| Notes |
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Pay for Success:
A Roadmap for Implementation in Minnesota
Capstone Paper
In Partial Fulfillment of the Master Degree Requirements
The Hubert H. Humphrey School of Public Affairs
The University of Minnesota
Aditi Kadam
Jared Swanson
Kyle Kretschmann
Min Lee
Nishank Varshney
May 9, 2018
May 8, 2018 May 9, 2018
Date of oral presentation Approval date of final paper
Mr. Dave Pinto
Prof. Judy Temple Mr. Rob Grunewald
Name and Title of Capstone Instructor Typed Name & Title, Client
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ACKNOWLEDGEMENTS
There are many individuals and organizations that provided help in various forms during the
writing of this report. However, we would like to start by thanking the 3 individuals who have been
with us throughout this entire process. We thank our wonderful instructor, Professor Judy Temple, for
not only providing our team with incredible guidance during the writing of this report, but also for
helping many of us during our graduate careers. We thank Representative Dave Pinto for his constant
and enthusiastic support despite his busy schedule. Finally, this report would not have come this far
without the involvement of Rob Grunewald. We are indebted to Mr. Grunewald for his generosity,
insight, and overall support.
The following individuals and their organizations aided our team when we needed targeted
help: Kevin Gerdes, Mary Lou Garza, Susan Viker, and Terri Barreiro of the Humphrey School of
Public Affairs; Brian Paulson of the Pohlad Foundation; Marcie Jefferys of Ramsey County; Lisa
Backer of the Minnesota Department of Education; Richard Chase of the Wilder Foundation; Rachel
Hardeman of the School of Public Health at the University of Minnesota; Margaret Kelly of the
Minnesota Management and Budget Department; Dave Greeman of the Minnesota Department of
Human Services; and Linda Li of Social Finance. We cannot thank them all enough for their time and
help. We are also really thankful to Andrew Harris for his help in proof-reading the report.
Finally, we would be remiss if we did not thank our friends and family. It was their day-to-day
support and love that got us all to this point. If we ever make the world a better place, it will be
because of them.
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Table of Contents
TABLE OF CONTENTS...................................................................................................................................... 3
EXECUTIVE SUMMARY................................................................................................................................... 4
PART I: PAY FOR SUCCESS – AN OVERVIEW........................................................................................... 5
INTRODUCTION.................................................................................................................................................... 5
HOW PFS WORKS................................................................................................................................................ 5
COST CONSIDERATIONS FOR A PAY FOR SUCCESS PROJECT............................................................................... 7
RISKS ASSOCIATED WITH THE PFS MODEL ........................................................................................................ 9
LIMITATIONS OF PAY FOR SUCCESS.................................................................................................................... 9
PART II: LESSONS FROM PAY FOR SUCCESS PROJECTS................................................................... 10
THE INNOVATION IN MINNESOTA PFS MODEL................................................................................................. 10
BARRIERS TO SUCCESS OF PFS IN MINNESOTA ................................................................................................ 11
THE CURRENT SITUATION OF PFS IN MINNESOTA ............................................................................................ 12
LESSONS LEARNED FROM PAY FOR SUCCESS LEGISLATIONS OUTSIDE MINNESOTA ....................................... 13
PAST & ONGOING PAY FOR SUCCESS PROJECTS............................................................................................... 14
PART III: HOW TO MAKE PAY FOR SUCCESS WORK IN MINNESOTA........................................... 16
FOUNDATIONAL ASPECTS ................................................................................................................................. 16
Statutes.......................................................................................................................................................... 16
Financial Mechanisms for a Pay for Success Model .................................................................................... 17
Timeline for a PFS Project............................................................................................................................ 20
ROADMAP FOR IMPLEMENTATION IN MINNESOTA............................................................................................ 20
Step 1 — Convening of Stakeholders ............................................................................................................ 21
Step 2 — Feasibility Study ............................................................................................................................ 22
Step 3 — Request for Information................................................................................................................. 22
Step 4 — Contracts and Risk Mitigation....................................................................................................... 23
Step 5 — Implementation .............................................................................................................................. 25
Step 6 — Evaluation...................................................................................................................................... 25
Step 7 — Assessing the Success of the PFS program.................................................................................... 26
RECOMMENDATIONS FOR INTERVENTIONS AND PROVIDERS IN MINNESOTA................................................... 26
Early Childhood Education........................................................................................................................... 27
Childhood Asthma......................................................................................................................................... 28
Child Dental Care ......................................................................................................................................... 29
Doula Care.................................................................................................................................................... 30
Homelessness ................................................................................................................................................ 31
CONCLUSION.................................................................................................................................................... 33
GLOSSARY......................................................................................................................................................... 34
APPENDIX.......................................................................................................................................................... 35
APPENDIX A – STAKEHOLDERS AND THEIR ROLE IN A PFS MODEL ................................................................. 35
APPENDIX B - RISKS ASSOCIATED WITH A PFS MODEL.................................................................................... 38
APPENDIX C – SUMMARY OF SELECTED PAY FOR SUCCESS LEGISLATIONS .................................................... 41
APPENDIX D - PAST & CURRENT PAY FOR SUCCESS PROJECTS ....................................................................... 43
REFERENCES.................................................................................................................................................... 49
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EXECUTIVE SUMMARY
Pay for Success (PFS) is a promising financing model that encourages investment in programs
that produce improved social outcomes resulting in future cost-savings for the government. In a PFS
project, investors provide initial capital to scale-up effective social programs and the government pays
back the investors only if the desired outcomes are achieved.
Minnesota emerged as a pioneer in this field, being the first U.S. state to enact legislation
authorizing a Pay for Performance pilot in 2011, even before the first PFS program was launched in
New York. However, despite having the legislation in effect for more than 6 years now, no PFS project
has been implemented in Minnesota. Meanwhile, over 20 PFS programs have been launched in other
states such as Illinois, Ohio, Colorado, and South Carolina among others, some of which have also
seen their first success payments made out to the investors.
This report describes the PFS financing mechanism and provides a set of recommendations for
the state government and other stakeholders to advance the implementation of PFS projects in
Minnesota recognizing the roadblocks that stalled implementation of the state Pay for Performance
Act. We present a set of steps through which PFS funding can be approached in Minnesota and provide
a list of program areas where PFS projects can be launched. The report also highlights the legislative
action that could move PFS projects ahead in the state of Minnesota and discusses some ways to move
forward in the absence of legislative involvement.
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PART I: PAY FOR SUCCESS – AN OVERVIEW
Introduction
Interest in finding alternative ways to fund social programs has led to an increased focus on
social impact financing or the PFS model. It is a financing mechanism where investors provide initial
capital to expand effective social programs and the government repays the investors only if the desired
outcomes are met.
Each year, governments spend hundreds of billions of dollars addressing social problems
(Liebman and Sellman 2013). Even though there is credible evidence that early investment in
preventive programs in areas such as early childhood education and healthcare can help avoid spending
on remedial programming later, thus saving money for the governments, they end up spending more on
remediation than prevention (Temple and Reynolds, 2007; Kozhimannil et al., 2013). One reason it is
difficult for governments to expand innovative preventive programs is that funding attempts at
innovation come with both financial and political risk. At the same time, tight budgets lead to underinvestment in preventive programs, even when doing so would lead to savings in the future (Liebman
& Sellman, 2013). The idea behind PFS is to create an investment opportunity in these program areas
and use the realized savings to pay back investors.
How PFS Works
The PFS model has the potential to improve social outcomes, overcome barriers to social
innovation, and encourage investments in cost-saving preventive services (Liebman & Sellman, 2013).
Under this model, public funds are distributed to proven interventions and the risk of program failure is
transferred from the public to the private sector.
The stakeholders involved in a common PFS program are the government, private investors, an
intermediary, a service provider, and an independent evaluator (For a detailed overview about each
stakeholder and their role, see Appendix A). As shown in the figure below, the government enters into
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a Pay for Success contract with the intermediary. The intermediary raises capital from the private
investors which is then used to expand and scale effective services.
Minimum performance targets, which are tied to government cost savings may be set prior to
the services being delivered. If these targets are not met, the government does not pay and the investors
lose their investment. However, if the targets are met, the government repays the investors. The
repayment is usually a stepwise increase in payment for performance that exceeds the minimum target,
with the highest performance generating the highest rate of return for the investors.
Measuring attainment of the performance targets is a crucial step in the PFS model and can be
challenging. The evaluation determines whether the investors are paid, and if so, how much they will
be paid. Factors such as sample size, time horizon, and program design can affect the difficulty in
obtaining a statistically valid measure of performance. Because of this, programs funded through PFS
Private Investors &
Philanthropic Funders
Intermediary Government
Service Providers
1. Investment 5. Principal + ROI
2. Working Capital
3. Outcomes & Savings
4. Performance
based payments
Fig. 1: Pay for Success Model
Adapted from: South Carolina Healthy Connections SIB Model
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are typically ones that have been implemented and evaluated in the past. The PFS model allows such
programs to be implemented in new places and scaled up to serve more people.
