‘Pay for success’ is no gimmick; it would improve social services

EDITORIAL | Editorial

September 15, 2011

HARD-PRESSED human-services groups in Massachusetts often claim they prevent far more in future expenses - in jails, say, or in hospital emergency rooms - than they cost right now. They deserve a chance to prove it. Fortunately, the Patrick administration is looking at an intriguing way to fund services now based on the good they produce in the future.

Using a financial instrument called “social impact bonds’’ could increase funding for effective social-service programs while avoiding weak ones. These aren’t typical bonds that must be repaid with interest. Instead, private investors - usually foundations or charitable trusts - provide the capital for social programs normally funded by government. If the program meets or exceeds its performance goals, the government repays the investors, often with bonuses. If the program fails, the taxpayers are off the hook. Nonprofit intermediaries broker the deals and provide operating oversight.

The bonds, also known as “pay-for-success bonds,’’ depend on the state’s ability to take an accurate measurement of the cost of social problems. Some lend themselves especially well to this approach. The typical high school dropout, for example, will cost taxpayers nearly $300,000 over the course of his or her lifetime in lower tax revenue and incarceration costs, according to a 2009 study by the Center for Labor Market Studies. So if a dropout prevention program succeeds, investors in social impact bonds could see a healthy return, and the government should still come out ahead.

Other fruitful areas for social impact bonds include programs that reduce the use of emergency health services by the homeless and lower the chances that convicted criminals will repeat their offenses. Roca Inc., a vendor of social services in Chelsea, argues that it can save the state at least $25 million in incarceration costs over the next four years by mounting an $11 million intervention program for 650 high-risk youths during the same period.

The bond program would serve the state well in two important respects: It creates an incentive for foundations to invest in services that traditionally have been supported only by government, thereby targeting more money at the most serious social problems. It also provides a new, market-based vehicle for judging which programs are effective; those that are unpromising won’t attract investors.

Tracy Palandjian, founder of the nonprofit Social Finance Inc., believes the program could have a major impact. Right now, she said, most foundations put only a small percentage of their assets back into the community in the form of grants, while keeping the bulk of their endowment in interest-bearing accounts and other investments. Social impact bonds, said Palandjian, will give foundations a new way to invest their endowments. Funders can take money that might otherwise have sat in the bank, and instead put it to work on the street.

If foundations devote more money to social services and government is scrupulous about entering deals only when they achieve net savings, these bonds should be a good deal for the Commonwealth.