Pay for Success: What It Will Take to Work

On a recent webinar addressing the Pay for Success (PFS) phenomenon, a presenter from the Nonprofit Finance Fund aptly described the Pay for Success movement as having “the highest ratio of words spoken to deeds done.” That ratio subsequently increased with the April publication of the Federal Reserve Bank of San Francisco’s (FRB’s) Community Investment Review, which featured several articles about Pay for Success.

The good news is that, relative to prior public dialog on this topic, the FRB’s article series as a whole offers a more balanced and thoughtful critique of this phenomenon—one that is more connected to the realities of complexity, institutional obstacles, and expense. Further good news is the apparent commitment of the Obama Administration and a growing group of bi-partisan legislators to make a meaningful investment in PFS.

The bad news is that in the nascent world of PFS there is a continuing disconnect between concept and execution, hence the high and worsening words-to-deeds ratio. And the irony of this post contributing to that disconnect is not lost on me. So I will suggest some course-correcting principles (and try and limit my word count in the process):

1. Simplify the structural templates to the three core participants: 1) service providers, 2) one level of government, and 3) investors. Structural simplicity is required to make this work. Bloated structures layered with administrative oversight, complexity, multiple levels of government, consultants, and unnecessary expense will likely fail. They are neither scalable nor easily replicated, and their expense and complexity reduce the likelihood of even short-term success. As an individual service provider, our only foundational need to make a PFS structure work is a committed government partner. That’s it. A service provider (or service provider group) can source the investment funding, provide the structure, execute the service interventions, source any other program needs, and then support the post-intervention, third party evaluation. The simpler the structure, the more likely it is to succeed: It will be lower cost, allowing a higher proportion of the investment to be applied to the service intervention; investors will find simpler, higher value structures inherently more attractive; and scaling more straightforward approaches is easier.
2. Create PFS structures that will attract market investors by offering a competitive rate of return, as well as reasonable, understandable, and measurable risks. We must prioritize investors’ needs. The reason is simple: What the sector needs most is committed, long-term capital. The service sector is deeply fractured and grossly under-capitalized. PFS structures need to attract new capital to support high-value interventions. This means that we need to attract market investors by offering transparent investment structures that connect risk and return, and that offer a market rate of return. The oft-repeated belief that PFS structures are not mature enough to attract market investors is simply untrue. With a strong government partner and programs that have demonstrated high, measurable returns on investment, a PFS structure can be created that offers a competitive, market-level return on risk to institutional investors. (We have done just this at my own organization, Twin Cities RISE!).
3. Create a much stronger focus for evaluating a program’s effectiveness prior to—not after—the service interventions. As service providers, it’s our responsibility to demonstrate to prospective government partners and investors that our interventions work, and that they create a high, measurable level of social and economic value. This value, for many types of interventions, can be (and has been) quantified in financial terms. If we can do that prior to engaging in a PFS program—and we can—our government partners and investors can then engage with a much higher level of confidence in ultimate success. This ties directly to point two above; with rigorous analysis based on actual experience, prospective investors have a much more tangible basis for conducting due diligence and assessing risk. This will naturally attract more investment and at lower cost. That is the point! This is not to say that past performance guarantees future success, but it will certainly be helpful as an indicator, and one that we can test and validate after the intervention as well.

Up to this point there has been a lack of depth to the discussions that bridge the obvious attractions of PFS at a conceptual level to the difficulties of structuring and executing a PFS program that will work. I suggest a much greater focus on execution details, recognizing that—as an important organizing principle—our greatest need is a large, incremental, and sustainable source of investment capital. Applying the principles described above will help open a pipeline for new investments in effective programs, improving our ability to meet our social missions—that is, meet basic needs such as shelter, healthcare, and job skills training of those we serve.

Read more stories by Art Berman.