The PFS model might appeal to all stakeholders involved due to what it offers for each of them.
Through PFS, governments are able to encourage innovation in social programs and shift the risk of
this innovation from taxpayers to private investors. At the same time, they are able to save money by
only funding proven preventive programs (Liebman & Sellman, 2013). Service providers are attracted
to this model because it provides a source of multi-year funding while building a relationship with the
government that may continue to provide funding if the organization is able to prove they are
successful. Finally, investors are attracted to the model because they see an opportunity to promote
social good while earning a reasonable rate of return.
Some of the features of PFS projects can vary on parameters such as investor composition, risk
bearing models, and repayment conditions (Nonprofit Finance Fund, 2018). In the South Carolina’s
Nurse-Family Partnership project, the senior investor is a philanthropic organization that has agreed to
reinvest the success payments to extend the service period of the program instead of claiming it as a
profit. The PFS project at Rikers Island in New York City had Goldman Sachs as the private investor,
but Bloomberg Philanthropies provided a guaranteed grant as a backstop to Goldman’s investment
(Burand, 2013). Thus, Goldman Sachs was protected from large losses in the project, reducing the risk
on their investment. The risk of investment can also be shared between the private investors and the
intermediary or service provider. In this model, service providers may cover some of the upfront costs
of providing services and only recoup these costs if the targets are met.
Cost Considerations for a Pay for Success Project
For any PFS contract to generate returns for the investment, it has to not only justify the cost of
service provision but also cover the overhead charges associated with the program. This means that the
benefits from a PFS project have to be lucrative enough to cover the cost of providing services, the
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cost incurred by intermediaries to run the project, the cost of evaluating the program, and the costs for
setting up the legal contracts. All of these costs included, a typical PFS project runs in millions of
dollars. Current project costs range from $2.37 million in Ventura County to $30 million in South
Carolina (Nonprofit Finance Fund Project Tables, 2018). The current statutes in Minnesota allow the
offering of Pay for Performance bonds up to $10 million.
Since the payment to investors is tied to the future prevented expenditure by the government, a
rigorous impact evaluation is required to attribute the cost savings to the program. While an evaluation
consisting of a randomized control trial is considered the most effective method, in some cases where
it might not be feasible, other methods (e.g. propensity score matching) can be employed. These
evaluation methods add a significant cost to the project, with a rigorous and reliable evaluation costing
around 10% of the overall program budget. The costs of such evaluations, however, can be reduced by
using outcomes measures already collected in administrative data sets.
Negotiation of legal contracts also adds significant costs to the Pay for Success projects with
the legal costs adding up for all parties. Because PFS is in many aspects still in its infancy, there is
little reproducibility across projects, requiring contracts with different due diligence processes for each
project. However, as PFS grows and contracts become more standardized, contract negotiation costs
may decrease. Existing contracts are available online through the Nonprofit Finance Fund's Pay for
Success Learning Hub.
In some instances, as in Chicago's PFS project, contract negotiation expenses have been
covered by philanthropic organizations in order to reduce the cost burden on involved parties and to
encourage the implementation of the PFS projects (Nonprofit Finance Fund Project Tables, 2018).
Covering these costs is another way for philanthropic organizations to be involved in PFS projects.
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Risks Associated with the PFS Model
One of the rationales behind the emergence of the PFS model is to transfer the financial risks of
program performance from the taxpayer to other parties. Most investment models require risk-bearing
and risk-sharing through diversification and this is also true of the PFS model. In her paper, Burand
(2013) identifies the following categories of risks: intervention model, execution, intermediary,
political, financial, and reputational. The assignment of these risks to agents which have the highest
capacity to mitigate them is the ideal way to tackle these risks. Two of the more important risks arise
from the possibility that the provided service may not generate predicted cost savings or that the
government intended to be the payor may renege on the agreement. These risks and others are
described in detail in Appendix B.
Limitations of Pay for Success
While the PFS model seems attractive and beneficial to all the stakeholders and society in
general, there are certain criticisms and limitations of the model. Many early adopters theorized that
the PFS model would pave way for innovative interventions, but in practice, it has only scaled up
proven interventions due to the risks involved in pioneering new projects. The mechanism of PFS is
complicated and therefore, the complexities may leave many stakeholders feeling unsure about how
this funding mechanism works. Additionally, this model involves significant overhead costs associated
with the intermediary and the evaluation that could be avoided if the government were to directly fund
the programs.
Another criticism of PFS is that projects with easier-to-measure outcomes are usually chosen
over projects with outcomes that may be very important but require a longer time horizon to see the
most important effects. Additionally, because of difficulty in contracting with multiple governments
that may all potentially serve as payors, the chosen projects are typically ones that benefit one level or
agency of government, restricting a number of potential programs from getting funded.
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PART II: Lessons from Pay for Success Projects
In 2011, Minnesota attempted PFS with the passing of HF681/SF434, which authorized the
creation of a PFS pilot project (Temple et al., 2015). The bill passed as Section 27 16A.94 as part of an
omnibus bill, was signed in to law in July 2011. This approved up to $10 million in bonding for nonprofit service providers who could meet performance and value targets. Bonding was favored as the
basis for funding because the state of Minnesota faced a $6.2 billion deficit for the 2012-2013
biennium and did not have funds to directly allocate to a sinking fund (Minnesota Senate Fiscal Staff,
2010).
The Act gave implementation authority to the Department of Management and Budget (MMB)
who created the Pay for Performance Oversight Committee. The committee received proposals from
agencies towards potential cost savings from social programs with a goal to innovate within the sphere
of PFS financing and increase the funding of preventive programming. The use of bonds to fund PFS
contracts made the legislation easier to pass as part of a bonding bill but created higher costs for future
projects due to project’s returns needing to cover bond payments in addition to intermediary and
evaluator costs. To avoid costs from bond payments, the next efforts in PFS in Minnesota may involve
amending the funding source of this act.
The Innovation in Minnesota PFS Model
Minnesota was the first state to pass legislation authorizing the use of state bonds under the
name of human capital performance bonds (Temple et al., 2015). The state attempted to innovate by
being the first to use fixed-rate, fixed-term bonds as proposed by Rothschild (2013). Although no
intermediary was mentioned in the Pay for Performance Act, as implementation proceeded, the plans
involved shifting responsibilities for raising working capital and bearing risk, towards intermediaries
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and service providers. In the Minnesota model, as the investors buy bonds, the proceeds are set aside in
a state fund. Services providers do not receive initial funding at the time of service expansion and are
not repaid until the evaluation is completed years later. To receive payments, service providers must
show that they are creating sufficient cost savings to the state. Further, pinpointing where the cost
savings occur can be difficult. Securing working capital remains the responsibility of the service
provider and the selected intermediary. In this version of PFS, private investors technically are not
directly investing in interventions but rather in bonds that may eventually pay for service provision.
Barriers to Success of PFS in Minnesota
A number of interrelated issues have influenced the lack of adoption of Pay for Performance or
human capital performance bonds:
• There was a political failure to find a passionate champion, a leader who brings together all
stakeholders together and drives the program forward, during the process of implementation.
• The requirement for raising working capital and the risk associated with not meeting success
targets lay with the intermediary and service providers, who lacked the capacity to bear this
risk.
• The bill lacked support from service providers, due in part to fears of perverse incentives.
• The legislation passed included provisions about the timing of compensation for investors and
intermediaries that interfered with contract negotiation.
• The state agency charged with overseeing pilot wanted to satisfy political considerations that
would not necessarily maximize the likelihood of the pilot's success.
While the human capital performance bond model was the idea of an entrepreneurial private
citizen and nonprofit service provider, once the legislature approved the pilot there was no public or
nonprofit leader able to push the process forward with sufficient inertia to clear the concerns about
high administrative costs and large legal fees required to create a PFS contract.
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According to numerous interviews with area informants, the “wrong pocket problem” (for
definition, see Glossary) imposed constraints on the set of potential interventions. The two pilot
projects that were planned but were not implemented were the EMPLOY program (Duwe, 2015) for
recently released prisoners and a supportive housing pilot backed by the Corporation for Supportive
Housing. Ultimately the chosen intermediary for the EMPLOY program (the Greater Twin Cities
United Way) backed away from the implementation and no new intermediary was selected. Concerns
expressed by the intermediary included its willingness to bear risk as well as the insistence by the state
agency overseeing the pilot that for political reasons the services delivered should have a presence
throughout the state when the intermediary wanted to choose service delivery sites to maximize the
chance of success for the pilot. Without a pilot program, PFS has stalled in Minnesota due to a lack of
proof of concept as well as uncertainty about the status of the 2011 Act.
The current situation of PFS in Minnesota
The agency that may be the furthest along in terms of planning for the implementation of a PFS
project is the Minnesota Department of Education (MDE). In late 2016, the U.S. Department of
Education awarded feasibility grants to Minnesota and 8 other states for studying the use of PFS for
preschool programming. Minnesota's study involved examining the feasibility of using PFS to improve
the quality of newly state-funded Voluntary Pre-Kindergarten (VPK) program that expands access to
school-based preschool programs serving high poverty populations.
