NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Tuesday, June 30, 2015

Do you care about reducing the prison population? Want to create work opportunities for homeless people? Re-employ veterans? Well, a new model of investing allows you to fund such projects — and even take home a profit.

It’s called Pay for Success, a radical form of civic-minded financial engineering that effectively reverses a problematic paradigm that prevailed during the financial crisis. Unlike the dysfunctional situation of 2008, when giant bank bailouts amounted to “privatized profits and socialized losses,” this model leaves private investors bearing the risk that a social program might fail but sharing the spoils with taxpayers if they work, explains Tracy Palandjian, chief executive officer of Boston-based nonprofit and pay-for-success pioneer Social Finance.

Often described as “social impact bonds” – somewhat erroneously, as they perform more like equity than fixed-income securities – pay-for-success securities steer investors’ money into civic improvement programs and deliver them a return, in the form of payouts from the sponsoring government agency. Their profitability is based on how well a predefined and independently measured positive social outcome is achieved.

The movement began in 2010 with a pilot program at Petersborough prison, north of London. With Social Finance’s help, the British government tapped £5 million from 17 investing foundations, handed the money to a coalition of nonprofits whose programs aim to keep ex-convicts out of trouble, and promised to pay the investors a profit if reconvictions fell below certain thresholds over six years. The thinking was that government would reap big savings from reducing the number of prisoners and could share some of that with similarly incentivized investors.

Since then, more than 45 projects worth $185 million have been launched across nine countries, according to Social Finance. Although that’s a tiny drop in the roughly $50 trillion ocean of government bonds worldwide, the idea is gaining traction, driven by a rainbow alliance of charitable organizations, tech-minded service providers, governments and asset managers.

In the U.S., there are now seven projects in five states targeting recidivism, education, housing and homelessness, and child and family welfare, as well as various others coming online for asthma management, maternal and child health, workforce development, and mental illness. Institutions engaged in organizing, funding and promoting these projects include Goldman Sachs, Bank of America Merrill Lynch, the Rockefeller Foundation, the Federal Reserve Bank of San Francisco and agencies from all levels of government.