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5 Ways to Make the Most of Pay for Success

New federal legislation provides an opportunity for state and local governments to use the innovative approach to reinvent social services.

Congress recently passed legislation that knocks down one of the main barriers that governments have faced in undertaking innovative pay-for-success (PFS) projects. Under PFS contracts, private investors who fund the scale-up of a promising program are repaid only if the intervention is successful. However, until now state and local governments seeking to make repayments based on budgetary savings generated by the project could not draw on the cost savings that flow to the federal government from the success of social-service programs.

The federal government's renewed support for PFS will likely inject new momentum into the movement. But to accelerate progress on the most urgent social challenges, governments need to seize on PFS as a steppingstone to reinventing how social-service agencies function more broadly. Based on our experience helping to launch many of the U.S.-based PFS projects, including most of those led by state governments, there are five key steps state and local governments need to take to make the most of the $100 million in newly available federal PFS funding:

1. Identify programs with major federal cost savings. One of the biggest hurdles for state and local governments interested in PFS projects has been the "wrong pockets problem": Most of the savings from successful services accrued to the federal government, which in turn was not contributing to the outcomes-based payments. Take, for example, a state diabetes-prevention program that reduces or delays diabetes among Medicaid beneficiaries. That results in Medicaid savings, but the fraction of those savings captured by the state is unlikely to outweigh project costs. Through this new legislation and the $100 million it earmarks, the federal government will now be able to return the federal-level savings to state or local governments that create successful programs. State and local governments should take advantage of this opportunity.

2. Make sure the program is appropriate for PFS funding. PFS is suitable for a specific set of social programs. Budgetary savings and public value produced by a particular program need to outweigh project costs. A rigorous evaluation should be feasible and have the potential to inform important policy questions. And there should be potential for greater impact through possible future expansion of the program to justify the large project-development costs.

3. Prioritize programs connected to the most pressing social challenges. Developing a PFS project is an incredibly complex and resource-intensive endeavor; often the most talented and innovative government officials across multiple agencies will be engaged for several years in constructing the project. To make this investment worthwhile for government, PFS projects should tackle the most challenging social problems.

4. Generate much needed evidence about successful solutions. While the legislation and the preferences of private investors are biased toward using PFS for programs already backed by strong evidence, the public sector may actually gain the most if PFS is used to fund programs with a medium-strength evidence base. At a minimum, programs need to have an adequate performance track record to shape deal construction -- that is, to inform the potential impact of the program, identify its target population, and work out financial terms and evaluation methodology. However, PFS can offer a great opportunity for promising programs to be rigorously tested for the first time in order to establish their evidence base going forward.

5. Prioritize rigorous evaluation. The learnings generated by evaluations of PFS initiatives are likely to inform future budget allocations and policy priorities, increasing the projects' potential post-PFS scale and impact. The more robust the evaluation, the better the data that will shape such decisions. As a result, using rigorous evaluation protects taxpayers' dollars, making it less likely that limited funding is spent on ineffective programs. In addition, a focus on paying for success creates incentives for providers and stakeholders to work together toward shared outcomes. Finally, rigorous evaluations also can help guard against practices like "cream skimming" -- avoiding hard-to-serve clients -- and ensure that the collaboration results in true improvements to outcomes.

The PFS model holds tremendous promise for testing specific interventions aimed at some of our most pressing social problems, whether to improve child welfare, reduce youth violence, tackle homelessness or mitigate substance abuse. Even more importantly, it can help governments develop the tools needed to fix the broader underlying human-services systems: to identify populations at high risk of negative outcomes, set up robust referral mechanisms to match them to appropriate evidence-informed services, structure contracts to align with desired outcomes, and engage with providers in sustained collaborations. By unlocking the federal government's share of the cost savings that the PFS approach can generate, the new legislation gives state and local governments an opportunity to use PFS as a stepping stone to scalable, data-driven improvements.

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