Chris Jurgens
Director, Impact Investing

Driving Pay for Success as a Vehicle for Systems Change | Why We Invested: Social Finance

February 7, 2018

Across the United States, government-funded social service programs are critical in serving many of our most vulnerable populations. And innovative nonprofits delivering these services can have transformative impact on people’s lives.

In South Carolina, with support from the state’s Department of Health and Human Services, Nurse Family Partnership works with first-time mothers in low-income communities to support healthy pregnancies and positive child development.

In partnership with Massachusetts, Jewish Vocational Services helps immigrants and refugees integrate into their local communities, develop skills, and get jobs.

In Oklahoma, Family & Children’s Services Women in Recovery program helps improve life outcomes for women who have served prison terms for non-violent offenses.

And in Alabama, with support from the Department of Veterans Affairs, IPS (Individual Placement and Support) works with veterans dealing with post-traumatic stress disorder to help them secure employment as part of an integrated set of mental health and recovery services.

As impact investors, we often focus on for-profit startups that are advancing innovative solutions. But nonprofit social service delivery represents an enormous market that merits greater attention from the impact investing community. Federal, state, and local governments spend a combined $5.4 trillion a year, with more than half flowing to education, healthcare, criminal justice, workforce development, child welfare, and veterans’ support.

Few question that social service programs have laudable goals, but a common critique of the social sector is that we don’t have concrete evidence of what works. And too often that’s true.

What’s particularly notable about the nonprofits cited above is that they are among a cadre of leading social service providers that are delivering innovative interventions backed by evidence of results. And they have all partnered with Social Finance US, along with state and local governments, as early pioneers of Pay for Success (PFS) financing. And in so doing, they have joined a movement that is seeking to shift how we finance and deliver social services to be more outcomes-driven.

Pay for Success is a public-private partnership which funds effective social services through a performance-based contract. PFS models, sometimes called social impact bonds (SIBs), connect evidence-based service providers with impact investors who provide upfront funding for programs, and government agencies that agree to repay that investment if a given program achieves predetermined goals. Put even more simply, PFS enables governments to partner with high-performing providers to better leverage private investments to expand effective programs.

Social Finance US has been at the forefront of the PFS movement in the US since the organization’s founding in 2011. As a leading PFS intermediary, they play multiple important roles bringing a PFS project to life: helping governments and nonprofits identify interventions and populations where a PFS approach is feasible; designing how payments can be linked to specific outcomes; partnering with governments and nonprofits to help strengthen their capabilities in outcomes measurement; and raising capital from commercial and philanthropic investors. And once a PFS project is underway, Social Finance helps provide the glue between the project partners to keep things running smoothly.

In the last seven years, thanks to Social Finance and a growing ecosystem of organizations championing the movement, PFS in the US has moved from an idea to a vibrant sector. 20 PFS deals have been launched in the US, collectively leveraging more than $211 million in private investment capital. There is a robust pipeline of PFS deals under development, and 15 states have either introduced or passed legislation to enable PFS projects.

Furthermore, the first generation of PFS projects, in the US and globally, have started to demonstrate results. In 2017, the landmark UK Peterborough prison social impact bond, the first-ever PFS deal, achieved its target outcomes in reducing recidivism, triggering full repayment with interest to the bond’s investors. And globally, ten PFS projects have returned investor capital with a return on investment, and an additional eight SIBs have made initial payments to investors based on successful social outcomes.

PFS is often characterized as an innovative impact investing instrument. At Omidyar Network, having partnered with Social Finance over the last six years, we’ve come to see PFS not only as a tool for leveraging private capital, but perhaps even more importantly, as an approach that can accelerate systems change.

PFS aims to transform how we finance and deliver social services to reach society’s most vulnerable. It requires fundamental behavior change among the multiple stakeholders involved. Nonprofits must shift from securing resources for inputs to being accountable for outcomes. Governments must change how they contract for social service provision, build new ways of collecting and using data, and work with private investors in sectors where there is no history of doing so. And investors are asked to fund the largely unfamiliar social sector, using a relatively new type of financial instrument, with repayment tied to interventions that have significant implementation risk.

Effecting such change is no easy task — but when it all comes together, it leads to multiple levels of impact. Most directly, nonprofits receive financing that allows them to impact individuals’ lives, and address key root causes of poverty, inequality, and injustice in our society.

But in addition, high-performing nonprofits build a stronger evidence base and get visibility to help them expand their impact. State and local governments get better at gathering data and managing to outcomes, and are incentivized to break down historical siloes between agencies and programs that actually have shared goals. And investors see how their capital can be deployed to improve social outcomes — often in their very own communities. When you look at the progress of the PFS market through this systems change lens, the field’s progress is that much more impressive.

But there is a very long way to go. PFS remains a nascent industry. Deals are time-consuming to set up and small relative to the size of the addressable market. And awareness, while growing, remains limited beyond the movement’s early champions.

Omidyar Network is re-investing in Social Finance because we see them not only as an effective financial intermediary that can help make PFS deals happen, but as a force multiplier that can continue to advance the PFS movement and catalyze broader systems-level impacts: they help all the stakeholders in the ecosystem play their roles more effectively, and have a dedicated team that keeps learning, adapting, and innovating in the long-term journey towards the bigger endgame that PFS is trying to achieve.

We are excited to partner with Social Finance in their next chapter, as they seek to expand their impact and build the field. We see several important priorities.

The first is optimizing the “PFS 1.0” model. Social Finance has been at the forefront of efforts to drive down the transaction costs of PFS deals and increase replicability. We see potential to make further progress — particularly with models such as outcomes rate cards as well as various approaches to performance-based contracting.

Second, we see potential to apply the principles of PFS to mainstream financial markets by testing models for linking social performance and financial returns. For example, early experiments have integrated outcomes-based payments into financing for green infrastructure. And Social Finance sees opportunities to integrate social or environmental performance into financing for a range of sectors, from charter schools to coastal restoration.

Finally, the endgame for PFS is changing how government works. Social Finance, through their Public Impact Initiative, is moving well beyond working with governments on individual PFS transactions to helping them shift policy, procurement, and funding practices towards more systematically measuring and rewarding results.

In the height of the Great Depression, Franklin Roosevelt said, “The test of our progress is not whether we add more to the abundance of those who have much; it is whether we provide enough for those who have too little.” Eight decades on, for all the progress we’ve made as a nation, we are still too far from having met this test. We believe that Social Finance, by continuing to build the Pay for Success movement, will help get us closer.

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