Social Impact Bonds and Community Foundations: Making Pay-for-Success Initiatives Accessible Maria Hernandez1 and Joshua Genser23
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ocial Impact Bonds are an elegant method of paying for solutions to some of our nation’s social problems, such as homelessness, recidivism, lack of early childhood education and chronic disease. Unfortunately, elegant does not mean simple. Establishing a social impact bond program is complex and fraught with substantial barriers. The complexity of using a Social Impact Bond requires a legal and financial infrastructure not yet ready to accommodate these programs, establishing agreed upon and validated successful outcomes, and defining the target population for the intervention to insure that services are being delivered consistently. We propose that Community Foundations, properly empowered, could be the foci around which communities can build the financial infrastructures that would facilitate the use of social impact bonds and other innovative financing that would attract impact investors. In doing so, the nation’s 750 community foundations would accelerate the use of Social Impact Bonds to pay for much needed social programs. A community foundation is, or ought to be, a creature of its community: known to and trusted by local charities, governments, businesses, financial institutions and community leaders. Trust and transparency is important to all of the other players, who are committing their money and time to the program, and local knowledge is invaluable to the design and successful implementation of the program. Community foundations are uniquely tied to local organizations that have the capacity to provide oversight for community interventions: local community leaders and experts who understand local needs as trusted resources. Our premise is that our hands on experiences can inform community foundations eager to develop alternative financing to address long standing problems. We begin with an overview of Social Impact Bonds and highlight several key issues a community must be willing to address in order to make use of this financial strategy. We conclude with how a community foundation can facilitate the financial transactions necessary for large scale success of Social Impact Bonds in the US, thus making them more accessible to a broad range of nonprofits, regional governments and local communities.
Social Impact Bonds 101
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Social Impact Bond, for the uninitiated, is not necessarily an actual bond. President Obama’s administration has used the term “Pay-For-Success” to describe an agreement between investors willing to finance a social program that achieves predetermined results and payors who will reimburse the investors.
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Maria Hernandez, PhD is President and COO of Impact4Health, LLC, a California based firm focused on healthcare innovations, strategy, and community engagement to address healthcare disparities. Impact4Health, LLC is the lead consulting firm for phase 1 of the Alameda County Pay for Success Asthma Initiative. 2
Joshua Genser is the Chair of the Board of the Richmond (California) Community Foundation. He has recently retired, after more than 30 years, from the private practice of business and real estate law to help funders, nonprofits, government agencies and community foundations establish pay-for-success social programs.
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The authors thank Laura Tomasko of the Council on Foundations for her invaluable advice and assistance with this article.
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A Social Impact Bond funds programs that will save payors money, and some of those savings from the success of the programs are earmarked to repay the investors. Social Impact Bonds provide sustainable capital for proven, effective interventions by attracting private investors to pay for the upfront cost of interventions, with the promise of receiving a return on their investment paid from the savings generated by the interventions. In order to understand the mechanics of a Social Impact Bond (SIB), the following illustration highlights the key players and the sequence of steps required in order to launch and complete a successful Social Impact Bond:
While no two SIBs are exactly alike, they have common elements: A population in need, a social program that can address that need, investors eager to make a positive impact, payors willing to pay investors principal plus interest based on a percentage of the savings derived from the intervention, and an intermediary. The intermediary manages the money being invested by the bondholders, coordinates the service providers who are actually going to deliver the services paid for by the bond proceeds, and oversees an independent evaluator. The evaluator manages the process of gathering the data and validates that the program met its target outcomes. Intermediaries are typically paid a portion of the savings earned from the successful intervention and oversee the pay-out to investors according to the agreed terms of the SIB or Pay-For-Success contract. It is the role of intermediary that we envision community foundations can and should embrace.
