Private money, public impact: a creative new "pay-for-success" funding approach for social programs is gaining steam--but also detractors.

AuthorHoback, Jane
PositionSOCIAL FINANCE

Everybody is talking about social impact bonds--an innovative yet controversial approach to reducing homelessness, helping ex-offenders stay out of prison, giving young children the opportunity to go to preschool, training old workers for new jobs, and expanding preventive health care for low-income people.

States are striking deals with investors to deliver results--reducing prison recidivism by 8 percent within five years, for example--and save taxpayers' money in the long run.

If programs meet their goals, investors, who put up millions of dollars, are repaid with interest by the state agency overseeing the project. If they don't, the foundations, investment banks and others are out their money, and don't reap a return. Financial heavy-hitters like the Rockefeller Foundation, Goldman Sachs and Bank of America Merrill Lynch are in the game.

Proponents say the financing method--with a track record of about five years--presents little risk to taxpayers and ultimately saves states money. But critics caution it is too soon to tell, arguing the new model is unproven, risky and expensive, and potentially excludes social programs not attractive to investors.

Millions in Massachusetts

The idea's popularity has grown fast. Today, some seven states and local governments have launched projects, and Massachusetts has the biggest--a $27 million, seven-year "Juvenile Justice Pay for Success Initiative," begun in January 2014.

The state contracted with Roca, Inc., a nonprofit whose mission is to help former offenders get back on their feet. Roca is working with young men in the Boston area who have left prison or are on probation, and its goal is to cut the number of days these men are re-incarcerated by 40 percent.

Massachusetts officials estimate that would save the state as much as $41.5 million.

Depending on it success, at about the fourth year of the program, investor Goldman Sachs will be repaid at 5 percent, Kresge and other funders at 2 percent. Roca and Third Sector Capital Partners, which oversees the project, will be paid service fees for target results. But if the results exceed goals, Roca and Goldman can get up to an additional $ 1 million each and Kresge and other funders up to $300,000 each. If Roca fails to deliver, the government pays nothing and investors lose their money.

The initiative won strong bipartisan support from the legislature. "The members are interested in seeing that we can make these young people's lives better," says Massachusetts Secretary of Administration and Finance Glen Shor. "They know the state's risk is diminished because success means shared savings. If the initiative doesn't prove out, the government is not on the hook."

Shor believes the financing...

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