Item 6. Pay for Success

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1 Item 6 Pay for Success 232

2 Pay for Success: What Does It Mean for First 5 LA? Special Meeting of the Board of Commissioners and Program and Planning Committee April 24,

3 Presentation Objectives Overview Pay for Success and Social Innovation Financing Discuss how PFS may apply to F5LA Share immediate PFS opportunities for F5LA 2 234

4 Pay for Success: Old Idea, New Application Pay for Success PFS Performance-based contracting within the social sector where government pays only if results are achieved. Social Impact Finance* SIF Financing that bridges the timing gap between government payments and upfront capital needed to run PFS programs. *Social Impact Bonds (SIBs) are a type of SIF 3 **Excerpt from Third Sector CA State Assembly Presentation, April 2,

5 Keys to Pay for Success Government/ Payor of Success Initiates contract and identifies intermediary and/or provider(s) End payer for successful outcomes, typically a government entity Service Provider Delivers service Receives complete cost coverage; may receive performance payments Investors Provide upfront working capital to intermediary/ providers May lose capital if project unsuccessful or be re-paid with government success payments Evaluator Supports rigorous evaluation design Measures progress towards outcomes based on contract requirements Intermediary Negotiates deal construction, identifies service providers and raises capital May also be contract holder and service project manager 4 **Adapted from Third Sector CA State Assembly Presentation, April 2,

6 Putting the Steps Together Government or other Payor of Success contracts with service providers, agreeing to pay for specific outcomes Investors provide necessary project financing Service Providers deliver services while Independent Evaluators measure success Government or other Payor of Success pays for outcomes achieved, repaying funders and/or service providers 5 237

7 First 5 LA Continues to Explore PFS Applicability Commissioned PFS Feasibility Study Examines whether any First 5 LA programs are wellpositioned for PFS Early findings Welcome Baby is well-positioned for PFS First 5 LA serves as the investor in the PFS structure What PFS means for First 5 LA s work 6 238

8 First 5 LA Applied To CA Pay For Success Initiative Led by Nonprofit Finance Fund and the James Irvine Foundation Applications were due the end of February Interviews in March Award announcement expected early May First 5 LA applied for Welcome Baby 7 239

9 Highlights from Irvine Application Early childhood is a critical time for support Findings from Pilot Community evaluation Funding to: Conduct an Economic Analysis Determine the cost-savings and which entities would incur the savings Build relationships with potential payors of success Structure the deal 8 240

10 Next Steps to Move Forward Nonprofit Finance Fund/Irvine Initiative Pending decision in early May Continued exploration of how to structure PFS 241

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12 Appendix

13 Where is PFS happening? States: Massachusetts, New York, Connecticut, Ohio, Illinois, South Carolina, Michigan, Colorado, Oregon Local Governments: Santa Clara County (CA), Cuyahoga County (Cleveland, OH), New York City, Salt Lake City (UT) Countries: United Kingdom, Canada, Australia, India, Brazil

14 Why Should a Payor of Success Consider PFS? Can shift nonperformance risk from government to investors Focuses on outcomes-based contract versus cost-reimbursement initiatives Independent evaluation creates transparency for all parties Attracts new forms of capital to the social sector for scaling Increase awareness of opportunity costs across multiple government agencies Increases data sharing and mining across agencies Creates opportunities to reinvest in successful programs and replicate over time 13 **Excerpt from Third Sector CA State Assembly Presentation, April 2,

15 When does PFS make sense? Government Leadership Net Financial and/or Social Benefit to Government Significant Unmet Needs and Targetable Population Risk Mitigation Credible Data 14 Service Providers with Capacity to Scale **Excerpt from Third Sector CA State Assembly Presentation, April 2, 2014 Interventions that Work 246