Two Unique Approaches for a Social Impact Bond
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he Richmond (California) Community Foundation (“RCF�) is working on a Social Impact Bond targeting blighted housing. The City of Richmond, California, suffered disproportionately from the Great Recession, and still has an oversupply of deteriorating houses awaiting tax sale, foreclosure or in the inventory of banks. RCF is working with the City of Richmond, which will issue $2 million in municipal bonds, then give the money to RCF, which will purchase boarded-up houses, rehabilitate them and sell them. The bondholders will be repaid from the proceeds of the sales of the houses. The program will be among the first Pay-For-Success programs in California, and the first in the nation to be financed through the sale of bonds. Richmond’s Social Impact Bond is simpler than others being contemplated or implemented, but is nevertheless an apt illustration of the challenges and potential of Social Impact Bonds. 2
The RCF Social Impact Bond does not rely on quantifying the less tangible benefits of the program, such as reduced blight, because the bondholders will be paid out of profits from the sale of the houses. RCF does, nevertheless, intend to attempt to gather data on reduced crime, increased property tax revenues and increased property values in neighborhoods where the program has operated, in an attempt to enable other communities to fund such programs even where the acquisition and rehabilitation of blighted buildings may not be as profitable. RCF expects to be able to make a substantial profit on the sales of the rehabilitated houses and use those profits to reinvest in the community. In neighboring Alameda County, a Pay-For-Success initiative will attempt to reduce asthma-related hospitalizations and emergency room visits. The program includes home-based environmental remediation (removing mold, pet dander, or other known asthma triggers) and health education on improving asthma management. The investors in the program will be repaid out of the savings realized from reduced hospitalizations and reduced emergency department visits. The payors are projected to be insurance companies, self-insured employers and other entities that benefit from reducing asthma related hospitalizations. This work emerged from similar work funded by the California Endowment that focused on the feasibility of a Social Impact Bond in Fresno, California, which also addresses asthma-related hospitalizations4.
It is relatively easy to determine the savings from the asthma intervention to those who pay the health care bills -insurers and health plans-- because their savings are the payments they don’t have to make for hospitalizations and emergency department visits. Based on public data available, the average price of an asthma related hospitalization in Alameda County for children is $16,585, and for adults is $53,6985. Given that the per person cost of the proposed intervention is only $2,500, any reasonable reduction in those hospitalizations will contribute substantially to a positive ROI. However, we also hope to capture the savings from reducing hospitalizations and emergency department visits by the uninsured, and that is much more difficult to determine. Measuring the financial savings requires a level of transparency in medical costs that remains elusive in the US healthcare industry.6 The cost to the hospital, or to the County operating the hospital to which the uninsured resort, of a single visit to the emergency room or an individual hospitalization may be very small, perhaps infinitesimal.7 The costs of operating the emergency department and the hospital are, after all, generally fixed, and, unless the reduction in the number of visits is quite large, the hospital must maintain the same number of physicians and nurses and the same level of supplies despite the reduction in asthma-related visits. Also problematic is that the hospitals may charge vastly different prices to different payors, depending on the applicable regulations and negotiated contracts. Thus calculating the true ROI will only happen with clear cooperation from hospitals, health plans and health insurance providers. While the traditional model for a Social Impact Bond was the intended starting point of this effort, Alameda County is exploring the development of a Sustainable Health Impact Fund—sometimes referenced as an “evergreen option” –to be housed within a regional community foundation. The management of this fund would be structured so that payment to investors is based on a clear performance agreement and not a percent of savings secured by the payers who benefit from the program intervention. The intervention must reduce 30% of
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A Market for Health: Shifting the Paradigm for Investing for Health. Hernandez, M. Brush, R. Syme, L. Unpublished white paper available at: http://www.impact4health.com/publications---resources.html
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California Breathing Alameda County Asthma Profile May 2011 http://www.californiabreathing.org
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Brill, S. Bitter Pill. Time Magazine, March 2013
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John C. Moskop, “Non-urgent Care in the Emergency Department – Bane or Boon?”, American Medical Association Virtual Mentor, June 2010, http://virtualmentor.ama-assn.org/2010/06/pfor1-1006.html
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hospital emergency room visits and reduce the total number of days in the hospital by 30%. In addition, a portion of the fund would be dedicated to support the feasibility studies often needed to establish a Pay-ForSuccess initiative. The following diagram illustrates the mechanics of a Sustainable Health Impact Fund that may operate with a community foundation managing the transactions:
A Sustainable Health Impact Fund would, admittedly, require substantial effort for initial set-up. Once established, however, the use of funds to support additional programs would be much easier than creating a new Social Impact Bond for each initiative. Depending on the specific set up of a fund, some portions may be dedicated to feasibility studies, which are often the precursor to setting up a Pay-For-Success initiative. It should be noted that the fund may be a regulated security, just as are the bonds, but the regulatory hurdles need be overcome only once. The purposes to which the fund is dedicated may need to be of some narrow definition in order to enable private foundations to characterize their investments as program related investments, but those purposes could still be broad enough to encompass many different social programs, such as health, recidivism, homelessness or early childhood education.
