Pay for Success Watch: Solving Government Uncertainty on Structure

The potential for Pay-for-Success (PFS) models in the human services field has captured the attention of the federal government, foundations and social impact investors.

But two years after America’s pioneer PFS projects began, there are fewer than 10 ventures being implemented. Many more are undergoing “feasibility studies” or are in some other stage of planning, but just a handful are actually underway and serving anyone.

So what’s the holdup on PFS projects actually happening? One factor appears to be that the structure is a bit of a square peg/round hole situation for state and local governments.

Canadian researchers John Loxley and Marina Puzreva, in a study of PFS work published in February, noted a “need for prior development of background supports” in terms of “legislation, government policy, budgetary practices and institutions, and lobbyists promoting and enabling.”

That’s research-speak for: We’re open to paying for this, we just don’t know how yet. There’s little precedent for agreeing to pay for certain social outcomes.

“This is a place of development in the PFS space,” said John Grossman, co-president of Third Sector, an intermediary working on several PFS projects. “The mechanical issue is, how do we enter into multi-year contingent contracts in a way that fits legally, fiscally, politically with our needs?

“The other issue is to also satisfy funders that money will be there. Those are not always complementary.”

Third Sector is involved in some active PFS projects, including a $27 million juvenile justice venture in Massachusetts and a $5 million project in Cuyahoga County (Cleveland) that addresses homelessness as a precursor to foster care.

Youth Services Insider asked Grossman, how did these jurisdictions managed to account for the possible PFS expenditures? Here’s what we learned.

Cuyahoga County has established what’s called a “sinking fund” to facilitate whatever payments are owed to the financiers of its project, which include The Reinvestment Fund, The George Fund Foundation and Sisters of Charity Foundation of Cleveland.

A sinking fund is established with an initial allocation and future, periodic payments scheduled thereafter.

Such a fund exists to service one specific obligation. It could be a planned capital expense, but more frequently it is created to finance the repayment of long-term debt.

The initial payment in Cuyahoga was $2 million, Grossman said. Money will go into the sinking fund at a pace that would cover the expenses of the project at any given time, and can only be spent on the project. At the same time, project funders were also allowed to put money into this in increments.

This arrangement provides a base level of protection for the investors. Let’s say after two years, the county just decides to abandon the work for whatever reason. The sinking fund will have enough money in it to pay out the funders for the cost of the services that had already been provided.

Massachusetts has taken what Grossman called the “belt and suspenders” approach to structuring its deal. It has also established a sinking fund to make investors whole, but the state went well beyond that in establishing its belief in the PFS structure.

In 2012, former Gov. Deval Patrick (D) signed a bill that essentially places the full faith and credit of the state behind its obligations in pay-for-success projects. It is, Grossman said, about as much as any state government can do to guarantee a contract.

“I don’t think will be a lot of other states willing to put their full faith and credit behind it,” Grossman said. “They might use their commercial credit risk behind it. And parties will recognize that’s valid.”

Click here to read an excellent rundown of Massachusetts’ law and others passed by Connecticut and New Jersey.

Both Massachusetts and Cuyahoga accomplish two key things with the structures they have come up with. First, the sinking fund prevents government from being presented with a large bill at the end, and that is key. Sticking a new governor or legislature with the full cost of a PFS signed by predecessors

And secondly, both have made some assurance to funders that the money will be there to pay them at the end of the day.

But at the moment, both structures assume success. What neither state has fully figured out, Grossman said, is what to do with the money if it some or all of is ­not owed in the end.

“Our systems aren’t set up to handle this perfectly,” Grossman said.

Presumably, the fate of those dollars would hinge on the prevailing philosophy of the sitting governor; a fiscal conservative might capture it into the general fund; others might choose to bolster other services within the realm of the project.

On a macro level, there is another facet of contracting that Grossman agrees is a weak point thus far: the impact of early government pull-outs from PFS ventures on the general reputation of the PFS structure.

The sinking funds protect the investors in individual projects from getting hurt if the government just decides to cease pursuit of a PFS project before it gets to an end date. But that protection does nothing to protect the “PFS industry” from appearing unstable and/or unattractive to investors.

Governments pulling out of projects that appeared troubled, or perhaps involved a controversial provider, would be bad. The darker scenario would be if governments bailed on PFS projects that appeared to be headed for success and subsequent incentive payments.

“That would be detrimental to the space,” Grossman said.

It is a possibility that PFS stakeholders should consider in earnest. The granddaddy of all these projects, the social impact bond work at Peterborough Prison in England, ended with the government pulling out early on the venture.

Youth Services Insider is mostly written by Chronicle Editor John Kelly.

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