16 Pay for Success: Leading Change in Results-Based Contracting Published in the February 2014 edition of APHSA s Policy and Practice magazine BY: Caleb Jonas and John Grossman Introduction Two and a half years ago, our colleagues Drew von Glahn and Caroline Whistler wrote an introduction to Pay for Success (PFS) contracting in this magazine. They concluded by expressing their hope that concrete examples of Pay for Success projects would emerge in the United States to demonstrate and advance the viability of the concept they described. Their vision has begun to materialize as Pay for Success has grown into a burgeoning field of practice across the country. A small handful of Pay for Success contracts have been formalized or enacted, and many more projects are currently being designed or negotiated. Each project is unique in the details of its implementation and scope, yet they share an emphasis on results-based contracting for social services. In this article, we will review Pay for Success and Social Innovation Finance, describe the concept s essential characteristics, and discuss notable trends and examples from the field. Terminology Pay for Success contracting is as simple as it sounds in theory, though it represents a major change in government procurement practices. When applied to social services, it describes a contractual arrangement between a government entity and an independent provider (or providers) of social services. The parties agree that the government will pay the social service provider only if and when an independent evaluator has determined that the provider has achieved an agreed-upon level of social outcomes. Because many social service providers cannot afford to deliver services for several years while waiting to find out if they will meet their goals and get paid, PFS arrangements are often supported by Social Innovation Finance (SIF). Using this tool, service providers raise working capital at the beginning of a PFS contract from funders (philanthropists and/or socially motivated commercial investors) to pay for the cost of providing services. In exchange, the initial funders may receive a portion of any future government success payments that are contingent on the provider s performance. As a result, PFS providers receive the initial capital they need to provide services, while their activities are measured by an independent evaluator who is tasked with assessing whether the provider meets its performance goals. Social Impact Bonds is a phrase sometimes used to describe one kind of SIF. Growth in the United States Across the country, a few PFS initiatives have been fully negotiated and begun implementation. In New York City, a PFS project is underway to reduce rates of reincarceration among juveniles exiting the Rikers Island Jail. Another PFS pilot is under way in Utah that will expand preschool opportunities for at-risk children. Our organization, Third Sector Capital Partners, was selected by the Commonwealth of Massachusetts through a competitive procurement to participate in a PFS project aimed at reducing recidivism in the high-risk young adult population. This 1 247

17 project, which will be launched in early 2014, involves up to $27 million in success payments from the Commonwealth and has qualified for over $10 million in additional success payments from the Department of Labor. Third Sector is also working with Santa Clara County (California) and Cuyahoga County (Ohio) to design and implement PFS projects. Cuyahoga County has identified a target population and procured a PFS service provider, while Santa Clara County is planning to begin procurement and contracting for two projects. Finally, a number of states have announced their intention to pursue PFS, including Colorado, New York, Michigan, Connecticut, South Carolina, Illinois, and Ohio. Additionally, some cities and counties have started to explore PFS, including Washington, D.C., Santa Barbara County (California), and Chicago. When Does Pay for Success Make Sense? Based on Third Sector s experiences developing and participating in several of the first PFS efforts in the United States, we have identified eight components that must be present in a successful initiative: PFS projects represent a new way of doing business for governments and can only be implemented where there is government leadership that is ready to explore a new tool for contracting for social services. We believe that this leadership is most effective when it originates with the chief executive or the finance or budget agency. A project must then identify significant unmet needs and a targetable population that can benefit from the provision of a PFS-contracted intervention. A PFS project relies on the presence of credible data that can be used to identify a target population, and to design and evaluate an intervention. The government initiating a PFS project must then identify an intervention that works, one that seems capable of improving outcomes for the target population. The selected service provider for the PFS project must also demonstrate its capacity to scale, since the provider will likely need to increase the size and scope of its operations. The PFS and SIF stakeholders must work together to implement risk mitigation strategies that address the most pressing concerns of each involved. For example, a government would need to be satisfied that the population receiving PFS services is not left worse off if lenders pull out before a project is complete. Finally, to warrant implementation, a proposed PFS and/or SIF project must present a net financial and/or social benefit to the government or some other party that is willing to pay for the attainment of outcomes. Trends and Examples: Proving Interventions Work For a PFS project to successfully solicit SIF funds, the project must demonstrate a good chance of achieving its programmatic goals. Some funders might choose to invest only in those programs whose effectiveness has been validated through a rigorous randomized controlled trial (RCT). There are, however, a limited number of social interventions that have undergone such a thorough evaluation

