your point about REDF’s successful program driving beneficiaries to use more government services is interesting. However, if you assume for the moment that those services were cost effective on an outcome-to-cost basis, then while it might have raised costs in the short term, it lowered long term costs.

      The creaming issue and the “teach to the test” issue are both really important.

      On creaming, the UK program uses “whole population” evaluation. I’m not an evaluation expert, but my understanding is that the program will evaluate against the drop in recidivism for the full prison population vs other prisons, meaning that they can’t “cream” the easiest to work with prisoners.

      The “teach to the test” issue cited by Jacob and by Peter York in the Chronicle of Philanthropy is of course important. But it is a failure of measurement, not an argument against measurement.

      If your goal is to make sure people don’t go back to prison, then tracking how many go back to prison is a pretty good metric. In education, if you are trying to supported an educated, civically involved citizenship while also preparing people for the work force, then standardized test scores are clearly not a useful standalone metric.

      I believe in measurement. I also believe that measurement isn’t easy, especially when you have complex goals. One of my favorite, commonsense examples is health. Your weight is a pretty poor standalone metric of your health. Focusing myopically on your weight is a very bad idea. But tracking your weight as one aspect of a more robust health tracking system makes a ton of sense.

      Warning people who want to set off on a health tracking program not to focus myopically on any one metric is useful. Telling people they shouldn’t try to track their health because effective tracking is complex, is not (not that you’re saying that, Melinda).

  3. Arthur Wood says:

    Sean – it is a long time since we last spoke in Dubai but as the person who is acknowleged by the UK Social Investment Bank as having given them the original idea of what has become known as a “social impact bond” , and presenting the idea to UBS Global Philanthropy forums and the Canadians since 2006 – you will allow me these few comments. I do this as there are some real misunderstandings of what this structure is and is trying and indeed what it could do. My comments are qualified in my old bankers hat as head of a Product development Unit of a major bank.

    First off you are quite correct it is not a Bond as such – it is what bankers know as Structured Product and as such is certainly very common in Europe Private Banking circles and with many instiutional investors. Thats is the reason when I first spoke about it publicaly in 2006 onwards I referrred to it as a Enhanced Social Investment Note or Contingent return model. SIB in the UK subsequently dubbed it an SIB. As an aside my hat off to them for there brilliance in getting the UK Tresury to accept the concept

    I however see no problems with Regulators as was implied by one post and no problem of any banker in London or NY understanding what it is.

    In terms of the framework for those of you with children you will recognise the nursey rhyme – This way – That Way – backwards and forwards over the Irish Sea – A bottle of rum to warm my tum – thats the life for me.

    In essence when you take all the mystique and buzz words out of financial product development much of it is in essence is just moving cash flows backwards and forwards.

    What this structure does is define a cash flow as a function of a social intervention – that cash flow does not just need to be the opportunity cost / benefit to Government as is currently proposed – it could also be applied to the opportunity cost to a company – legitimsed by the use of an L3C in the US or SELLP in the UK (which I have also been involved in). As an aside but I slightly digress an L3C or SELLP should also provide a mechanism to replicate these structures cost effectively to Social Entrepreurs and an easy compliance framework for Govt.

    In essence this flips the traditional model on its head – as opposed to a traditional grant and for profit model with social impact almost taggged on — this then creates a clear cash flow as a function of social impact.

    As any banker will tell you once you have cash flow you can create a whole range of fiancail products for social purpose. For example under this model if the cash flows were to be securitised (conceptually not that hard) – you would create instruments that would then trade as a function of the achievement of the social purpose. These could be traded on a social stock excahnge to ensure adherence to core values – and as a very positive aside create an entry and exit opportunity for the social capital market – the lack of a secondary market is a major detrient to investment in this market.

    A comment was also made that these are very risky – that is not a compliance issue as long as the risks are clearly laid out and would have to be – however it is worth noting that the standard position is that the Investor gets a negative 100% return – its called a grant. This offers them a return and if they help / pressure the outcome quicker a higher return

    The structure was designed so that this process drives creative destruction into the system – this will not be welcomed by all. But as a sector we should ask for the most part why do we have the same players as existed thirty years ago.

    The role of the corporate sector / investor in this structure is to incentvise and drive the quickest achievement of the social metric. It rewards results and incentivises innovation. For the Social entrepreneur it gives long stream income flows in support of there core compettnce – not as oppse to spending 50 cents on the dollar raising unleveraged unannuitised income – this surely should be welcomed.

    To the Metrics point – as in business – what ges measured gets done – so the definetion of the metric is the hardest bit – but logically will be applied where the highest social impact can be identified.

    If we get this right this structure also moves us towards outcome models – not Input how much money do we raise, nor Output – ie how many hospitals / services do we provide – but an Outcome asks a far more blunt question – How many children die in this area or How polluted is this river ? This will force intra and inter sectoral collaboration – what we all surely want and what we all intuitively realise is necessary to the major issues.

    This should NOT be seen as a bi lateral process for the social sector as it flounders to get money in an increasingly hostile fiscal environmement – the Minnesota Performance Bond proposal is classic in this regard – with no clear indication as to who will provide cash flow or take the risk – a mysterious “intermediary who has not been identifed yet” Perhaps Santa Claus and his eleves – see you at the North Pole….Best Arthur