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Governments Experiment With Risk-Free Financing

Massachusetts may be the first state to use social impact bonds, a unique model that started in the U.K. for financing social programs.

Molly Baldwin’s world revolves around risk.

Since 1988, she’s been running a nonprofit operation in Chelsea, Mass., designed to keep young people off the streets and out of jails. They’re between 14 and 24 years old, and her programs teach them how to get a job and succeed in society. Over a two-year period, she observes patterns and tracks growth to see what’s working and what’s not. But in her world, she says, success doesn’t always reap rewards.

“We have big social problems and they cost a lot of money, and we don’t apply the same type of thinking we do to for-profit businesses,” says Baldwin, the founder and executive director of Roca Inc. “I could go find 200 more kids on the street, but that doesn’t mean they come with money.”

When it comes to funding new program models, state and local governments aren’t exactly big-time, put-it-all-on-the-table gamblers. In many cases, agencies tend to focus on inputs rather than outcomes. As a result, defective programs can persist for years on end, while successful organizations that focus on issues like homelessness, recidivism and youth violence don’t get the money they need. “If you’re busy piecing together money all the time,” Baldwin says, “you don’t get to put all the effort into what the program is.”

But what if there were a different financing model, one that pumps dollars into social programs the government can monitor over time without paying a single dime up front? It may sound like an ad for a pyramid scheme, but the United Kingdom is in the middle of a pilot program based on just such a model, known as a social impact bond. In Massachusetts, Gov. Deval Patrick’s administration is taking steps to become the first state in the country to use this strategy.

Here’s how it works: Investors (charitable foundations, wealthy individuals, monied families) put up the initial investment for the expansion of a nonprofit program. The nonprofit must agree to meet specific benchmarks within a certain period. A government agency signs off and oversees the progress. If the program meets its benchmarks, the government refunds the investors. There is also the possibility of a profit if the program exceeds expectations. In theory, the government wins either way. If the program succeeds, the government saves money. (Reducing recidivism, for example, cuts incarceration costs.) If the program fails, the government owes nothing.

With the ever-increasing strain on public revenues, governments may look at this new model as a risk they can afford to take. The approach appeals to Massachusetts for its potential to address homelessness, adult corrections, juvenile justice and several other areas where the state hopes to improve certain outcomes, according to Jay Gonzalez, Massachusetts’ secretary of administration and finance. The state is exploring the idea now, consulting with experts and soliciting feedback. The goal is to identify the top areas that would benefit from the social impact bond model and contract with providers by the end of the year.

“We’re never going to be quite in the same place we were before the recession,” Gonzalez says. “In order to deal with this new fiscal reality, we need to find new ways of doing business. This is a concept that typically isn’t the way government works, but it’s a direction we need to go under this new rubric.”

In the U.K., 60 percent of short-term offenders are back in jail within a year of their release, turning the prison system into a revolving door, according to Social Finance, an independent investment bank intermediary.

Social Finance wanted to reverse that trend. The organization pitched a pilot scheme to help 3,000 short-term inmates from a prison in Peterborough, England, find jobs, housing and counseling by securing $8 million worth of social impact bonds. The funds were raised and the program launched last fall. If the program manages to reduce the prison’s recidivism rate by 7.5 percent in six years, the British Ministry of Justice agreed to give the investors their money back. If it drops more than that, the return could be even greater.

“In a successful scenario, all the parties win,” says Tracy Palandjian, the CEO of Social Finance’s U.S.-based arm. “The government only pays for what works. Investors get their returns, and nonprofits are given scaled capital to do what they’re good at doing.”

The U.K. pilot still has five years to go before the results come in. But President Obama is already sold on the concept of the government only paying for what works. In his 2012 budget proposal, he asked Congress to set aside $100 million for seven “pay-for-success” projects that target job training, education, juvenile justice and children with disabilities, to name a few. In the U.S., state and local agencies deliver social services. The various agencies and disparate accounting could make potential U.S. models slightly more complicated than in the U.K., Palandjian says, but it also gives investors more diverse opportunities.

For all their noted benefits, social impact bonds also have potential problems that need to be worked out in advance, according to Jeffrey Liebman, a professor of public policy at Harvard’s Kennedy School of Government. In a report published by the liberal Center for American Progress in February, Liebman wrote that this funding model will only work if proven programs have high net benefits for investors, outcomes that can be easily measured, a well-defined treatment population and credible impact assessments. In addition, shutting down a failing program shouldn’t cause damage to the targeted group.

The U.S. can use social impact bonds to overcome barriers to social innovation, Liebman says, but the government must take steps to identify promising areas, assess the investor market, and establish “a neutral authority to measure outcomes and resolve disputes, independent of both the government and the bond-issuing organization.” He also mentions the importance of organizations that can act as go-betweens, connecting private investors with public agencies and service providers.

“Innovation is a crucial characteristic of how we’re going to solve social problems,” says Antony Bugg-Levine, managing director of the Rockefeller Foundation, which invested $500,000 in the U.K. pilot. “These bonds will offer a new way to mobilize for-profit investments. Investors can come in and fund ideas at a time when there’s more risk involved and governments are less inclined.”

As with any investment, risk plays a critical role. Although in this case, the stakes are the highest for private investors, not the governments. To increase the chances of seeing a return, Bugg-Levine says, investors should put their chips on programs that have already proven successful.

Regardless, risk comes with the nonprofit territory. And even though many innovative programs have had trouble securing public funds because governments considered them high-risk, social entrepreneurs like Baldwin believe desperate times call for different measures.

“I don’t want to watch kids die in the street or go to prison, and the potential of social impact bonds allows us to look at things in a different way,” Baldwin says. “I like the idea of getting the government on the hook for outcomes instead of trying to rub nickels together.”

Tina Trenkner is the Deputy Editor for She edits the Technology and Health newsletters.
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