Pay for Success/Social Impact Bonds: RFI

Transcription

1 Pay for Success/Social Impact Bonds: RFI Response from Capital Partners We are delighted to respond to the Pay For Success/Social Impact Bond RFI, and to be part of this very exciting and innovative movement. Who are we? Capital Partners is a nonprofit boutique investment bank. Our purpose is help capital flow into the social sector in healthy ways, and our focus is the fledgling Pay For Success/Social Impact Bond industry. We believe that financial intermediaries like ourselves will be vital to PFS/SIB success, just as they are to all the other capital markets that make our economy work. Our role: We can help to architect the initial vision of a promising PFS/SIB arrangement: Which issue? Which providers? Who plays the lead contractor role? How much capital is required? What are the impact targets? What is the payoff? Etc. As a PFS/SIB transaction comes together, we can help to identify and coordinate the many steps that need to take place among providers, government, investors, lawyers, auditors, evaluators, administrative agents and others. If a service provider hopes to participate in a PFS/SIB deal, we can assess whether it is capable of doing so, and, if not, identify the gaps that need to be closed. If risk capital needs to be raised for a SIB transaction, we can help to quantify how much is needed, draft a detailed investment prospectus, and support the capital raising process. If SIB investors need a better understanding of a SIB/PFS deal's risks and rewards, we can conduct due diligence on their behalf. If the parties of a PFS/SIB transaction need a better understanding of the interplay between funding, performance and returns, we can build and communicate detailed financial models. As contracts between the government, investors, lead contractors and administrative agents are negotiated, we are able to advise how they might best be structured, and to furnish detailed proposed contract terms. 1 As transaction specialists, we do not plan to play an intensive post-transaction management role. We do plan to monitor the outcomes of the deals we have supported, and to facilitate follow-on investments.

2 Our core team: George Overholser, a Boston-based former venture capitalist and member of Capital One's founding management team, has spent the last ten years working full time to advance nonprofit capital markets. As the creator of NFF Capital Partners, a boutique nonprofit investment bank, he innovated the philanthropic equity concept, helping 16 high-performing nonprofits secure over $300 million in equity-like growth capital. Mr. Overholser is a recognized thought leader in the field of nonprofit finance and first pitched the idea of providing SIB-like philanthropic guarantees to government in Over the past twelve months, he has participated energetically in PFS/SIB discussions at the federal, state and local levels. Drew von Glahn has for twenty-five years held senior positions in investment banking, at the predecessor firms to J. P. Morgan and at Credit Suisse First Boston. There, he worked in the areas of corporate finance, capital markets, project finance, venture capital and public finance, implementing numerous first-of-kind solutions for corporations and governments. He recently was the CEO of the behavioral health social venture of the Alliance for Children and Families. He has co-authored several papers on the PFS/SIB construct, including recent papers for the Federal Reserve Bank's Community Development Journal and for APHSA's Policy & Practice Journal. Caroline Whistler recently returned from a Fulbright Fellowship in Brazil researching nonprofit sustainability and philanthropy with Ashoka, where she analyzed the Brazilian philanthropic sector and potential for impact investors. Previously, Caroline was an analyst for NFF Capital Partners, providing transaction analysis and structuring for the growth capital campaigns of high-performing nonprofits. She is a Robertson Scholar from Duke University with degrees in Political Science and African Studies. 2

3 A Perspective on PFS/SIB Before diving into particulars, we would like to make some framing comments about the fledgling PFS/SIB innovation. The most profound feature of the PFS/SIB innovation is its shift to a procurement system that focuses on social outcomes, not inputs. A well-structured PFS arrangement frees up providers to innovate and invest in ways that a prescriptive cost reimbursement system simply does not permit. It invites investment towards innovation, and it replaces Fund What Once Worked with Fund What's Working Now. By layering SIB financing onto PFS contracting, we address several of its most significant obstacles. SIBs shift risk of failure away from government. SIBs provide private financing to a sector that is profoundly strapped for cash. SIB investors are disciplined and help to maintain focus over periods of time that may outlive the tenure of government champions. SIB investors bring valuable skin in the game due diligence and risk management know-how to government contracting. And SIBs bring added transparency to a system that can sometimes feel byzantine and obscure. Administrative data is a key enabler. Contingent contracting is certainly not new to government. Nor is the private financing of government receivables. But without rigorous, affordable and welltrusted metrics, the PFS/SIB vision will never lead to large-scale improvements to our social and fiscal outcomes. We believe there is a quiet revolution taking place: for the first time, fueled by advances in information technology, administrative data can now be captured in a way that truly produces rigorous, affordable and trustworthy measures of social impact. Indeed, before recent advances in administrative data management, most PFS/SIB contracts would probably be untenable. Administrative data is ongoing: movies, not snapshots. This provides the feedback loop needed for program management and continuous improvement. Administrative data makes it easier to create standard metrics. Administrative data lends itself well to Randomized Control Trials (RCTs). It makes it easier to use whole populations (like a whole prison, a whole school or a whole zip code) as the unit of analysis. This helps to overcome issues of skimming or creaming that are of central concern to RCT designs. Also, in a randomized way, administrative data make it easier to employ the elegant comparative interrupted time series methodology that supports the UK SIB demonstration. We see great promise in the mining of multiple databases to understand the interconnection of actions in one area of government (education, for example) that may affect others (justice, healthcare and TANF, for example). 3 Ultimately, PFS/SIB needs to be about reallocations of government resources, not just infusions of private capital. Even if the SIB asset class were to become twice as large as the entire CDFI industry - $60 billion it would still represent only a small fraction of the nation's K-12 education budget, let alone TANF, justice, Medicaid and the many other government social spending streams.