The PFS study currently underway involves examining the use of the Pyramid Model to
improve the quality of the VPK program. The Pyramid Model would be incorporated as a professional
development framework, training teachers on how to support social-emotional competence in young
children. The hope is that having teachers trained with the Pyramid Model will reduce behavioral
problems in the classroom, ultimately producing potentially monetizable outcomes (e.g. lower teacher
turnover, lower rates of special education placement, and higher rates of kindergarten readiness).
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A $400 thousand grant from the U.S. Department of Education has enabled MDE to partner
with SRI International, an independent consulting firm, to explore the practicability of using PFS
(United States Department of Education/Health, 2016). The study involves preliminary data analyses, a
prospective cost-benefit analysis, identification of potential PFS partners (payors, investors, etc.), and
development of the evaluation methodology. The feasibility study began in early 2017 and is expected
to be complete by late 2018. Pending the results, MDE hopes to begin securing funding from private
investors to expand the use of the Pyramid Model using PFS. As this report is being written,
interviewees point toward ongoing conversations on using PFS, including a plan for reducing county
justice system involvement for at-risk youth in the Saint Paul Public Schools as well as plans in
Ramsey County exploring use of PFS for supportive housing.
Lessons Learned from Pay for Success Legislations outside Minnesota
Starting in 2012 with New York City, several state and local governments have launched PFS
initiatives with considerable success. Some states passed legislation to facilitate PFS funding of social,
health, or human service projects. These legislative actions allow for the creation of PFS contracts,
establish how state or local governments can set aside cost savings in order to repay the investors,
designate who authorizes the contracts, establish a cap for funds, and create a flow of funds (Nonprofit
Finance Fund Project Tables, 2018). Thus far eleven states and the District of Columbia have
successfully enacted PFS legislation that provides a framework for project approval and the required
funding. An additional five states including Maine and Delaware have taken a separate approach of
passing legislation allowing for the study of PFS projects to be recommended to the legislature for
future funding. In the states that have provided a funding mechanism, nearly 82 projects are either in
progress or in development across the US (Nonprofit Finance Fund, 2018). There is a strong interest in
accessing the funds in the states that passed PFS legislation, as evidenced by the fact that each state
that passed legislation is currently developing or implementing a PFS project.
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The common mechanism across states is to establish a trust or sinking fund with a maximum
amount that can be appropriated for PFS contracts. A common appropriation cap across states is $50
million as seen in Texas and Massachusetts, though no state has approached that limit yet. Which body
appropriates and oversees funding is, thus far, the main difference in PFS programs between states. In
Texas the legislation enables the comptroller to act as the trustee who makes payments without
legislative appropriations, but the Legislative Budget Board must certify the contract. Any unpaid
funds are returned to the state treasury fund or its initial account. In Massachusetts, the Secretary of
Administration and Finance oversees the funds and the legislature is responsible for appropriations
each fiscal year which correspond to future savings. In Washington D.C. the Mayor enters into
contracts and fills the sinking fund with the amount of savings each fiscal year. Colorado has
established a dedicated fund for PFS and has also specified the roles of involved parties, defined where
the risk is located, and set a maximum project length of seven years. While the content of the
legislation can be flexible, having mechanisms to keep funds separate from the General Fund is vital to
any PFS legislation.
A detailed summary of PFS legislation in select states can be found in Appendix C.
Past & Ongoing Pay for Success Projects
PFS is still a relatively young concept. Only a few projects that have ended, many are currently
ongoing. We analyzed some of the notable PFS projects that encompass a wide variety of topics,
outcomes, and approaches. Table 1 provides a brief comparative analysis of six PFS projects and
valuable lessons learned from them. Overall takeaways include: not overpromising on outcomes in the
contract phase; using a short-term outcome that research ties to long-term savings; and that PFS
financing should serve as complementary funding for the service program, and not as replacement
funding. For more detailed information on these projects, see Appendix D.
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Table 1: Comparative analysis of six PFS projects
Project Peterborough Rikers Island South Carolina’s Nurse
Family Partnership
Utah High Quality
Preschool Program
Chicago Child Parent
Center
Cuyahoga County PFS
Location Peterborough Prison, UK Rikers Island, New
York
State of South Carolina Salt Lake County, Utah Chicago, Illinois Cuyahoga County, Ohio
Year of
Launch
2010 2012 2016 Pilot from 2006-2012,
PFS contract in 2013
2014 2014
Cost £5 million $9.6 million $30 million $7 million $17 million $4 million
Focus Reduce Recidivism Reduce Youth
Recidivism
Improve Infant/Early
Childhood health
outcomes
Early Childhood
Education and Special
Education reduction
Early Childhood
Education and Special
Education reduction
Homelessness and
Child Welfare
Status Ended in 2015 when policy
changes rendered the
comparison group invalid
Ended in 2015 when
project failed to reach
targets
In progress with success
payments reinvested in
expanding service
In progress with success
payments to investors
In progress with
success payments to
investors
In progress
Lessons
Learned
Intermediaries who nurture
the relationships of all other
parties involved and monitor
all the moving pieces are
critical. A trusted flow of
information between
organizations and access to
physical space improved
effectiveness. Different
payment triggering
components might be more
appealing to investors.
A well thought out
evaluation is a critical
part of PFS projects.
Tax-payers are not free
from risk. Private
investors are not always
willing to take on all of
the risk, foundation
backstops can encourage
greater risk taking.
External funders can be
philanthropic and might
expect no interest on their
return should repayments
be triggered. There are
ways around the wrong
pocket problem i.e.
Medicaid waiver. A feefor-service and Pay for
Success model can be
combined.
Using a proof-of-concept
year can be useful in
securing state level
investment. Using
simplified payment
triggers allows multiple
sources of funding to be
integrated. Identifying
short
term measurables that are
correlated with long term
outcomes is key.
PFS model is feasible
for programs such as
early childhood
education where the
returns are usually
observed much later in
life. Private lenders are
willing to enter PFS
contracts with periods
of repayment as long
as 17 years.
Integrated Data systems
are key to project
success. Senior and Subor
dinate investors can have
different
interest rates. Deferred fe
es can increase financial
interest in project
success. Indexing paymen
ts to level of project
success reduces risk for
all parties.
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PART III: HOW TO MAKE PAY FOR SUCCESS WORK IN MINNESOTA
This part provides a roadmap for how a PFS project can be implemented in Minnesota that
identifies the steps involved in initiating and carrying out a project. Additionally, we discuss potential
interventions that could be funded through PFS.
Foundational Aspects
Statutes
There are two Minnesota Statutes related to PFS (Minn. Stat. § 16A.94; Minn. Stat. § 16A.96)
that were passed for the state's pilot in 2011. The Pay for Performance Program (Minn. Stat. § 16A.94)
establishes a pilot to “demonstrate the feasibility and desirability of using state appropriation bonds to
pay for certain services based on performance and outcomes for the people served.” This statute
establishes an oversight committee, authorizes the commissioners of agencies to enter into pay-forperformance contracts with service providers, requires commissioners to establish evaluation methods
for the programs, and requires annual reports to the governor and appropriate legislative committees on
the pilot program. The second statute, Minnesota Pay for Performance Program (Minn. Stat. §
16A.96), authorizes the sale and issuance of appropriations bonds, up to $10 million for the purpose of
funding pay for performance programs.
These statutes require the state to sell bonds to pay for PFS projects, rather than allowing for
appropriations to be set aside into a trust or sinking fund, an approach that other states have taken. This
makes it more difficult, and potentially costlier to initiate a project as the return on investment must
also be large enough to cover the state's bonding cost.
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Financial Mechanisms for a Pay for Success Model
Various financing models have been proposed and implemented for PFS projects which can be
broadly categorized into two types. The first, and most common involves the government
appropriating the required amount of money into a trust or sinking fund prior to signing the PFS
contracts or during each year the project is in progress. The second does not require any funds to be set
aside prior to or during the PFS project.
The first method attempts to address the challenge that the cost savings may not be realized in a
typical two-year cycle of a state budget. Therefore, there is a need for a mechanism that allows funds
to be set aside beyond the two-year budget period. This could be achieved through laws that support
legal contracts and guarantee a future payment to the investors if the PFS program is successful.
States including Texas, Colorado, Massachusetts, as well as the District of Columbia, have all
set up dedicated sinking/trust funds for PFS projects where the amount corresponding to future savings
is to be appropriated each fiscal year that the contract is in effect. Some of the considerations for
establishing a set aside account are:
• This money could be appropriated by the state, either from the general fund or from the
department that is expected to observe the cost savings. It may be more feasible for the state to
appropriate the money from the general fund, if the state has a budget surplus.
• The set aside account could be created within the state treasury, like the state of Colorado, or
outside the state treasury, like the state of Texas. This could have an effect on the
administrative process of appropriation of the money for the state, and on paying the
intermediaries in the future, if the project is successful.