18 In the Massachusetts young adult recidivism PFS project, for which Third Sector Capital Partners was selected as lead intermediary, the selected service provider, Roca, has not proven its efficacy through an RCT. However, Roca has two decades of experience delivering an intervention based on a combination of evidence-based practices and has collected extensive data on its programmatic outcomes, giving it a strong track record of successful outcomes to present to potential funders. Third Sector has witnessed the emergence of pilot projects where the merit of an intervention is tested prior to the development of a full PFS contract. In Fresno, California, for example, a collaboration of organizations has received philanthropic support to create a demonstration project to improve the health of low-income children with asthma. In this project, the partners hope to rigorously demonstrate the financial and social value of the intervention before finding investors and government payers to create a PFS contract. We anticipate that in future PFS efforts, governments will focus on contracting with service providers that deliver interventions whose effectiveness and capacity has been accepted after an RCT or quasi-experimental evaluation and which can produce cash-able government savings for each successful outcome. For this kind of project, like an initiative that can decrease the duration of foster care placements, a government would likely be willing to make payments on a shorter timeframe, without waiting for the statistical certainty required if payments are based on an RCT or other evaluation. Trends and Examples: Net Financial and/or Social Benefit As the PFS field has evolved, participating governments have learned that it can be challenging to construct a PFS project that produces sufficient cash-able government savings to generate repayment to SIF funders within the timing of a project. For instance, reducing a target population s utilization of an emergency room might result in decreased wait times for other patients, but that is a positive externality that has no direct financial benefit to government. As a response, some government officials have broadened their understanding of savings to include the avoidance of future costs. For example, there is compelling evidence that enrollment in high quality early childhood education can make a child less likely to require special needs education, as well as make toddlers less likely to commit crimes years in the future. For an early-childhood education PFS program, a government might be willing to base PFS payments not on solely on the short-term savings tied to a reduction in special-education referrals but on the present value of anticipated long-term savings attached to a reduced involvement in the criminal justice system. In Santa Clara County, where Third Sector is designing two PFS projects, the county government has directed us to pursue a PFS project in the area of chronic homelessness. The County is optimistic that placing the chronically homeless in permanent supportive housing will reduce the use of public services. Still, the County is primarily interested in using PFS contracting because of its emphasis on accountability and its potential to attract SIF. Most of the PFS projects currently under way in the United States seek to create financial savings by providing cost-effective, preventive programs that remove the need for government to provide a costly remedial program. In these cases, successful preventive programs create government savings that can be used to make success 3 249

19 payments. In the future, we expect that existing public spending streams might be converted to PFS contracts, allowing governments to achieve more impact for their funds. As an example, states and school districts might want to compensate Supplemental Educational Service providers on the basis of their success in improving student outcomes, rather than on a per-pupil basis. Trends and Examples: Risk Mitigation PFS contracting and SIF require a government to commit in the present to pay a variable amount of money in future years, depending on the performance of a provider. Because the duration of such a commitment can exceed the terms of many elected officials and the budget planning cycles for social services, governments must think creatively about how to assure SIF funders that they can expect to receive the payments they are owed. Massachusetts addressed this problem through legislative action, when a twothirds vote of the legislature committed the Commonwealth s full faith and credit to its PFS commitment. As a result, the state s credit rating will suffer in the event that it fails to meet its PFS obligations. In our response to the Treasury Department s recent Request for Information (published October 2, 2013), Third Sector proposed that federal and philanthropic funders could provide funds that would be used to repay investors if a government were to default on its obligation to SIF funders. This proposed counterparty guarantee would not be used to compensate funders if a PFS provider failed to meet its goals, but would serve to protect investors against the risk of government default. Looking Ahead As this field continues to grow, we are eager to see PFS projects become more creative and ambitious. We look forward to future projects that tackle challenges such as engaging multiple service providers to achieve collective impact, aggregating several SIF opportunities for interested funders, and drawing success payments from different governmental jurisdictions. We anticipate that Pay for Success and Social Innovation Financing advocates will continue to encounter challenges as they pursue major changes in government contracting, social investing, and programs. However, we firmly believe that these efforts can truly improve outcomes for our country s vulnerable populations