The Challenge of Developing Social Impact Bonds
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he three primary challenges a community foundation will face at establishing a Social Impact Bond are finding proven programs that address a specific need, designing an intervention that can produce a real return on investment, and attracting investors. Social Impact Bonds are relatively new, which creates an additional requirement to build effective community awareness about how these work. We will use our two community examples as illustration of these challenges and of a potential path forward to make Social Impact Bonds more accessible to communities. Social Impact Bonds Require a Track Record of Measured Success. The first requirement of a Social Impact Bond is to identify a program or intervention with a proven, data-driven record of success. Investors will not agree to finance an experimental program, for the risk of repayment would be too high. 4
The Richmond Community Foundation housing rehabilitation program does not have any difficulty demonstrating that rehabilitating boarded-up houses will reduce blight, improve property values, reduce crime, increase property tax revenues and reduce the city’s costs of code enforcement. The benefits of cleaning up blighted neighborhoods have been demonstrated in cities around the country.8 This part of RCF’s program in not revolutionary. In most other contexts, however, very few social programs can prove with independently validated data that they are successful. As John Brideland (a former George W. Bush administration official) and Peter Orzag (a former Obama administration official) wrote recently in The Atlantic, “less than $1 out of every $100 of government spending is backed by even the most basic evidence that the money is being spent wisely.” 9 This does not mean that programs with proven track records are nonexistent. In fact, Dr. Robert K. Ross, the CEO of the California Endowment, suggests “The greatest impediment to solving these problems is not a lack of innovation. Rather, it is our inability to scale up solutions that we know work.”10 In other words, we know what works, but we’re not often doing it. In Alameda County, Healthy Homes and Asthma START have collected information about their respective programs and have already demonstrated substantial success within their own program strategies and target goals. Unfortunately, the Pay-For-Success Asthma Initiative will be the first time the combined impact of their programs will be assessed and the first time an independent evaluator and actuary will measure the health care cost savings. This validation process is the precursor to creating and attracting independent investors. The fact that there are model programs with proven results does not necessarily mean that the data to prove that the beneficial results have occurred is easily gathered. In the nonprofit sector, outcome data may not be gathered at all, or be collected incorrectly, and there may be no control group against which to compare the program to determine what works and what happens by chance. As a consequence of the fact that government and insurers have long required medical facilities to keep track of reasons for admission and treatment, there is good data on the cost of asthma hospitalizations.11 We may have less reliability to track two other sources of potential savings: [1] reduced school absences due to asthma and [2] reduced paramedic use when responding to asthma related emergencies. Historically, student absences are selfreported and, thus, considered less reliable. Unfortunately, there are considerable challenges in asking school districts to fine-tune how they track absent students and then obtaining permission to transmit that data to an
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The City of Philadelphia, for example, commissioned a study in 2010 that determined that, “Vacant property reduces market values by 6.5 percent citywide and by as much as 20 percent in neighborhoods with the most empty lots and structures. The report estimates that 17,000 vacant properties are tax delinquent and rob the city of $2 million in tax revenue each year. Vacant properties also consume $20 million in city services a year, $8 million of which is spent on code enforcement and maintenance, such as boarding up buildings or demolishing them.” “ The Cost of Blight: Vacant and Abandoned Properties”, Pittsburgh Quarterly, Fall 2011, http://www.pittsburghquarterly.com/index.php/Region/the-cost-of-blight/All-Pages.html 9
“Can Government Play Moneyball?” by John Bridgeland and Peter Orzag, the Atlantic Monthly, June 19, 2013, http://www.theatlantic.com/magazine/archive/2013/07/can-government-play-moneyball/309389/ 10
“We Need More Scale, Not More Innovation” by Dr. Robert K. Ross, Stanford Social Innovation review, Spring 2014, http://www.ssireview.org/articles/entry/we_need_more_scale_not_more_innovation 11
Asthma is ICD-9-CM Code #493. ICD-9-CM is the “official system of assigning codes to diagnoses and procedures associated with hospital utilization in the United States.” Centers for Disease Control and Prevention, “Classification of Diseases, Functioning and Disability”, http://www.cdc.gov/nchs/icd/icd9cm.htm