• In cases where projects fail to meet the targets, funds that have been set aside could be returned
back to the general fund or appropriate department, as is done in Texas. The funds could also
be kept in the set aside account and used for future projects, as is done in Washington DC.
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• Whether to set a limit on the amount of money that can be set aside should also be considered.
A number of states, including Texas and Massachusetts, have kept this limit at $50 million.
This would be a reasonable limit for Minnesota as well since most PFS projects are around $10
million.
Another promising mechanism that has been tried in Europe and is now expanding to the U.S.
is the outcomes rate card approach. Under this model, the government predetermines selected
outcomes, its measurement methodology, and sets a price for each outcome up front. It then issues an
RFP inviting private investors and service providers to work on the program. Unlike the abovementioned appropriation models, the bulk of the cost-benefit estimation work in the rate card approach
is done prior to issuing the RFP. This approach reduces the cost of carrying out an impact evaluation
since the outcomes and relevant metrics are determined prior to the project launch. It also has the
potential to solve the “wrong-pocket problem,” as the outcome payment can be divided among
different departments and across different levels of government. It also provides the ability to contract
with multiple service providers at the same time and is easier to expand.
There are, however, certain limitations to the prior appropriation of money for PFS projects. In
this model, the government would be expected to appropriate the full amount of funds corresponding
to the highest possible levels of outcome achievement, even though these levels may not be fully met.
This creates a problem of opportunity cost, as the same pool of money could be allocated to other
programs, rather than lying idle in a set aside account as a guarantee for potential success payments.
This could translate into a political challenge as well, since legislators may not be willing to
appropriate a large sum of money up front.
A slightly different method of obtaining funds for success payments was established by
Minnesota in 2011. The state opted for a financial model that secured funding using social impact
bonds. The limitations of this approach, discussed in the previous section, may impede the
19
implementation of PFS in the state. Creating a sinking fund where PFS funds can be appropriated prior
to or during the project, as other states have done, rather than the state relying on the sale of bonds to
fund the projects, seems to be the most feasible method. However, there may be certain political
hurdles to creating a sinking fund where some legislators might demand using this money for other
purposes. If the state is unable to create a method for setting aside funds, three potential alternative
methods which are outlined below could be considered -
One alternative could involve the intermediary or investors entering into a contract directly
with the unit of government that would save money if the project's targets are met. Success payments
would be made directly from the department's budget as the savings produced by the intervention
would reduce the funds required by the department. This approach has not been attempted in any PFS
project thus far. One barrier that this method faces is that, because success payments are taken directly
from the department budget, the financial savings must occur prior to the success payment. This may
limit projects to those that produce savings in a short time or require contracts that allow success
payment to be made farther into the future. Additionally, investors may be less willing to invest in a
project that does not appropriate the success payments up front.
A second way state and local governments can initiate PFS projects without appropriating
money before/during the project is by tapping into federal funding newly available for PFS. In early
2018, Congress passed the Bipartisan Budget Act that included $92 million for PFS projects and
feasibility studies (H.R. 1892). The new Social Impact Partnerships to Pay for Results Act (SIPPRA)
authorizes the U.S. Treasury to award grants to state and local governments for PFS projects related to
a range of issues. These grants could potentially allow states to fund projects with federal money,
eliminating the need to make appropriations.
A third possible way to finance PFS projects could be through a new legislation with the
support and involvement of philanthropic organizations. Under this mechanism, legislation allowing
20
private organizations to provide upfront cost of service provisioning would have to be passed, allowing
the savings accrued through the program to be shared with the investors. The legislation will also have
to be clear about who will evaluate the savings and the details of payback to the investors.
Finally, while it might initially seem challenging to carve out a sum as large as $10 million
from the state budget for a PFS program, for the state of Minnesota, which has a budget of
approximately $40 billion, it amounts to only 0.025% of the total state budget. In fact, it is only around
3% of the forecasted surplus of $329 million in the year 2018 (Berkel, 2018).
Timeline for a PFS Project
Stakeholders in the process, particularly legislative stakeholders, have an interest in a PFS
contract being completed within two years. This reflects the two-year budget cycle used by the state
and the desire by legislators to have the saving of the preventive spending accrue within a single cycle.
This has both - political value for showing immediate savings, and fiscal value by not tying up funds
across budget cycles. However, a two-year timeline is not feasible as the contract development, project
implementation, and its evaluation can rarely be completed within a two-year timeframe, making at
least a three to four-year timeline more realistic.
Roadmap for Implementation in Minnesota
The following roadmap provides a pathway for implementation of PFS in Minnesota. While the
steps are presented sequentially, the implementation need not necessarily occur in the order shown
below. This is particularly true with the first four steps as projects can begin in many ways. For
example, a project may begin with a conversation among key strategic partners including an investor,
selected community leaders, and representatives from the prospective government agency that might
serve as the payor depending on the nature of the program. These partners could commission a
feasibility study that would then suggest which other relevant stakeholders could be added to the
21
process. The steps listed can be iterative and occur in different orders. This roadmap is meant to
highlight the processes needed to implement a project.
Step 1 — Convening of Stakeholders
Pay for Success initiatives typically start with discussions among various stakeholders
including interested private funders, government agency representatives, nonprofit service providers
and interested community members. As mentioned above, these conversations could commence with a
set of key strategic partners, before a convening of a larger set of stakeholders occurs. The discussions
Step 1
Convening of
Stakeholders
Step 2
Feasibility Study
Step 3
Request for
Information
Step 4
Contracts and Risk
Mitigation
Step 5
Implementation
Step 6
Evaluation
Step 7
Assessing the
success of the
PFS program
Fig. 2: Roadmap for PFS
22
could arise due to shared interests in addressing a particular costly social problem or stakeholders
could be brought together with a common interest in PFS who will later identify the social problems to
be tackled along with the chosen intervention.
A common theme that emerged in our analysis is the need for a passionate champion for a PFS
project. Liebman (2013) notes that due to the significant coordination and effort required to implement
a PFS contract, these projects are only worth pursuing with a leadership team willing to devote the
time and energy to make it work. This champion can be an elected leader or appointed agency head
who drives the project forward. Alternatively, this champion may be a community leader concerned
about a particular issue.
Step 2 — Feasibility Study
A feasibility study is conducted in order to understand the potential outcomes and resulting cost
savings that could occur from the expansion of various social services while also identifying the
relevant level of government that might serve as the payor. This step is strongly suggested to
understand the context of the program and could be funded by philanthropic groups. Additionally, a
feasibility study can serve as a tool to build consensus for the intervention.
Step 3 — Request for Information
A Request for Information (RFI) is used to identify possible service providers. A well-designed
RFI ensures that the service provider selected has the experience, qualifications, and approach to help a
PFS contract succeed. Quality bids should be expected to include organizational background, project
goals, intended participants, timeline, location, evaluation capability, data tracking, budget of project,
and criteria for selection. Ensure that the request emphasizes future needs of the program, uses open
communication with bidders, and uses comprehensive decision making in selecting the service
provider. We recommend innovative and effective service should take precedence over price. Also,
consider state goals of working with targeted organizations that are majority women, minority, and
23
veteran-owned or located in an economically disadvantaged region. In total, administrative expenses
should be 10% or lower.
Step 4 — Contracts and Risk Mitigation
Contracts
To start a PFS project, stakeholders enter into a written agreement. In this step, the involved
parties agree upon the structure, payoffs, and timeline of the project. The contract phase is often
overseen by a project coordinator, the intermediary, that structures and manages risk. All parties
involved in the process must be included in this step. If a party is not involved in the process, it can
result in the contract requiring renegotiation which could extend the timeline of the project. Within the
process, each stakeholder attempts to protect themselves from risk. Differences in opinion about how
risk will be balanced and results will be measured, can lead to delays in implementation and possibly
failure of the project. Contract negotiation is part of the transaction cost of successfully implementing a
PFS model. We recommend including the following components in a successful contract:
• Program Description
• Goals of the contract
• Clear definitions of terminology
• Project timeline and cost
• Responsibility for underwriting and securing upfront capital
• Eligibility for services
• Responsibility for program promotion
• Data sharing and access
• Governance structure
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• Benchmarks and evaluation parameters
• Payment formula and schedule
• Termination clauses
• Limitation of liability for advisors to the project
• Randomization ratio and sample size
• Defining senior investor vs. subordinate investor payments
• Well defined flow of funds including initial funding and the flow of excess funds
Risk Mitigation Strategy
Because most PFS projects span multiple budget cycles of the legislative bodies that are
responsible for appropriations, nearly all of the current PFS project have an appropriations risk
mitigation strategy. Governmental appropriations are often subject to political and economic forces,
which can make obligations promised years into the future difficult to guarantee. Appropriations risk
mitigation strategies assure the investors that funds for success payments will be available if and when
the project’s outcomes are met.
