Pay-for-Success Financing: Beyond the Social Impact Bond

convergenceWhile social impact bonds have certainly captured the attention of the impact investing community globally, there’s a greater movement at play behind the development of similar tools and financing vehicles. In countries around the world, an important shift is taking place whereby governments, private sector players, foundations and other financiers are looking to fund measurable outcomes – not simply inputs and activities.

The pay-for-success or outcomes-based financing concept, which has a number of unique and potentially transformative characteristics, is a way to bring supplementary capital into the social sector. Over the past couple of years, the concept – and the social impact bond in particular – has generated a significant amount of attention. While the terms are often used interchangeably, it’s important to note that pay-for-success financing is not just the social impact bond (or any one type of vehicle). Instead, it’s an umbrella term that encompasses a variety of existing and emerging structures, some of which will be described in this post.

Paying for Success and Doing More With Less

Typically, government programs provide funding based on metrics that reveal how many individuals an organization is serving but little about how they are improving their lives. With pay-for-success contracts, however, the government pays for social and environmental projects after outcomes have been achieved, not based on the effort or promise of success. In this way, taxpayer dollars are used more effectively as public funds are directed to high-performing programs and services that produce their intended outcomes. And now more than ever, in a time of fiscal austerity, publicly funded programs must be measurably successful and designed to do more with fewer resources.

During a webinar hosted by Social Finance UK in February 2012, Toby Eccles, founder and Development Director, outlined several challenges the organization has encountered when developing social impact bonds and other outcomes-based finance products. Many of these were reiterated in a webinar held the following month by the US Department of Justice in partnership with Nonprofit Finance Fund. Some of the biggest barriers include demonstrating proof of concept, coordinating the multiple government departments that are often involved in addressing a particular social problem, growing the investment community, and building capacity among service providers for outcomes measurement.

Despite the barriers, exciting developments in pay-for-success financing are underway. Many of us are familiar with the Peterborough social impact bond that is being piloted in the UK (http://socialfinance.ca/blog/post/video-toby-eccles-explains-social-impact-bonds), so I’ll briefly describe two other examples that illustrate the range of approaches being tested in countries around the globe.

Minnesota was the first US state to pass legislation on pay-for-success contracts with $10 million designated toward human capital performance bonds (HUCAP) in Governor Mark Dayton’s July 2011 budget. The new performance vehicle will be issued in the US municipal bond market under the authority of the state. The process is relatively straightforward: the state will raise funds by issuing general obligation bonds, direct those funds to nonprofits that have created positive social outcomes and government savings, and use the cash unlocked through the savings to repay private investors such as banks, pension funds, individuals, and foundations.

Across the Pacific Ocean, the New South Wales (NSW) Government in Australia has plans to issue the country’s first social benefit bonds, instruments modeled after the UK’s social impact bond. According to NSW Treasurer Mike Baird, the government has been “overwhelmed” by interest in the bonds since they were first announced as a cost-cutting measure in 2011. Earlier this year, Baird announced that three private and community sector groups were selected to develop pilot bonds geared towards reducing foster care and preventing young criminals from returning to prison. Interestingly, to attract for-profit investors, the government was considering sharing some of the bond’s downside risk by purchasing the lowest tranche of the bonds.

Nigel Cowan, chief executive of Sydney-based Social Finance, believes that social benefit bonds have the potential to change the way social services are funded in Australia and to attract major investors. “This can’t just be seen as a change to the way government contracts with non-government organizations,” said Cowan in The Australian Financial Review. “This has to be a way to improve funding in a sustainable way for this whole sector.”

I couldn’t agree more with this statement, particularly when considering our own situation here in Canada (where we’re still in the very early stages of exploring outcomes-based financing models). It’s encouraging to read in Canada’s Budget 2012 that senior policy leaders recognize the need to continue exploring social finance instruments as a way to build government-community partnerships. Similarly, the Commission on the Reform of Ontario’s Public Services (the Drummond Report) recommends reforming “funding practices in the nonprofit sector … by focusing on measuring outcomes rather than inputs,” indicating a desired shift to pay-for-success financing approaches in Ontario.

Nonetheless, whether these plans and proposals lead to lasting, beneficial changes in Canadian funding practices still remains to be seen. In my view, the greatest challenge we face as a collective in moving towards a system that regularly channels limited resources to our most promising, high-performing programs is advancing the field of social impact measurement – fundamental to any outcomes-based financing mechanism. Until service providers are empowered with the resources, knowledge, and motivation to consistently measure, monitor, and manage their impact, it will be difficult – if not impossible – to “pay for success.”

Photo credit: http://www.flickr.com/photos/storm-crypt/410187354/

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