4 How should Pay for Success contracts and Social Impact Bonds be structured? At this stage of the PFS/SIB industry's evolution, we believe it would be a mistake to pre-suppose that a best structure for PFS/SIB can be known. The respective pilots in the UK and New South Wales are materially different in structure. Indeed, the correct structure for any given PFS/SIB will depend strongly on specific circumstances, including the skills and preferences of the parties involved. For these reasons, we feel it would be best to allow PFS/SIB structures to cater to specific circumstances, and therefore to make future RFP language quite flexible in this regard. Below, we depict a form of the construct that is similar to the one piloted in the U.K. It makes use of both the PFS and the SIB features It involves a lead contractor that does not provide direct services It places 100% of nonperformance risk onto financial investors It provides investors with a positive return on investment And it depends on independent evaluators to assess impact 7. Government Program acheives social outcomes that meet government established targets Contracts 1.for Services Provides $ s 2.for Program Investors Return on 8.Investment Analysis of 6.Outcome Metrics Lead Contractor 3. The Lead Contractor selects, manages and funds service provider(s) Independent Evaluator Service Providers Social 5.Outcomes Target Population Social Services 4.are provided 1: The government contracts the Lead Contractor for services. 2: The investors provides the resources for the Program. 3: The Lead Contractor selects, manages and funds service providers. 4: The Service Providers offer social services to a target population. 5: The Lead Contractor manages providers to ensure social outcomes are met. 6: Independent Evaluators and Lead Contractor verify outcomes through rigorous processes. 7: Program acheives social outcomes that meet government established targets. 8: If social outcomes meet government set targets, investors receive a return on investment. Otherwise, government is not obligated to make any payments. 4

5 Alternatives to Consider As alternative structures are contemplated, we believe that it will be important to consider the following: Multi-year, contingent commitments from government are essential. As powerful participants in the negotiation process, both investors and providers will insist upon contract terms that are resilient and transparent. A main benefit of SIB investors is the role they will play in promoting long-term focus and transparency, even as the political process moves on to other matters. We are intrigued by the proposal put forth by Steven Rothschild in Minnesota whereby a general obligation bond would be floated to act as a pool of monies to be used for payouts against PFS contracts. Another idea is to use incentives from other levels of government to promote followthrough on PFS contracts. For example, the state could provide incentives to a municipality that is contingent upon seeing the PFS/SIB program through its originally contracted period. In some cases, the SIB component may not be desired. As a general rule, we would recommend that PFS-only deals be avoided during these formative years. But in some cases, providers may possess balance sheets, or bank lines of credit that are large enough to finance/absorb the risk of missing impact goals on a PFS contract. In these cases, a non-sib PFS may be viable. The lead contractor role could be played by any of three types of organization: financial, provider, or independent management company. We feel that all three approaches are viable, and that the choice will depend upon the specifics of each program. Financial. In the UK pilot, the intermediary plays a dual role. First, they act like an investment bank to put the deal together. Then, post-transaction, they take on the lead contractor role, managing a variety of procured services. Provider. So long as the provider's contract with government is PFS and outcomes-driven, we see no reason why a strong provider could not also play a lead contractor role. Typically, an investment bank would assist in the up-front structuring of the contract and the raising of SIB capital. Upon closing, the provider would take on the lead contractor role, using subcontracting to complement its own in-house capabilities. 5 Independent Management Company. It may be that professional lead contract management companies arise to serve the emerging PFS/SIB industry. This would be analogous to property management companies that are commonplace in the real estate development industry. They are professional operational managers and procurement experts that orchestrate delivery, monitor day-to-day operational performance, gather and report upon performance data, and otherwise ensure that adequate focus is kept on achieving project success.