Most current PFS projects have an appropriations risk mitigation strategy that involves setting
aside a portion of the total success payment annually or biannually, rather than waiting until the
success payments are due before appropriating funds. In most cases, these appropriations are placed
into an escrow account or sinking fund. Regularly setting aside funding to be used for success
payments is an important part of a PFS project’s design. An appropriations risk mitigation strategy
lowers the risk for investors and ensures that funding for success payments is available when needed.
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Step 5 — Implementation
The work completed in steps 1 through 4 culminate in Step 5. This step is when the theoretical
framework of the contract reconciles with the actual application. Using the well-defined terms of the
contract the oversight committees should be able to provide clarification during implementation.
Access and open communication are immensely important during this step. There should be
reasonable and supportive access to physical spaces and data between stakeholders. Previous projects
note this as an important component to maintain a highly tangled inter-organizational structure. Data
sharing allows for smoother collaboration and implementation.
The following will depend on the design and contract specifications, but one of the first steps
during the implementation phase will be to transfer funds to the service provider. Once the service
provider receives their funding, they can begin to expand and provide their services. The success of
Step 5 mostly falls on the service providers; but investors, the intermediary, governmental
organizations, and evaluators should be active in both supporting and, when needed, participatory
roles.
Step 6 — Evaluation
This step involves using the evaluation plan including the sample size required to measure the
effect, randomization of the treatment group, and deciding the parameters for defining and measuring
success. Benchmarks or a payment formula can be used to evaluate success and may change year to
year. The evaluation process is usually ongoing with the program. Benchmarks chosen should tie to the
social good created by the program but are not required to explicitly provide savings.
Based on the result of the evaluation, funds could be disbursed to the intermediary and used to
repay the investors. Depending on the outcomes agreed in the contract, the payments could vary in
size, based on the extent to which the performance outcome targets are achieved, and the duration
taken to achieve these targets. However, if the performance outcome targets are not met, the
26
government may have no payment obligations and, the investors could lose some or all of their
investment.
Step 7 — Assessing the Success of the PFS program
Upon completion of the PFS program, the government will need to decide on future funding. If
targets are not met, it is unlikely that the program would be funded going forward. However, outside of
the financial savings outlined in the PFS project, some other benefits may be realized. These should be
taken into account when deciding on the future of the program.
If the intervention proves successful, it is likely that the government agency will want to
continue funding PFS programs. This can be done through a shift to a more conventional funding
approach or through a ‘follow-on’ PFS contract, i.e., extending the contract (Liebman & Sellman,
2013). In order to avoid gaps in service delivery, Liebman and Sellman recommend that decisions
about follow-on contracts should be made at least one year before service in the initial contract ends.
Recommendations for Interventions and Providers in Minnesota
A healthy PFS project will hinge on factors such as how well the project is designed, how much
funding is available, and careful selection of a working intervention. An intervention will be a good fit
for a PFS project if: it is simple in terms of training and implementation; it has a short time horizon; it
yields a high return on investment, and the savings are easily attributable to a specific governmental
department. These factors are also highly interconnected – for example, a simple intervention is
important because it will save time which satisfies the desire for a short time horizon.
More importantly, PFS could unlock the potential of burgeoning service providers. PFS gives
service providers a secure, multi-year, and flexible source of funding that allows them to focus on
providing high-quality service. This also moves service providers away from a fee-for-service model
which allows them to focus on outcomes more than the number of people they serve.
27
Context will play heavily into whether an intervention is a good fit for a PFS project. That is to say, the
needs of different populations in different areas will be very different. Understanding this context will
help PFS projects target their work which will generate more return on investment.
Generally speaking, PFS has focused on workforce development, early childhood education,
early childhood development, health, criminal justice, and family welfare interventions because
research has shown the cost-saving potential of these preventive interventions. With that in mind, we
provide a brief overview of promising interventions. This section examines interventions related to
early childhood education, childhood asthma, child dental care, doula care, and homelessness.
Early Childhood Education
Problem: Research has shown that the benefits of high-quality preschool programs far exceed
the costs (Temple and Reynolds 2007). But even within established early childhood educational
programs, there are problems that, when addressed, may produce cost savings. There is evidence that
lower levels of behavioral and social skills are correlated with poor academic performance and later
behavioral problems (Campbell, Shaw, & Gillion, 2000; Gregory, Skiba, & Noguera, 2010). Lower
socio-emotional learning among preschoolers could also lead to their suspension or expulsion, with a
nationally representative study finding at least 50,000 students were suspended once, and another
17,000 students were estimated to be expelled (Malik, 2017). Intervening effectively in social and
emotional learning during the early childhood is critical to forming the foundation for children's
learning (Blair 2002; Diamond & Lee, 2011).
Costs: Expulsion of children from Pre-K due to lower socio-emotional learning can have an
adverse effect on their performance in Kindergarten, requiring them to be offered special education. As
per an estimate, Minnesota spends nearly $1.8 billion per school year on special education. While the
average annual cost for a general-education student is around $8,500, the average cost for special
education of kids is almost 2.5 times higher, at $22,000 (Meitrodt & McGuire, 2013).
28
Intervention: Benefit-Cost analysis has shown that socio-emotional learning programs can
produce returns of $11.00 (Belfield et al., 2015). The Minnesota Department of Education (MDE) is
currently exploring the feasibility of using PFS to fund the expansion of the use of the 'Pyramid Model'
in some of the state’s Voluntary Preschool Programs (VPK). The Pyramid Model is a positive behavior
supports framework for educators used to promote young children's social and emotional development,
as well as to address challenging classroom behaviors. The goal of using the model in VPK classrooms
would be to improve educational outcomes for students and increase the overall quality of VPK
classrooms while reducing the number of suspension/ expulsions, and reducing the need of special
education at later stages.
Recommendation: Upon completion of MDE's feasibility study, expansion of the Pyramid
Model in Minnesota's VPK programs using Pay for Success should be considered.
Childhood Asthma
Problem: More than 24 million Americans have asthma, affecting about 8% of children
(Centers for Disease Control and Prevention, 2017), while an estimated 393,000 Minnesota children
and adults have asthma (Minnesota Department of Health, 2016a). Every year, asthma accounts for
more than 439,000 hospitalizations and 1.6 million emergency visits (Centers for Disease Control and
Prevention, 2017). It also affects low-income children and black Americans disproportionately – for
example, black Americans are 2-3 times more likely to die from asthma than any other racial or ethnic
group (The 6|18 Initiative, 2015, p. 2).
Costs: In 2009, the cost of treating asthma across the United States was estimated to be $62.8
billion by private insurance, Medicaid, Medicare, and other sources (The 6|18 Initiative, 2015).
Minnesota Department of Health estimated the asthma cost across the state at $669.3 million, including
$614.9 million in direct medical expenses and $54.3 million in lost workdays (Minnesota Department
of Health, 2016a).
29
Intervention: There are a variety of tactics to mitigate asthma such as, but not limited to
medication; monitoring inhaler use; monitoring breathing; identifying triggers such as cold air, air
pollution, and pollen; and getting certain vaccinations (The Mayo Clinic, 2018). The following
examples show potential interventions that can reduce healthcare costs related to childhood asthma.
Recommendation 1: Healthcare provision using the National Asthma Education and Prevention
Program (NAEPP) guidelines led to a 41% reduction of asthma-related emergency visits, a return of
$3.00-$4.00 (The 6|18 Initiative, 2015, p. 3).
Recommendation 2: Primary care providers using NAEPP protocols to diagnose asthma and
provide a written asthma plan led to a 20% reduction in symptom days among children and 13%
reduction in emergency visits compared to a control group. This creates a return of $3.58 due to
savings in Medicaid and State Children's Health Insurance (Ibid).
Recommendation 3: Expand home visits by professional and qualified health workers to
provide targeted care, education, and identify and reduce in-home asthma triggers. Preliminary
research found this creates a return of $5.30-$14.00, with most savings generated with children
younger than 6 years old (Ibid, p. 10).
Child Dental Care
Problem: Dental care is particularly important during early childhood as untreated dental decay
has effects on a child’s growth, body weight, and cognitive development (Arrow, Raheb, & Miller,
2013, p. 1). More specifically, in Minnesota, 55% of third graders had experienced dental decay while
18% had untreated cavities (Minnesota Department of Health, 2013). Lack of dental care more heavily
impacts the American Indian and low-income populations. For example, 5 out of 10 American Indian
children between the ages of 6 to 9 have untreated tooth decay. Meanwhile, only 61% of children
living in low-income households visited a dentist compared to 85% for households living well above
30
the federal poverty line. Children under the age of 6 are 2 times less likely to visit a dentist for
preventive means compared to children over 6 years old (Minnesota Department of Health, 2016b).
Costs: The Minnesota Oral Health Plan 2013-18 estimated the cost of hospital-treated nontraumatic dental emergencies - which could have been treated by a dentist - at nearly $148 million
from 2008-2010 (Minnesota Department of Health, 2013).
