By Judy A. Temple
Private investors are spending $70 million dollars to expand cost-effective social services in other states through social impact financing, but none of these investments have been made in Minnesota. Since 2012, private investors in five states are helping state and local governments scale up promising interventions serving hundreds of individuals and families by reducing recidivism, homelessness and unemployment or by expanding preschool programs.
Investment banks and private foundations in other states have provided upfront financing for social or educational service projects ranging from $3 to $18 million in size. The funded services are selected for their potential for public cost savings. When successful preventive interventions are expanded, taxpayer costs for prisons, welfare programs, health care and special education may be reduced. The resulting cost savings are used to repay the investors.
What is keeping private investors in Minnesota from making social impact investments? While the initiatives described above involve direct payments from social impact investors to intermediaries and service providers, Minnesota went down a different road and was the first state to pass legislation authorizing social impact financing through a state bond. The Pay for Performance Act of 2011 authorized the state to issue appropriations bonds of up to $10 million as part of a pilot program. So far, no bonds have been issued.
On Dec. 7, Nonprofits Assistance Fund released its report [PDF] offering insights from the Minnesota pilot planning process and from other states. An important issue addressed in the report is the perceived complications of the bond pilot that stalled in Minnesota versus the direct funding approach implemented in seven projects in five different states between 2012 and 2014.
Two major differences
Two major differences are worth noting between the proposed pilot and the Pay for Success efforts launched in the other states. The first one involves cash flow issues. In the other states, private investors make payments to intermediaries who then promptly pay the service providers for additional staff and resources needed to expand the number of individuals or families served.
In the Minnesota bond model, investors buy the bonds and the proceeds are placed in a state fund. Service providers start to serve additional clients, but they won’t be paid until several years later, after the cost savings associated with the expanded social services are confirmed by an external impartial evaluator. At that time, the bond proceeds are then used to pay back the service providers for the costs incurred years earlier. How nonprofit service providers obtain the working capital to pay for the upfront costs of service delivery is not specified in the pay for performance bond model.
The second issue has to do with risk assignment. Current Pay for Success initiatives are attractive to policymakers because they impose no risk on taxpayers. What if the cost savings are not large enough to cover the administrative costs of the intermediary and evaluator (and the interest on the Minnesota bonds)? In the seven other Pay for Success initiatives in the United States, private investors do not get their money back if success targets are not met. In the Minnesota pilot, there is no consequence to bondholders if the cost savings are not realized. If neither the taxpayers nor the investors are at risk, the only parties left to pay when targets are not met are the nonprofit service providers or intermediary.
Risk is a real concern
Recent evidence from other Pay for Success initiatives indicates that risk is a real concern. In the first projects in the UK and in the U.S. (both focusing on recidivism), recent evaluations found that neither program met the success targets in terms of estimated cost savings. Success payments to investors recently were made in a preschool Pay for Success project.
A social impact funding mechanism that uses state bond markets has the promise of being able to tap into many millions of dollars in private funds to help repay nonprofit service providers for greatly expanding preventive services that may save more money that they cost. But more attention is needed in the Minnesota bond model in terms of cash flow and risk bearing.
Currently, policymakers in several Minnesota state agencies are making plans to use private funds to expand supportive housing services without relying on bonds. Private investors and policymakers in Minnesota can learn from our recent experiences with the Pay for Performance pilot and experiences in other states to determine how to move forward with or without a Pay for Performance bond.
Judy A. Temple is a professor of public affairs at the Humphrey School at the University of Minnesota. She is the lead author on the Nonprofits Assistance Fund report called “Pay for Performance financing to expand cost-effective social services: Lessons learned in Minnesota.” [PDF] She served on the state’s Pay for Performance Oversight Committee.