John Hoffmire: 'Pay for success' — when government, private and community interests align

November 23, 2015
Author: John Hoffmire

Not all government policies are as effective as intended. This can happen for a variety of reasons, including failure to thoroughly research a policy’s consequences or a misunderstanding about which people will be affected. Often policies are proposed based on stories and anecdotes rather than data, or no measurable goals are proposed to accompany a policy. In the last few years, innovative “pay for success” programs are transforming the way in which government develops and implements policy in various places around the country, including Salt Lake City.

What is a “pay for success” program? It is a program initially funded by investors through which, if successful, as determined by an independent third party, the government pays said investors a pre-specified return. If the policy is unsuccessful, the investors can lose some or all of their investment. This is good for citizens and government since taxpayers’ dollars are only spent on policies that actually deliver results. The organizations that implement work also often receive upfront monies and do not have to fundraise on a yearly basis to provide the services which are contracted.

So what is an example of a problem that can be addressed through a pay for success program? Children who are not prepared for kindergarten often perform more poorly in school than their peers. Consequently, special education programs have been developed to assist these students. However, catching up these students is more difficult than preparing them prior to kindergarten.

To better help children succeed in school, as well as reduce costs, Salt Lake City began a pay for success pilot program in 2013 for preschool kids. The goal was to provide a high quality preschool education that would better prepare kids for kindergarten and reduce the number of students who need to utilize special education.

In the pilot program, nearly 600 children were placed in a high quality preschool funded by Goldman Sachs and J.B. Pritzker. Of the 600 children who enrolled in the preschool, 110 were identified as likely to need special education services. In the first year of kindergarten, only one of the 110 at-risk children utilized special education services. The initial investors receive a percentage of the money that is saved from special education expenses as a return.

But who would invest in initial pay for success programs, especially when there may be little or no knowledge on whether or not the program will be successful? Clearly such an investment would not be attractive to those who are only interested in making a profit. However, many corporations and philanthropists already donate large sums of money to charity without any expectation of a return. For now, pay for success programs provide the philanthropist with the opportunity of making a difference with the added benefit of a possible financial return. Generally, as these types of pay for success programs gain in popularity, the hope is that investors will be found among those who have significant for-profit interests.

Pay for success programs help governments and private organizations set goals that are measurable and realistic. This is a consequence of the financial contract entered into by the governments, investors and other involved organizations. If goals and outcomes are not measurable and well-defined, it is difficult for a third party to determine whether or not those goals have been met and whether or not the government should pay for the outcomes. The financial agreement between all parties provides an added incentive to accomplish specific and measurable outcomes.

Pay for success programs have the potential to help improve both the effectiveness and efficiency of traditional programs. Although pay for success programs are not the solution to every policy question, they are proving to be effective in a number of areas. Their success is yet another example of the important role of private corporations, organizations and investors in improving lives.

John Hoffmire is director of the Impact Bond Fund at Saïd Business School at Oxford University and directs the Center on Business and Poverty at the Wisconsin School of Business at UW-Madison. He runs Progress Through Business, a nonprofit group promoting economic development. Richard Payne, Hoffmire’s colleague at Progress Through Business, did the research for this article.