Intervention: Research points to dental visits early in a child's life and education for parents as
the leading interventions which can be seen in a comparison between "early starters", children who had
their first dental visit before age 4, and "late starters," children who had their first dental visit after age
four. When considering fillings, crowns, pulpotomies, and extractions, early starters on average had
7.69 operations compared to 11.27 for late starters (Nowak, Casamassimo, Scott, & Moulton, 2014, p.
491). The average early starter accrued costs of $694.32 over 8 years while late starters accrued
$1,051.44 (Ibid).
Recommendation: Dental programs that enable parents to provide dental care for their children
before age 4 should be considered for PFS projects that attempt to address child dental care issues.
Doula Care
Problem: Doulas are trained professionals who provide individualized emotional, educational,
and physical support during and shortly after the prenatal phase, even though they don't provide direct
medical care. Use of doula care continues to rise in the United States as the benefits of doula care
become more widely known, but total use remains low at about 6% in 2011 and 2012 (Declercq,
Sakala, Corry, Applebaum, & Herrlich, 2013, p. 16). Access is a major issue for women and families
seeking doula care, as the costs can vary from $300 to $1,200 with health insurance programs typically
not covering doula care (Kozhimannil, Attanasio, Jou, Joarnt, Johnson, & Gjerdingen, 2014, p. e341).
Furthermore, there are barriers to individuals seeking doula training, especially for those from
disadvantaged groups.
31
Costs: In 2009, the cost of maternity and newborn care across the US was over $27 billion and
45% of that cost was billed to Medicaid programs (Ibid, p. e340). Cesarean births are also about 50%
more expensive than vaginal deliveries (Ibid, p. 2). In 2010, nearly 1 in 9 births happened preterm and
35% of all infant deaths were from preterm-related causes. Infants born preterm generate medical costs
10 times higher in the first year compared to full-term infants (Kozhimannil, Hardeman, AlaridEscudero, Vogelsang, Blauer-Peterson, & Howell, 2016, pp. 20-21).
Intervention: Research across 12 states in the West North Central and East North Central U.S
has shown that births supported by doulas would decrease the number of preterm births and could save
$58.4 million among Medicaid beneficiaries (Ibid, p. 25). There is also a growing body of literature
that shows having access to doula support can reduce the amount of non-indicated cesarean
procedures.
Recommendation: A program that provides doula training and expands access to doulas for
expecting mothers would be a promising intervention, especially programs that remove barriers to
doula training for individuals from disadvantaged groups. Interventions involving doula care have the
potential to produce cost savings in a shorter time than many other interventions.
Homelessness
Problem: Estimates indicate that on any given night in 2014, 578,424 people experienced
homelessness and of that group, 401,051 were sheltered while 177,373 were unsheltered (United States
Interagency Council on Homelessness, 2015, p. 16). Homelessness impacts African-Americans
disproportionately – African-Americans make up 12.6% of the U.S. population but they represent
41.8% of the sheltered homeless population (Ibid).
In Minneapolis, more than 3,000 evictions are filed in the 4th District Housing Court each year
and most of those cases were concentrated in a handful of zip codes. In two specific zip codes, 55411
and 55412, 45-48% of renters experienced an eviction filing in the last 3 years (Minneapolis
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Innovation Team, 2016, p. 2). Nearly all of these evictions were due to non-payment of rent, with
tenants, on average, behind by $2,000 (Ibid).
Costs: In 2013, Hennepin County observed that one-fourth of the families in the emergency
shelter had been there before. It is estimated that preventing these families’ return to shelter could have
saved $1.5 million in shelter costs per year for the community, in addition to the trauma caused by the
homelessness (Kittock, 2016).
Intervention: Having a stable home leads to increased educational, economic and health
outcomes, decreased reliance on social safety nets, and a reduction in crime, further cutting costs to
society. There are currently five PFS projects in the U.S. aimed at reducing homelessness including
Assertive Community Treatment (Colorado), Project Welcome Home (California), Home and Healthy
for Good (Massachusetts), Just in Reach (California), and the Cuyahoga County Partnering for Family
Success program in Ohio (Nonprofit Finance Fund, 2018). Depending on the focus of an intervention,
these programs could be good candidates as they will be evaluated over the course of their respective
project and can be replicated accordingly in Minnesota.
Recommendation: One of the challenges with funding homelessness projects through PFS is
that measuring the impact might take more time than ideally desired, making it less appealing to the
investors due to the longer time duration of the projects. While this might be a promising issue area for
PFS, we would recommend starting with projects that have a shorter duration, to begin with, in
Minnesota.
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CONCLUSION
Pay for Success has the potential to drive innovation and save the government money while
improving social outcomes. There is interest in implementing PFS in Minnesota, but in order to launch
a project, the state must change its approach towards PFS.
One recommended step to move away from the bond model currently in the statute would be to
adopt the more common model of funding PFS projects by appropriating funds into a trust or sinking
fund, which is used in nearly all PFS projects across the country. Legislative action would be required
to repeal the current statutes and replace them with a system that allows funds to be set aside. This
might appear to be a large undertaking, but many states have already followed this process and their
legislation can serve as a model for Minnesota.
If prior appropriation of funds by the legislature is not feasible, the state could consider passing
legislation to allow philanthropic organizations to fund PFS projects. Finally, the state should consider
applying for a PFS grant from the U.S. Treasury (outlined in Part III) to fund a project.
Interventions that are smaller in scale and that produce cost savings in a short amount of time
should be considered for the first project once the groundwork is set. Such a project could serve as a
pilot and allow the state to implement PFS on a smaller scale and in a shorter amount of time. As the
number of projects in the state increase and the PFS process becomes more standardized, some aspects
of the model (e.g. writing contracts) will likely become less expensive and easier to implement.
The roadmap outlined in Part III can serve as a guide for all stakeholders involved in a PFS
project. However, it is hard to imagine a PFS project being implemented without a strong champion.
PFS projects need a strong leader willing to see the project through, advocating for the project and
helping to coordinate all of the stakeholders involved. PFS seems to be an alluring model that benefits
all stakeholders involved while giving the opportunity to expand socially beneficial interventions.
34
GLOSSARY
Creaming Process where providers only sign up clients with the highest probability for
success, rather than serving the clients with the greatest need.
Evaluator Person or firm charged with determining if and to what degree a project has
had the desired impact. Responsibilities include creating the evaluation plan,
gathering information, analyzing data, making a determination and
producing a report, the results of which are typically used to determine
repayment to investors.
Intermediary An organization that coordinated the project, is involved in the selection and
payment of the service provider and the evaluator.
Pay for
Success
A public-private partnership in which investors provide upfront capital to
scale prevention-focused social interventions. Government re-pays the
upfront capital plus a modest return only if the intervention produces
measurable social impact.
Request for
Proposal
A type of bidding solicitation in which an organization or institution
announces that funding is available for a particular project or program, and
companies can place bids for the project’s completion.
Senior
Investor
When there are different classes of investors, senior investor claims to
repayment stand in front of those of more “junior” investor classes. (See
“Subordinate Investor.”)
Service
Provider
The organization, often a non-profit, that delivers the services to the
population stipulated in the contract.
Sinking Fund A government pool of money that is set aside for a specific payback purpose
typically the gradual repayment of a debt.
Social Impact
Bond
A form of financing in which investors provide upfront financing for the
delivery of services in a Pay for Success contract and are repaid only if the
services achieve a pre-agreed upon set of outcomes. (Note: this does not
work like traditional financial bonds. The misappropriation of the word
"bond" has caused confusion.)
Subordinate
Investor
Investor whose claim to repayment stands behind another investor class.
Synonym for “junior investor.” (See “senior investor.”)
Wrong Pocket
Problem
Describes a situation where the entity that bears the cost of implementing a
practice—including an evidence-based best practice—does not receive a
commensurate benefit. In PFS projects, if the benefit or savings from an
intervention accrues to an entity other than the likely end payor, project
development can be more challenging.
Adapted from: Pay for Success Glossary online. Retrieved from http://www.payforsuccess.org/learn/glossary/#C
35
APPENDIX
Appendix A – Stakeholders and their role in a PFS Model
Investors
Through the PFS model, investors can produce a social impact in a targeted community, reap a
financial return, diversify their portfolios, and improve their public image (RAND, 2011). In addition
to a lead investor(s), there could be one or more subordinate investors who get repaid only after the
lead investor is paid back. These subordinate investors are usually philanthropic organizations. Having
this kind of a tiered investment structure reduces the risk for the lead investor and is more replicable
than the high-guarantee models since philanthropic organizations have a higher tolerance for risk in
PFS and have a higher capability to blend financial resources with other risk-averse investors.
Intermediaries
An intermediary is the stakeholder that plays a major role in managing the relationships and
duties of the other actors involved in the PFS. One of the primary roles of intermediaries is to monitor
the smooth functioning of each of the parties involved. The intermediaries facilitate all the monetary
transactions associated with the PFS.
