From Input to Impact: Pay-for-Success Drives Government Performance (Harvard Kennedy School)

By Magdalena Seol

When I started my stint as a public servant with a prior background in the private sector, one question puzzled me and continued to remain in my mind: Why does government spending and activities tend to focus on inputs rather than outcome or impact? As time passed, I was able to see and understand various reasons behind this approach: government spending is often tied to legislative requirements that lead to backward-looking budgeting; public scrutiny makes it hard for government to take risks or try new things; and, more fundamentally, political leadership is given only a limited time to operate in a democratic society. These are only a few of the reasons I could name; however, regardless of all the constraints, innovation is still possible. Governments can prioritize programs, rigorously measure the outcomes, experiment with different funding interventions to achieve impact, and ultimately push forward creating a culture of performance in public service delivery. This new approach, known as “pay-for-success” (PFS), has been generating attention, especially in the realm of social services provision.

Pay-for-Success 1.0: Social Impact Bond (SIB)

In the social impact bond model, government pays for social services on a delayed basis, only after the target performance has been achieved. It contracts with a private-sector intermediary to obtain social services; the intermediary obtains operating funds from the commercial or philanthropic investors and uses the funds to contract with service providers to deliver the services necessary to meet the target performance. Performance is rigorously measured by comparing the outcomes of the group who received the service with a control group. When the target performance is achieved, government pays the intermediary based on the achievement; if the program fails, investors lose some or all of their money while governments would not have to pay for the services rendered.

Pay-for-Success 2.0: Social Impact Guarantee (SIG)

A Social Impact Guarantee is a money-back guarantee insurance model in which government initially pays for a social service. When the outcome or impact of the social program falls short, the government receives its money back from private funders. The model has been introduced by Third Sector Capital Partners, which is aiming to implement the world’s first SIG project in 2016. The new model addresses the problem that governments are not accustomed to contracting for social services over a multiyear period — laws and regulations often become barriers for governments to take on multiyear social impact bond obligations. With the SIG model, government can purchase social services in a way that resembles its traditional timing and practice of paying as the work is done; private funders are giving the multiyear contingent promises to which they are already accustomed. Social Impact Guarantee also addresses the technical problem of “double capitalization.” In social impact bonds, governments make advance appropriations or place capital into escrow accounts to give private funders the confidence in initial projects, which may substantially limit the scaling of PFS.

Changes and Consequences

Both approaches allow public funding to go to only those programs that clearly demonstrate outcomes. By attracting private return-seeking investment capital and philanthropic money to serve society’s critical social needs, SIB and SIG transfer the funding risk of program failure from taxpayers’ money to the private sector. Both also allow governments to determine which program can be scaled up to better serve the vulnerable population.

Some experts view that PFS’s potential contribution is actually to unlock philanthropic assets to bring scalable outcomes rather than to attract pure return-seeking private capital to social programs, given the prominent role that philanthropy has played in PFS deals. Impact-seeking capital, rather than return-seeking capital, is likely to spur the growth of SIB and SIG. One cautious effect of PFS would be the inability of many social organizations to raise PFS funding, hampering their delivery of social services. Also, the application of PFS contracting can be constrained in those social issues where the outcomes are hard to pin down or successful interventions difficult to identify due to the complexity of the societal challenge.

Innovation for Impact

Regardless, PFS has more than enough potential to drive innovations from various aspects. It can change government spending behavior, accelerate data-driven social policy and evidence-based program implementation, create a culture of performance in the government and social sector, and give birth to fruitful public-private partnerships. There seem to be much to be explored and experimented with the PFS models.

Stay tuned next week for an interview with George Overholser, the CEO and Co-Founder of Third Sector Capital Partners, on the pay for success model.