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intermediary overseeing the Pay-For-Success program. Similarly, county paramedics may have collected utilization data but these costs have not been attributed to the cost of care for asthma patients. The requirement that a social program have a proven strategy to drive quantifiable results is, ironically, one of the great strengths of Social Impact Bonds. This requirement to prove at the outset to potential investors that the program is likely to succeed will impose a level of accountability often absent from the nonprofit world. Unfortunately, this additional evaluation rigor is a capacity building issue that may pose a challenge for smaller nonprofits. Social Impact Bonds Require a Return on Investment. The second challenge in using social impact bonds is to assign a value to successful outcomes that can be then calculated for the Return on Investment. Once a community has selected a proven program and found a way to gather and analyze the data to prove that the program works, it must find a way to monetize the results. In Richmond, we have no doubt that once homes are refurbished or repaired they will sell in the Bay Area’s tight housing market. In addition to improving the housing stock in the community and the other benefits of reducing blight, RCF will also be creating job-training opportunities and jobs for those hired to refurbish the homes. While capturing these elements of the ROI is not a requirement for our bond, we understand this additional benefit of our program may facilitate future bonds. In Alameda County, the total return on investment for reducing hospitalizations and emergency room visits may be as high as 3.83 based just on average prices. A more accurate picture of the true return on investment would include the cost of missed days of school, or Average Daily Attendance12, and paramedic responses. Unfortunately, capturing this data may pose unique challenges because it is not easily accessible. The cost of asthma-related absences in California’s San Joaquin Valley, for example, has been estimated to be as much as $27 million per year in lost ADA13. Paying for an asthma intervention should be an easy investment. Unfortunately, one school district Superintendent to whom we mentioned such a possibility was aghast at the prospect of having to give up any ADA, at all. Social Impact Bonds require investors to invest. A community that has identified a proven social program and that has found a way to monetize its benefits then must find buyers for its bonds or social impact investors willing to invest in the program. The market for such bonds or investments is new and uncertain, because the programs inherently bear above-market risks. In all of the deals structured to date, the investors will lose principal plus interest if the social program fails to meet its target and agreed-upon goals. In short, if the programs could pay market-rate returns at market-average risks, the for-profit sector would already be investing in them, and the philanthropic sector would not need this article.14 The good news is that there are investors willing to make investments with above-market risks, some out of philanthropic motives, others because they are incentivized to do so. The former include private and family foundations willing to make what are called “Program-Related Investments” (PRI), individuals, and socially-
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The Public Policy Institute of California reports that California school districts on average receive $5,342 in Average Daily Attendance per student. This translates into $30 for each day a child is absent (Funding California Schools: The Revenue Limit System, 2010). 13
Hernandez, V. Sutton, P., Curtis, K. and Carabez, R. Struggling to Breathe: The Epidemic of Asthma Among Children and Adolescents in the San Joaquin Valley. Central California Children’s Institute, October 2004. 14
Paul Brest and Kelly Born, “When Can Impact Investing Create Real Impact?”, Stanford Social Innovation Review, Fall 2013, http://www.ssireview.org/up_for_debate/article/impact_investing
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responsible mutual funds. The latter include banks that need to meet their Community Reinvestment Act obligations, and corporations that consider community investments and corporate social responsibility part of their profit-maximizing strategy. Ironically, the very fact that the purchase of a Social Impact Bond or an impact investment is an investment with a possible return of principal plus a profit complicates the ability of some of these entities to invest in them. A private foundation, for example, is required by the Internal Revenue Code to give away a minimum amount annually, usually five percent of its corpus.15 Whether an investment -- as opposed to a grant or donation -counts against that minimum depends on whether the investment is a Program Related Investment or a Mission Related Investment.16 In crude terms, the former are investments made to further the foundation’s program, and only secondarily made for the purposes of profit17, while the latter are made primarily for profit to fund the foundation’s programs, even though they may be chosen in part for their social impact. Thus, in order to facilitate the investment by private foundations in Social Impact Bonds, the purpose of the bond program must