Evaluators
The evaluator determines whether the target outcomes were achieved in accordance with the
agreement between the parties in the contract. Some commenters suggest that there could be two
distinct evaluator roles: 1) an evaluation advisor that helps define performance targets, designs
assessment approach, monitors progress during life of PFS project, and analyzes interim assessment
results as part of a PFS management team so as to help guide corrective action when/if necessary; and
2) an independent assessor that works on an arm's length basis from all of the other parties, and reports
on whether SIB targeted outcomes have been met (Callanan et al., 2012).
36
Government
The government passes legislation that allows for the creation of PFS contracts and the
appropriation of funds into designated trusts and sinking funds. Additionally, the legislature creates
different forms of governance structures who are tasked with supervision and oversight. While there
are many potential arrangements for the management and oversight/governance structures of PFS
projects, the standard structure for current PFS projects consists of two governance groups: The
Operations Committee and the Governance Committee. These committees require all parties involved
to dedicate time and energy to project coordination and seeing the effort through from beginning to
end.
Committees to support PFS Implementation
Operational Oversight Structure
The Operations Committee is the working group involved in the day-to-day monitoring of
project progress. Because of this, these committees often meet more frequently, especially at the
beginning of the project. They will meet as often as biweekly at the start of a project, then monthly as
the project moves forward. The members typically include representatives from the service provider,
the payor, the intermediary, the evaluator, and from the technical assistance provider (if there is such a
provider for the project). Some of the responsibilities of the Operations Committee include monitoring
operations of the project, identifying and resolving issues while the project is in process, elevating
issues to the Executive Committee when necessary, and providing status updates to the Executive
Committee.
Executive Oversight Structure
The Executive Committee is the decision-making body that provides strategic direction and
oversight for the entire PFS project. These groups tend to meet less often than the Operations
Committee, often quarterly to semi-annually. The members typically include representatives from the
37
service provider, the payor, and the largest investors. Executive Committee members should champion
the PFS project within their respective organizations. Some of the responsibilities of this committee
include providing leadership to ensure the project stays on track, review status updates from the
Operations Committee and resolve issues raised by this committee and ensure compliance with the
contract.
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Appendix B - Risks associated with a PFS Model
Intervention Model Risk
The chosen social service interventions might not produce the expected outcomes (Burand,
2013). The probability of this occurring increases when the intervention is not administered by a
proven social service provider. Inability to expand the model to a larger population (i.e. lacking
statistical power to prove the success of the intervention) could make the model fragile. Thus, three
ways to minimize intervention risks can be used. Firstly, use proven interventions instead of promising
interventions that have no proven deliverable outcomes. Secondly, select measurable and unambiguous
outcomes. And thirdly, accurately match the at-risk audience with an intervention that provides the
maximum benefit.
Execution Risk
Execution risks arise from unclear lines of authority, poor communication among multiple
participants, lack of resources and capacity, lack of follow-through by one or more partners, or failure
to capture timely and reliable data on progress (Burand, 2013). Address risks by conducting rigorous
prior research about the quality of service, the capacity, and the sincerity of the service
providers. Additionally, strict provisions should be made to ensure the safety and the adequate
protection of the population served by the PFS program (Burand, 2011). Warner (2013) expresses
concern about organizations serving the most “fragile” clients including disadvantaged children,
prisoners, and the homeless. If success targets are not met, the ability to serve these populations might
be compromised in the future.
Intermediary Risk
Intermediaries are involved at every step of the PFS programs. Their involvement may differwhile some intermediaries may be very active in the program, some others may play a passive role in
39
the evolution of the PFS. There is a risk that the intermediaries may fail to perform their duties of
coordinating between different agents. It is also possible that the intermediaries may fail to perform
their duties for reasons out of the scope of the PFS Program. The scope of the intermediaries'
responsibilities should only include those duties which are required for the success of the PFS.
Political Risk
Political risk is inherent to the PFS model and can be difficult to mitigate. Interference with the
measurement outcomes of the PFS, non-cooperation for repayment to the investors, failure to provide
support, and forcing re-negotiations of the contract, are all ways politics can impede the success of the
PFS. Mutual understanding and agreement among different government elements is necessary to
negotiate the outcome-based contractual agreements. Change in the ruling party or a change in the
economic condition complicate the risk. A strong political champion of PFS who thoroughly
understands its intricacies and is willing to advocate for PFS is needed.
Financial Risk
The early PFS models involved the private investors bearing all of the financial costs of the
program, thus transferring all of the financial risks onto the private investors. However, due to the long
term and non-liquid nature of investment, adding to the conditional repayment of the investment,
would keep a wider range of potential private investors away from PFS investments. To mitigate these,
risk sharing tools such as the provision of external collateral support, reserve funds, and first-loss
provisions should be incorporated into the PFS model (Burand, 2013).
Reputational Risk
The service providers face a reputational risk if the PFS does not succeed. They could be
publicized as not having met the desired deliverables for attaining the social outcomes. Burand (2013)
recognized another important reputational risk, on the aggregate level there can be contagion risk of
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highly publicized PFS controversies spilling over to the general marketplace. As PFS programs fail to
meet their targets, the general confidence in the PFS reduces, and thus, more government agents and
private investors would not be interested in taking these programs forward. Learning from previous
PFS programs and avoiding similar mistakes while adopting the successful methods can mitigate this
risk.
41
Appendix C – Summary of Selected Pay for Success Legislations
Colorado
In 2015 the Colorado Pay for Success Act passed. The act creates a PFS contracts fund in the
state treasury where the general assembly transfers the funds based on an expectation of reductions in
state expenditure resulting from the intervention. The state then pays the lead contractor based on the
success of the outcomes based on an independent evaluation.
The act identifies a "Lead Contractor" as an organization or local government that either
provides interventions directly, or sub-contracts (and oversees the subcontractors) through either its
own money or by borrowing it, while the "Provider" provides the interventions. Under the act, the lead
contractor or the local government could be a provider if they do not sub-contract the service provision
to a third party. In this model, the risk, if the program does not meet the required outcomes, is borne by
the lead contractor (if they invest their own money), or the investor (if the lead contractors raise money
from private investors). The act does not specify any agreement between the state and the private
investors, meaning, the risks and responsibilities for execution of a PFS project lie mainly on the Lead
Contractor. In fact, the Act specifically restricts an investor from dictating the manner of delivery of
services except for performing due diligence on their investments. The Act identifies a maximum time
period of seven years for the intervention unless one or more defined performance targets specified in
the contract are met within the first seven years.
Texas
The state of Texas enacted an Act relating to the administration of PFS contracts. The Act set
up a “Success Contracts Payment Trust Fund” outside the state treasury, with the comptroller as its
trustee. This enables the comptroller to make success contract payments as per the contract terms
without the necessity of an appropriation from the legislature. However, the contract can be executed
only after the Legislative Budget Board certifies that the proposed intervention will result in significant
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cost savings, and the state legislature appropriates the money for credit to the trust fund. If the contract
fails to meet the outcomes or is terminated, the unpaid amount is returned back to the state treasury
fund or the account from where the amount was initially appropriated. The act restricts the balance of
the trust fund to a maximum of $50 million at any time.
Washington DC
Washington DC passed the Pay-for-Success Contract Authorization Act in 2014. The Act
provided for initial funding of services by private investors for social programs performed by nonprofit
service providers, with the contract being between the district and a social service intermediary. The
Act authorized the Mayor to enter into the PFS contracts and operate a sinking fund where the amount
corresponding to the savings would be appropriated in each fiscal year as per the future payment. The
DC act ensures that the unrestricted fund balance is not reverted back to the General Fund of the
District of Columbia.
Massachusetts
Massachusetts was one of the first states in the United States to pass an Act regarding the PFS
program. The act established a Social Innovation Financing Trust Fund for the purpose of "Pay for
Success Contracts." The Secretary of Administration and Finance is responsible for entering into the
contracts and overseeing the trust fund. The Act requires setting up of a sinking fund where the amount
corresponding to future savings is to be appropriated each fiscal year that the contract is in effect. The
act restricts the maximum amount of payment at $50 million.
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Appendix D - Past & Current Pay for Success Projects
PFS is still a relatively young concept and many are still looking for the one-size-fits-all model.
It's possible that model does not exist considering how complex PFS projects can become. Only a few
PFS projects have fully finished while many are ongoing at the time of this writing. However, as with
anything else, history provides valuable lessons that can be used when moving forward. The following
section provides brief summaries on five PFS projects and valuable lessons learned from them.
Peterborough's Prison – World's First Ever PFS Project
The Peterborough PFS program was the world’s first attempt at PFS. The primary mission
behind this program was to reduce reoffending by criminals with short sentences. The program was
launched in 2010 when Social Finance raised £5 million from a mixture of trusts and foundations. This
money then went to One Service who provided the intervention by identifying the needs of reoffenders
such as mental health, substance abuse, housing, employment, and access to money.
During the program's design phase, the national UK reoffending rate was around 60% (Social
Finance, 2017, p. 1). A reoffending reduction rate of 7.5% was set by the Ministry of Justice as the
level to trigger payments back to investors. The evaluation determined that this PFS plan reduced
reoffending by 9% compared to a national control group and as a result, all 17 investors received their
payment which consisted of their initial capital plus a 3% annual return (Social Finance, 2017, p. 1).
