Over the past two years both of our organizations, The Reinvestment Fund (TRF) and Living Cities, have explored Pay for Success as a promising new way to invest in human capital and build on our decades-long history of impact investing. As a result of that exploration, we both decided to invest in Pay for Success (PFS) transactions. Living Cities invested in both the Massachusetts Juvenile Justice PFS and the New York State Workforce Re-entry PFS, and TRF recently announced it will invest in the child welfare PFS project in Cuyahoga County. Our investments are designed to have social impact and also make a financial return – we fully expect to get our principal back and earn interest on our investment.
Assessing the likelihood of getting paid back from these deals was unlike anything either of us had done before. Because of our backgrounds in community development finance, we naturally defaulted to considering the four “Cs” of credit (Character, Collateral, Capacity and Capital). But in PFS deals, there is no collateral or capital, so we had to rethink our underwriting framework.
So, how did we assess the credit worthiness of these transactions?
While underwriting three deals by no means makes us experts, our ideas solidified around what we’re calling the four “Ps” of Pay for Success:
With so many people necessary at the table in PFS transactions (government or other payers, investors, intermediaries, evaluators and service providers) the need for trust, collaboration, and agreement on a shared vision and metrics for success is paramount. The tighter the partnership and the more aligned the goals of the project, the more likely it is to succeed. When things go wrong (and they will!) a set of partners committed to a shared goal is critical to finding a way forward. Partnership is hard to quantify, but it can be objectively assessed: Do the partners instinctively frame work in shared terms? Can the partners clearly identify challenges they have faced in working together, and do their responses to those challenges suggest an ability to clearly communicate, put self-interest aside and compromise to find a solution? Do the partners have strong interpersonal relationships? The answers to these questions speak volumes.
Ultimately, the repayment of the investment is dependent on the program’s ability to deliver successful outcomes. To determine the likelihood that the program will deliver those outcomes, it’s helpful to understand both the evidence-based research and the implementation aspects of the program. In other words, what does the research say about the type and effectiveness of the intervention? What factors contribute toward its successful implementation?And what is the track record of the service provider in producing the outcomes? Both Living Cities and TRF hired third parties to help us evaluate the program, the implementation plan and the evidence as we didn’t feel we had enough programmatic expertise to do it ourselves. PFS projects are unique in that they require financial expertise and programmatic expertise to work together in ways we previously haven’t done before.
Another aspect to consider when underwriting a PFS investment is the capacity of the public sector, or other payer, to create a policy environment that supports the project. Whether it’s passing a law to provide a mechanism to fund outcome payments or creating a reserve account within an existing budget line, having the payer’s buy-in is critical to ensure their commitment to the outcome/success payments, but also to provide ongoing leadership of the project. If the payer is the public sector, as it has been to date, having a government “champion” who spans political terms and can continue to provide leadership and oversight of the project is integral to the project’s success.
Not only does the program need to be sound, it also has to work within a process. By process we mean how the individuals in the project move through the system from beginning (usually referral) to end (ideally successful achievement of the desired outcome) and every step along the way. It’s important to understand how the handoffs of data, and people, are made to ensure there are no gaps in information sharing or program delivery. In particular, processes often break down at the intersection of different agencies or data systems, so it’s important to understand how the approach will address coordination across bureaucratic lines. The more the PFS process differs from business as usual, the more critical it is to assess the potential problem areas and identify solutions before they arise.
In the coming weeks, we’ll be exploring each of the four “Ps” in more detail – including real life examples of how we’re seeing each element play out in our own investments. Check back in on Wednesdays for the comings posts.
Our thinking about analyzing PFS transactions for credit worthiness is in its infancy, and we know our list is not complete, so we pose the question to you: What aspects of a PFS transaction do you consider most important when weighing your investment or are there risks inherent in a PFS investment that we have not considered?
Share your feedback and join the discussion in the comment section of this blog. And sign-up to receive new information about our Pay for Success work and evolving thinking.
Image source: Money in Hands from Flickr user, 401(k)2012. CC by SA 2.0.