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Is Pay-for-Success the Future of Government Spending?

Governments around the country are exploring pay-for-success funding solutions.

By Dwyer Gunn


(Photo: netzanette/Flickr)

A few years ago, South Carolina decided to expand its Nurse Family Partnership program, which provides nurse home visits to vulnerable mothers during pregnancy, lasting up to two years after birth. The nurses educate parents about everything from healthy behaviors and nutrition during pregnancy to effective parenting strategies to baby-proofing.

In numerous evaluations of various nurse visiting programs, researchers have found they dramatically reduce childhood injuries, emergency room visits, behavioral problems, and parental coping issues. One study shows that nurse home visits have positive effects not just on healthy behaviors during pregnancy, but on the overall health of women and their babies. Another study found reductions in welfare usage among mothers who participated in the program, and lower incidences of child abuse and neglect among the women’s children. In long-term follow-up studies, researchers reported that, in adolescence, the children of women who received nurse visits exhibited lower rates of arrest, fewer lifetime sex partners, lower rates of alcohol and cigarette usage, and lower rates of (parent-reported) behavioral problems.

In other words, nurse home visiting programs are an astonishingly effective means of improving outcomes for vulnerable, low-income children and families. But the programs aren’t free, and they require a significant upfront investment. Nurses and administrators have to be hired, trained, and paid. Families need to be recruited and enrolled. The costs pile up, and cash-strapped local governments and non-profits often lack the consistent funding needed to scale up or launch the programs.

So South Carolina decided to explore an intriguing new public-private financing mechanism for funding social programs: a Social Impact Bond. In February 2016, South Carolina Governor Nikki Haley announced a $30 million expansion of the state’s existing NFP program, funded entirely by a combination of private individuals, foundations, and a Medicaid grant.

The first social impact bond was introduced six years ago in the United Kingdom; the concept has since attracted growing interest in the United States. To date, 10 different pay-for-success projects have been launched in the U.S. (one has already concluded), and a project in Connecticut will soon launch. In a recent report on the topic, Third Way, a centrist think tank, calculated that, worldwide, “60 SIBs have been launched in 15 countries with a total investment over $200 million.”

Nurse home visiting programs are an astonishingly effective means of improving outcomes for vulnerable, low-income children and families.

The concept behind pay-for-success funding isn’t dissimilar to a small business seeking a loan from a bank or private investor to expand and grow their production capabilities. A government agency identifies the need for a new or expanded social program that also has the potential to produce cost savings down the line. Private investors — individuals, philanthropic organizations, even a few banks — loan the necessary start-up or expansion costs to the service provider. An independent evaluator then determines if the program has met its goals (as defined by a set of pre-determined metrics) and produced the expected cost savings. If the program is successful, the investors are re-paid by the government for their upfront “loan” (the terms vary — some investors also receive successful payments as well, and some philanthropic investors recycle their pay-outs back into the program to allow for further expansion). Should the program fail, the government pays nothing, and the investors lose out.

In the case of South Carolina, an independent evaluator will assess the effects of the expanded NFP program on four metrics, most of which are associated with cost savings for local government: pre-term births, child hospitalization rates and emergency department usage, healthy spacing between births, and the number of first-time mothers served in high-poverty zip codes. If the expanded NFP program meets its goals, South Carolina (which will be saving money in the form of lower spending on pre-term births and emergency room usage for Medicaid-eligible mothers in the program) will make “success payments” to the investors, although the investors in this case have all committed to directing their success payments back into the program. In the event that the program is a total bust, the state pays nothing.

Pay-for-success initiatives elsewhere in the country have focused on investments in early childhood education, interventions targeting at reducing recidivism among juvenile and adult offenders, and providing supportive housing services to homeless people. In some cases, service providers have used the flexibility of the funding mechanism to design programs that provide an unusually wide variety of services to needy populations.

“This is a way to try to align the forces and really increase the kind of value that you can provide to individuals who are struggling and the organizations that are working with them by allowing that kind of alignment,” says Justin Milner, the co-director of the Urban Institute’s Pay for Success Initiative.

Milner says the funding mechanism solves a couple different issues that have plagued the social services sector. For non-profits, pay-for-success funding provides stable, consistent funding over the course of several years, a luxury that many non-profits lack. Governments, meanwhile, are not only protected from footing the bill for ineffective programs, but are able to learn, from an unbiased third party, whether a program is effective and worthy of further investment.

It’s perhaps not surprising, then, that the concept enjoys broad bipartisan support; projects have been implemented in both red and blue states. “It brings people to the table for different reasons,” Milner says. “Republicans are really interested in the accountability mechanism that’s built into pay for success. If a program doesn’t work, then you might stop funding it. And Democrats are excited to think about new ways to potentially fund programs that do work.”

That’s not to say pay-for-success is some sort of cure-all. For starters, it’s application is currently limited to programs that can produce clear, measurable cost savings in the relatively near-term, and the metric must be carefully chosen. “You need a very narrowly defined metric, so that you can very clearly determine if the program is a success or not,” says Third Way’s Emily Liner.

The deals executed so far have also carried high transaction costs, both in the form of actual fees and in time invested. “We’ve talked to several stakeholders who have said it can take up to two years to pull everything together,” Milner says. “It’s hard to find the data systems that can support the kinds of questions that PFS projects ask, in terms of whether or not a program works or not. And the contract construction is also challenging. Most places are doing this for the first time.”

But both Liner and Milner expect that the various transaction costs and administrative headaches associated with these deals will decline as they become more common. “This is a big paradigm change,” Liner says. “There are best practices being developed, and they’ll continue to be developed around SIBs as they become more popular.”

Despite their shortcomings, however, it’s hard not to get excited about a funding mechanism that both rewards evidence-based, effective programs and offers local governments a way to scale up effective programs even when current budgets are limited and politicians are more interested in cutting taxes than investing for the long term.

“We don’t factor those longer time frames into our thinking about cost and benefits and government spending,” Milner says. “This is a way to force that to happen — to really focus policymakers and investors, to think about what do these programs actually mean over the long-term for people that we know are struggling.”