Policy & Practice June 2015

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By Gary Glickman and Douglas Besharov

Budgeting for Results Funding Pay for Success Initiatives

P ay for success financing (PFS), often part of a social impact bond, is a new concept in which private investment supports the delivery of preventive services that save the gov- ernment money with those savings used to repay the investment. PFS is attractive because it has the potential to finance innovative evidence-based services and ensures that taxpayer dollars will only be spent once the desired outcomes have been achieved. In this article, we draw an important distinction between financing (raising capital) and funding (budgeting for results). Any governmental organization considering funding a PFS project must answer the questions of how to define savings and how to capture them. Defining Savings? There are generally three ways to think about savings in the context of PFS: 1. Budgetary savings. A reduction from costs that would have been incurred without the program. These savings typically stem from reductions in anticipated spending from uncapped program accounts. 2. Productivity savings. A reduction in the costs of capped programs in which there may be a waiting list or insufficient funds to serve the entire population. In this case, reducing the cost per outcome allows more people to be served using the same level of funding. 3. Social or long-term benefits. Benefits created from a re-oriented system, typically appearing 5 to 10 years after the PFS program.

Principal Stakeholders in a Pay for Success Project

Capturing Savings Making the calculation more

“Set Aside and Hold” Problem

complex is the fact that savings may accrue to agencies and/or programs within or across levels of govern- ment. Shaun Donovan, the director of the U.S. Office of Management and Budget and former secretary of the U.S. Department of Housing and Urban Development, referred to this as the “wrong pockets” problem. An investment made by one agency can yield savings in another. Consider a county government that reduces homelessness, and, thus, reduces emer- gency room visits. The costs are borne by the county, while the savings accrue to the Medicaid program at the state and federal levels or perhaps to a third- party provider. While there are several potential solutions to such situations, most of them depend on accessing savings from the entity to which they accrue— but sometimes that is constrained by regulation or law.

PFS contracts are usually long-term agreements in which agencies commit to making a payment at a future date when certain outcomes have been achieved. However, most state and local governments are unable to commit future resources (as opposed to current resources to be paid out in the future) without specific budgetary authority. This situation raises questions about how sufficient funds can be set aside to pay for the results when they occur— without being counted as current obligations. Investors may well be unwilling to come to the table if there is risk of funds not being available. Or, at a minimum, they will expect to be compensated for this risk through an increased rate of return. Also, state law may not allow agencies to enter into a contract that is not fully funded. Some states have addressed this risk—usually known as “appropria- tion risk”—by setting aside funds on

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