Pay-for-success (PFS) contracts, also called social impact bonds, have shown a significant impact on how consumers enjoy human services. PFS is an innovative type of financing model that many private investors find attractive and is now gaining wider acceptance among specialists in the counseling industry.
To learn more, check out the infographic below created by Wake Forest University’s online Master of Arts in Human Services degree program.
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The PFS Model: A Closer Look
Overview and Statistics
Currently active PFS contracts have an estimated worldwide value of $200 million. The U.K. was the first nation to develop a large-scale PFS project. It holds a huge share of the current PFS contracts, with an estimated $60 million dedicated to 15 projects that focus on youth employment, foster care avoidance and recidivism.
In the US, several counties and cities have begun developing, initiating or launching PFS projects. These areas include Chicago, Fresno, Memphis, Denver, Dallas, Cuyahoga County, Newark, Philadelphia, New York City, Pima County, Washington, D.C., and Salt Lake City. In Asia, South Korea has begun using the PFS model for the improvement of its family support, foster care and child welfare issues. PFS is also known as Social Benefit Bond (SBB) in Australia.
The Social Innovation Fund (SIF) held a PFS competition that awarded grants to several organizations in 2014. These organizations included the Green and Healthy Homes Initiative, Corporation for Supportive Housing, Institute for Child Success Inc., Harvard Kennedy School Social Impact Bond Lab, Nonprofit Finance Fund, National Council on Crime and Delinquency, University of Utah David Eccles School of Business PFS Lab, and Third Sector Capital Partners Inc.
How PFS Works
Upfront capital funding is provided by investors from private, nongovernmental sectors. The purpose of the funds is to provide services required over the term of a PFS contract. The contract is an agreement between the payer and the service provider, and between the payer and the investors. The payer has an agreement with the service provider to provide or create specific outcomes. He or she also has an agreement with investors to repay their investment if the specific outcomes are realized. An independent evaluator will assess whether or not the outcome is achieved. If the outcome is not achieved, the investors will not receive payment.
Requirements of the PFS Model
To apply the PFS model, the justice system cost and the population drivers for a well-defined problem must first be assessed. Next, the service gaps must be identified, and evidence-based solutions should be developed. Once completed, the suitability of the PFS funding is then determined.
A report published in 2014 by the Corporation for National Community Service and the Social Innovation Fund states that there is a five-step process required to develop a PFS project for the justice system:
- Attribute a price to the PFS product.
- Set the performance targets using existing evidence as reference.
- Arrange the funding and develop the infrastructure.
- Implement the program.
- Evaluate the results.
Improving Social Outcomes
The success of a PFS project relies on a well-implemented process flow. Here is a look at how the ideal process works.
The investor provides the funding through the intermediary, who is in charge of structuring, coordinating and managing the risks. The process then moves on to the social service providers, who will deliver the services to the target population. It is the responsibility of the target population to produce the desired outcomes.
Once done, the outcome is measured and validated by an independent validator or evaluator, who then transfers the process to the back-end payer if the outcome is assessed as successful. The back-end payer then pays for success and works through the intermediary, who then repays the principal and the return back to the investor. Incidentally, there are three types of PFS investors: senior lenders, junior lenders and venture philanthropists.
PFS Model Drivers
The PFS model is driven largely by the diminishing funding from government for social welfare services. Hence, PFS will be mobilized by nonprofits that want to not only receive a return on their capital but also increase their impact on society.
An Example of How the PFS Contract Works
In January 2014, the state of Massachusetts and Roca, a nonprofit organization, signed a contract with the purpose of providing aid to young, high-risk men to help them stay out of jail, keep their jobs and maintain stable lives. The state reported a 40 percent recidivism reduction — a break-even rate. At that rate, the payouts and program savings that will be given to investors and service providers will both equal $22 million. If the contract is a success, Roca will provide aid to Massachusetts to help the state achieve a 70 percent recidivism reduction.
Benefits and Limitations of PFS
The PFS model promotes an effective partnership between nonprofit sectors and the government. It also challenges lawmakers to expand their program development role. Lawmakers can also focus on program outcomes, instead of on the compliance or activities of a program.
The PFS model has created innovation opportunities for private investors, specifically in the nonprofit sector. When programs are successful, they can expect stable funding.
The PFS model also ensures that funding is directed toward the right recipients. If a PFS contract is moved to the private sector, this could result in efficient public spending. The model also allows local, tribal and state governments better flexibility in funding programs that produce measurable results.
Limitations and Drawbacks
In terms of financing, the PFS model tends to be complex, both legally and operationally. It also focuses heavily on goal achievement and measurable results, which may jeopardize the well-being of the individuals the program serves. Most of the risk that investing in PFS projects carries is dependent on junior lenders and not on senior lenders who have an eye for profit. This may make private-market capital hesitant to provide funding for PFS deals if philanthropists and investors with the bigger impact will not be involved.
There is also a risk that the PFS model could favor organizations that have already committed to PFS contracts, thus discouraging other fund providers from operating and innovating the model efficiently. Governments will also be obliged to monitor the success of every program and eliminate non-achieving programs. Lastly, the level and type of tracking and measurement necessary to assess the effectiveness of a program may increase the burden on the resources of nonprofit organizations.
The success of larger nonprofits may intimidate smaller nonprofits and discourage them from seeking PFS funding. As a result, essential services could be compromised when some search for financial aid. Furthermore, some social causes may produce outcomes that are not easily or effectively measured. These causes include domestic violence prevention, job training, mental health intervention for adults and early childhood education.
How Is the Human Services Sector Traditionally Paid?
The human services sector usually receives funding from local, state and federal grants, corporate philanthropy, charitable contributions, and different foundations. It also receives monetary support from service fees charged by nonprofit organizations.
How PFS Models Have Evolved
The Community Reinvestment Act (CRA) requires banks to show capability in meeting the credit needs of their communities — moderate- and low-income sectors included. If banks consider PFS projects as CRA obligations, this could potentially provide large volumes of investment capital to projects financed by PFS. There is also an advantage to viewing the PFS model as a process and a tool that produces varying outcomes, some of which are good and some of which are less desirable. PFS models will also be considered as opportunities to use past results as a reference for future success and to encourage nonprofit organizations to improve their efficiency and processes.
What to Expect
The PFS model is gaining more attention from private investors, the nonprofit sector and governments. As a result, demand will increase for professionals in human services with excellent analytical skills. What remains the key to pay-for-success projects succeeding is an understanding of the best means to measure, track and optimize services.