align with the programmatic purposes of the foundations. However, if we hope to “scale-up” Social Impact Bonds, the pool of possible investors will have to grow. Issuing bonds for sale to the public or offering investments in pay-for-success programs to non-institutional investors may mean that the offerings become securities, just like bonds issued by corporations or municipalities and like stock in corporations.18 Securities are heavily regulated,19 and their issuance can be expensive because of the costs of lawyers and underwriters. The technical requirements of issuing bonds are beyond this article, but they are formidable. Beyond the Hype--Social Impact Bonds are New. When we began looking at Social Impact Bonds in 2011, a simple search of the term on the internet yielded less than 1,000 listings. Today that same search (“social impact bond”) yields 122,000 results, even though there are only a handful of SIBs in existence within the US! This is the fourth challenge for this nascent field of work -- the bond itself! This is truly an innovative financial tool and anything new requires a bold level of risk taking and promoting the idea that is often difficult for any sector. RCF has embraced the role of financial intermediary for this current housing rehabilitation effort—a first for a community foundation. RCF is young, less than four years old, and evolved out of a nonprofit that was operating a charter school when it found itself at the center of a number of collaborative projects involving local, state and national governmental agencies, nonprofits, private and family foundations, for-profit businesses and community groups. RCF, thus, emerged at the cutting edge of the community foundations’ collaborative role. Thus, now, whenever there is discussion of a collaborative program with multiple participants, RCF is part of the discussion to facilitate and manage the program. In order to begin the housing rehabilitation program, RCF has had the advantage of pro bono legal work from one of the nation’s most prominent municipal bond law firms20, which is also working pro bono on a SIB program in Ohio.
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Internal Revenue Code §4942
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David Levitt, “Unscrambling ‘MRIs’ and ‘PRIs’”, Philanthropy Journal, April 5, 2011, http://www.philanthropyjournal.org/resources/managementleadership/unscrambling’mris’-and’pris’ 17
http://www.irs.gov/Charities-&-Non-Profits/Private-Foundations/Program-Related-Investments
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Kimberly Amadeo, “Securities”, About.com, http://useconomy.about.com/od/glossary/g/securities.htm
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U.S. Securities and Exchange Commission, http://www.sec.gov/about/laws.shtml
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Orrick, Herrington & Sutcliffe, LLP, www.orrick.com
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Even though its housing rehabilitation program has not yet launched, RCF is investigating whether it can serve as a catalyst for more Pay-For-Success programs by establishing sustainable impact funds with a more flexible and sustainable design. That is, instead of creating a new Social Impact Bond for every local need for which such a program is appropriate, a single fund might be created and managed by the Community Foundation into which investors may place funds and from which the Community Foundation may finance pay-for-success social programs. If such a Sustainable Health Impact Fund had existed, the feasibility study for Alameda County’s Pay For Success Asthma Initiative would have started much sooner, shortening the planning process which has, so far, consumed two years. It would also mean that the eventual structure for the financial agreements between the investors and payers would be managed by a community foundation.
Community Foundations Making Social Impact Bonds Accessible
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e see an important opportunity for community foundations to address the complexity of Pay-ForSuccess initiatives and Social Impact Bonds that can make this financing strategy accessible to more communities. It is this role for which community foundations may be situated ideally.
The current need for new sources of revenue to pay for social interventions inspired the innovation of Social Impact Bonds. But the challenge of creating the right application for each community should not rest on the willingness of local agencies and nonprofits to master the complexity of financial mechanisms that require securities analysts. Despite the wide enthusiasm for Social Impact Bonds in the US, criticism has centered on the complexity of the flow of money and the payment of dollars saved to so many third parties: consultants and attorneys. Another critique is from those who feel Pay-For-Success initiatives threaten long-standing public service models and the public trust. The future of this body of work will not likely fulfill its promise unless it becomes an accessible and transparent process that communities can fully embrace. Community foundations have a natural role to play as stewards of the communities they serve and we encourage thoughtful engagement ahead.
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