May 15, 2011 | Chronicle of Philanthropy
President 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.