PFS overcomes traditional barriers to government efficiency (lack of access to significant capital, risk-aversion, and short-time horizons) to help deliver social programs that jointly produce a public good, government savings, and private profit. PFS requires two stages: (1) strategic planning to identify superusers of government services (those who touch multiple sectors and use disproportionate resources) and (2) a five-step process to develop a financial transaction in partnership with nonprofit, philanthropic, or commercial partners.
The Five Steps
- Step one: Value the product and assess risk.
- Step two: Set reasonable performance targets and make the deal.
- Step three: Build infrastructure.
- Step four: Deliver services and targeted technical assistance.
- Step five: Evaluate the program and determine whether the performance goals have been met.
Five actors are essential to develop the deal once the project is set. Governments identify the problem. Knowledge intermediaries recommend high-performing programs and price the product, while financial intermediaries structure the deal and solicit investors to contribute capital. If independent evaluators determine that the program has met its goals, governments pay the investors their principal and return.
Knowledge intermediaries work with governments to identify evidence-based best practices. Before the PFS project has been priced and the deal structure is agreed on, two questions will guide the development of the transaction: (1) Are there existing, proven (or promising) programs to better serve constituents? and (2) can the effects of those programs be reasonably predicted?
Multiple factors influence PFS pricing. Key factors include (1) how much infrastructure needs to be built and capital needs to be raised to support the program, (2) what the performance targets for the PFS program will be and the time it will take to reach them, (3) what the savings will be for the government and what portion of these savings will be cashable, (4) and how risky the project is and what return investors will require to support it.
Outcomes trigger payment: PFS transactions conclude with the independent evaluator determining if the project has achieved the performance targets. Ensuring transparency and that all parties agree with the evaluation results are key factors to preserving the integrity of the payment process and to building the consistency, stability, and viability of PFS as a financial instrument.
Advantages . . .
- Transfers financial and political risk from the government to private investors
- Fosters accountability and incentives to choose evidence-based programs because payment is dependent on results
- Has the potential to build sustainable community-based service-delivery infrastructure
- May reduce siloing across multiple departments and sectors
. . . and disadvantages of Pay for Success.
- Requires expertise from legal, empirical, institutional, and financial actors that may be difficult or expensive for government to manage
- Risks reallocating funds from existing philanthropic sources rather than attracting new money
- Could limit innovation by placing a premium on proven programs