The Peterborough agreement includes three cohorts of prisoners and early on cohort 1 failed to trigger
an outcome payment. Evaluation found an 8.4% reduction in the frequency of reconviction in cohort 1
below the target for early repayment of 10% (Disley, Giacomantinio, Kruithof, & Sim, 2015, p. 3).
The evaluators found the presence of a service director whose goal it was to coordinate and
facilitate working partnerships throughout multiple phases was vital (Disley et al. 2015, p. 57). The
complex inter-organizational design of PFS requires a central stakeholder who focuses on nurturing
healthy partnerships. To highlight the importance of inter-organizational cohesion further, evaluators
44
found that amiable information sharing and accommodating access to physical spaces improved the
program. Additionally, the evaluators advise future PFS programs to carefully consider the upfront
cost of processing and training volunteers and the marginal benefit (Disley et al. 2015, p. 62). All
interviewed prisoners expressed positive experiences with the One Service compared to prior
experiences. Analysis indicated the primary needs of the participants were: material accommodations,
financial aid, and education and training. A potential concern is the focus on the early month needs of
prisoners and that longer-term engagement was more difficult (Disley et al. 2015, p. 60).
Main Lessons Learned from Peterborough:
• Having an intermediary whose primary objective is to nurture the relationships of all other
parties involved and to monitor all moving pieces was critical.
• Having a trusted flow of information between organizations and access to physical space
improved effectiveness.
• Having different payment triggering components might be more appealing to investors.
Rikers Island - First Attempt at PFS in U.S.
In 2012, the Rikers Island PFS project was the first PFS attempt in the United States; inspired
by the Peterborough PFS project. The project involved: the Vera Institute of Justice as the evaluator;
Bloomberg Philanthropies as the philanthropic backstop; Goldman Sachs as the investor who provided
$9.6 million (Olson & Phillips, 2013); and MDRC as the intermediary. The project employed Moral
Resonation Therapy and sought to reduce the re-incarceration rate by at least 10% (Porter, 2015). The
Rikers Island project failed to trigger payments to Goldman Sachs. In that regard, it is considered a
failure, but in many ways, it provided clarity to future PFS projects. Logistical issues contributed to the
failure. The Education Department offered and rescinded to put teachers on Rikers Island to assist in
the intervention. The Osborne Association, responsible for carrying out the therapeutic program, was
45
eliminated from the project when the teen population fell below the contractual threshold (Porter,
2015).
Critics of the Rikers Island project point out that the tax-payer is not risk-free in this scheme.
According to MDRC, “the arrangement required considerable in-kind support from city government
leaders and staff,” and critics believe that these costs should be accounted for (Cohen & Zelnick,
2015). Critics also stress that all stakeholders involved need to agree on the evaluation metrics and that
ample time is needed for honest evaluation.
Main Lessons Learned from Rikers Island:
• Evaluation will be a critical part of PFS projects and should be thoroughly thought out.
• Tax-payers are not free from risk.
• Private investors are not always willing to take on all of the risks.
South Carolina — First State Wide PFS Project
In 2016, South Carolina’s PFS project became the first in the United States to be implemented
statewide (Social Finance, 2016, p. 1). The program focuses on health outcomes for both mothers and
children living in poverty due to a 2015 report produced by the Annie E. Casey Foundation found that
27%, or 280,000, children in South Carolina lived in poverty. In line with early childhood development
research the primary goals of this PFS project were: to create long-lasting results by helping first-time
mothers become responsible parents and with their pregnancies; to support early childhood
development in both urban and rural areas across South Carolina; to better understand the NurseFamily Partnership (NFP) model; and to create a more accountable government.
South Carolina’s PFS project was led by the South Carolina Department of Health and Human
Services (SCDHHS) in coalition with NFP as the service provider; J-Pal North America as the
evaluator; Social Finance as the intermediary; and BlueCross BlueShield of South Carolina
Foundation, The Duke Endowment, The Boeing Company, Greenville County — SC First Step, and
46
the Laura & John Arnold Foundation providing $17 million (Nonprofit Finance Fund, 2017). The
funding was supplemented by $13 million coming from a 1915(b) Medicaid Waiver given to SCDHHS
for a total of $30 million was available for the project (Social Finance, 2016).
With the help of this PFS project, NFP aimed to serve 3,200 additional families over 4 years to
the 1,200 they already serve (Nonprofit Finance Fund, 2017). The NFP model, which has been proven
through 3 randomized control trials, pairs at-risk first-time parents with specially trained nurses who
conduct home visits during pregnancy through the child’s second birthday. The evaluation period is 5
years and the outcomes that would trigger success payments include: a reduction in preterm births by
13.5%; a reduction in childhood hospitalization and emergency department visits by 23.4%; an
increase in health spacing between births by 18%; and increased number of first-time mothers served
who lived in high poverty areas (Nonprofit Finance Fund, 2017). If outcomes are achieved success
payments will be reinvested in expanding NFP service delivery in South Carolina instead of returning
to investors.
Main Lessons Learned from South Carolina:
• Please note that this project is ongoing at the time of this writing.
• All external funders involved are philanthropic.
• External funders expect no interest on their return should repayments be triggered.
• This project addressed the wrong pocket problem (for definition, see Glossary) with a Medicaid
waiver.
• This project combined both a fee-for-service and PFS model.
Utah — A Promising PFS Attempt Nearing Completion
The Utah High-Quality Preschool program is considered one of the more promising PFS
initiatives (Nonprofit Finance Fund, 2017). The program expanded the availability of preschool with
success payments tied to special education avoidance. Currently in progress, the project has a five-year
47
delivery term and uses a longitudinal study to evaluate effectiveness over 12 years. A pilot from 2006
to 2012 showed promising results in reducing achievement gaps in language arts and math.
In 2013 Goldman Sachs and the Pritzker Foundation added an investment of $7 million to a
two phase PFS initiative. The senior investor, Goldman Sachs, is repaid first then Pritzker Foundation
at a rate up to 7.26%. The intermediary is the United Way of Salt Lake. Phase one is the proof of
concept which is funded by the United Way of Salt Lake and Salt Lake County and enabled 595 lowincome children to attend high-quality preschool. Phase two is supported by the State of Utah with the
passage of H.B. 96 in 2014 that created the school readiness board and allocated funding (Utah H.B.
96 2014).
The funding from Goldman Sachs and Pritzker allowed up to 3,050 children to attend the
program. Repayment is triggered using results from a pre and post assessment. The project pays for
outputs and outcomes. The threshold for repayment is 90% avoidance of special education for at-risk
students. Of the 737 low-income students who attended Granite School District preschool only 1 of the
110 at-risk students used special education services by third grade (Goldman Sachs 2015). Therefore, a
success payment was made.
Main Lessons Learned from Utah:
• Using a proof-of-concept year can be useful in securing state level investment.
• Using simplified payment triggers allows multiple sources of funding to be integrated.
• Identifying short-term measurables that are correlated with long-term outcomes is key.
Chicago - A Promising PFS Attempt with a Long Time Horizon
In 2014, the City of Chicago passed an ordinance authorizing a PFS contract to implement
high-quality pre-kindergarten programs in certain schools. The major goals were to promote
kindergarten readiness, increase proficiency in early school achievement, improve socio-emotional
learning, increase parent involvement, and enhance educational attainment, career opportunities, and
48
the personal development of parents and family members. Funded by a $17 million social impact bond,
the investment into the PFS program was made by Goldman Sachs Social Investment Fund (GSSIF),
Northern Trust, and JB Pritzker Foundation (as a subordinate investor), in the proportion of 44%, 32%,
and 24% respectively, with the Finnegan Family Foundation underwriting the program evaluation for
the first two years. IFF is the intermediary, while the Chicago Board of Education is the outcome payor
who has committed to a maximum repayment of $34 million over a repayment period of 17 years.
The program has a four-year service delivery window with 374 children served in the first year,
and 782 children each year for the subsequent years of operation. The city created a PFS Escrow
account to fund the program contingent on its success. Payments triggers to investors were based on
the evaluation of kindergarten readiness at the end of the second year of the project, third-grade
literacy at the end of the fifth year, and special education utilization to estimate the savings for the
City. The first two years of the PFS Program has triggered payments of $500,000 towards
Kindergarten Readiness Success Payment, and $17,600 towards Special Education Payment for the
Cohort 1, and approximately $900,000 towards the Kindergarten Readiness of Cohort 2.
The ordinance included a comprehensive evaluation plan with the details of the construction of
the treatment and comparison groups, estimation methods, and the required data and data sharing
arrangements in order to evaluate the success of the program. The contract also included additional
evaluation components related to the Child-Parent Center program that were not related to the PFS
calculations but help improve the performance of the program going forward.
Main Lessons Learned from Chicago:
• PFS model is feasible for programs such as early childhood education where the returns are
usually observed much later in life.
• Private lenders are willing to enter PFS contracts with periods of repayment as long as 17
years.
49
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