6 In some cases, a sole provider, with no subcontracting, may be desired, in lieu of employing a lead contractor. For example, government may choose to contract directly with a particularly wellestablished and integrated provider of services. We believe that this may indeed be the right path in some cases, so long as the contract is outcomes-oriented and the provider has the full range of in-house capabilities needed to succeed. Financial investors need not absorb 100% of performance risk. Indeed, as is the case in the New South Wales SIB demonstration, we believe it likely will be helpful in many cases for the government to retain a portion of the risk. This may unlock private investors that would otherwise shy away, and, through skin in the game, would bring about greater alignment and transparency between government and the other PFS/SIB participants. It may be unrealistic to believe that early deals can offer market-level risk-adjusted returns to investors. We expect that most early PFS/SIB opportunities will not have high enough benefit-tocost ratios to produce market level returns on investment, especially when risk of failure is taken into account. Also, even if the monies were available, there will be a reluctance to create the appearance of enriching private investors with taxpayer monies. Thus, as was the case in the UK, investor returns will likely need to be capped at a lower rate than would be required to attract mainstream capital markets. Tapping into mainstream capital markets is a worthy long-term goal. But we don't see a strong downside to having early investors accept below-market risk-adjusted returns. Indeed, philanthropic investors might be willing to accept evergreen arrangements, whereby there is an obligation to reinvest all earnings back into the programs they have supported. In this way, welldocumented investment track records could be created, but issues of putting taxpayer money into the pockets of philanthropists could be set aside. Once PFS/SIB deals establish a track record (and this will take years), our view is that returnseeking financial markets will respond accordingly. Moreover, if history is a guide, tax legislation could become an additional stimulus to attracting large sums of additional private capital. For example, the Low Income Tax Credit was instrumental in sparking the growth of our large and flourishing CDFI industry. There may be pressure to exclude independent evaluators. Impact measurement is a notoriously subtle science. All too often, impact analyses seem to be compelling, even in the eyes of experts, only to be debunked when put to a more rigorous test. Indeed, whether it be in medicine or in social sciences, it has become clear that the world is full of false-positive evaluations. This is due to a large number of factors: underpowered experimental designs, publication bias, low-fidelity execution, wishful thinking, regression to the mean, and many others. For all of these reasons, we believe that the number one risk of PFS/SIB failure is tied to the possibility of non-rigorous evaluation. We are particularly concerned that PFS contracts could be designed in conjunction with non-rigorous evaluation. In this case, every party of the transaction might have good news to report, and yet society would be worse off. Thus, we feel the continued presence of highly rigorous independent expert evaluators, with a strong focus on counterfactuals, and a power to audit, is absolutely essential. 6 Several other types of firm will need to play independent supporting roles. An audit firm will need to be appointed to audit each PFS/SIB arrangement throughout its lifecycle, as will an administrative agent. (Administrative agents collect information as in compliance with contract language, manage cash flows in accordance to contract terms, and disseminate required

7 documentation/reporting to all parties.) The administrative agent role should be independent and not played by the lead contractor. What makes for a promising PFS/SIB opportunity? We believe that the PFS/SIB model fits best when there are: Social needs that are unmet, high-priority and large-scale Target populations that are well-defined and can be measured separately Impact metrics that are clear, valid and auditable Interventions that are highly likely to achieve targeted impact goals Service providers that are proven and prepared to scale with quality Cost-benefit propositions that are compelling Administrative, regulatory, legislative, evaluation process feasibility Which social service areas hold the most promise? Community-Based Services as a Replacement for Residential Treatment in Foster Care and Juvenile Justice. Several states have already made strong PFS inroads in the areas of redirecting youth away from expensive residential foster care and juvenile detention while also improving future recidivism. Several reputable and scalable providers seem to be poised to experiment with PFS/SIB in Massachusetts. Dropout Prevention and School Turnaround. Dropouts and graduation rates are strongly tied to juvenile justice, Medicare, TANF and tax revenue economics. Several providers have demonstrated an ability to move the needle for whole schools, which lend themselves to straightforward and rigorous evaluation. Philanthropic markets are interested in this area. Student Achievement Programs. We feel that early learning, summer learning, after school, and other education-related programs would be well-suited to act collectively as part of the wraparound philosophy that a PFS/SIB lead contractor arrangement fosters. Long-term fiscal benefits have been well documented. We expect that near term benefits may also hold promise. Medicaid. Medicaid spending is so large and lends itself so well to data analysis that we feel it will be important to float at least one Medicaid-oriented RFP. Asthma appears to be a particularly cost-effective area, with already existing capacities to roll out proven interventions. Transitional Care Nursing (led by Mary Naylor of the University of Pennsylvania) is a highly evidence-based intervention that reduces re-hospitalization profoundly. Nurse Family Partnership's home nurse visitation for first-time pregnant young women is also a highly proven, scalable and cost-effective program. 7 Homelessness. The homelessness area has many existing programs and providers, many of which have already experimented with extensive subcontracting and collaborations. In such a complex environment, particular care will need to be taken when framing up experimental designs that handle counterfactuals. Programs that target and prevent chronic homelessness, particularly heavy users of Medicaid, look promising as a cost-benefit proposition. Programs that divert families from the shelter system also show potential cost savings in Emergency Assistance.

8 Workforce Development. A growing number of interventions have been shown to produce rigorous impact and scalable models. Keys to the PFS/SIB include (a) creating experimental designs that overcome issues of skimming and (b) ensuring that the economic gains with placing an individual into a job are netted against the losses that may have been incurred as another individual is displaced from filling the same job. For more information, please contact: George Overholser - goverholser@thirdsectorcap.org Drew von Glahn dvonglahn@thirdsectorcap.org Caroline Whistler cwhistler@thirdsectorcap.org 8