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"Social Impact Bond" Buzz Heads West

JAN 10, 2013 4:13pm ET
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SAN FRANCISCO — Seeds are being sown in Fresno, Calif., for one of only a handful of “social impact bond” pilot projects, in which investors are repaid out of savings reaped by social welfare programs.

The early-stage program would create so-called health-impact bonds out of savings achieved by reducing the need for children in the area to visit emergency rooms and hospitalization for asthma problems.

The program is one of a few that have sprung up in the last few years that try to find new ways to attract private investment by monetizing efficiencies gained by social welfare programs. This may be the first project to use the financial instruments for improving health care.

“I think this is a real cool way to finance a lot of good that has a financial return as well,” said Rick Brush, chief executive officer of Collective Health LLC in Simsbury, Conn., who is spearheading the Fresno program. “If we can demonstrate the savings, then we would be in a position to share the savings with the investors.”

Social-impact bonds, also known as “pay for success” bonds, are not traditional financial instruments and the use of the term “bond” is somewhat inaccurate.

Although there are few examples, they typically work when a private investor loans money to a nonprofit that is only paid if it achieves goals. The investor makes money from the payments out of the savings from the program’s success.

“The bond term is definitely a misnomer,” said Caitlin Reimers, a director at Social Finance in Boston, which acts as a financial intermediary for social impact bonds, including the program in Fresno. “At present time the rate of return is not fixed; it is dependent on performance. The bonds are really only sold to qualified investors. They are not intended to be tradable. It is much more a structured product.”

Reimers said the price per outcome, or yield, is determined by Social Finance, the government involved, and the nonprofit provider based on the level of savings and value created using a cost-benefit analysis.

For example, in Fresno, the MediCal providers may find in their data that hospital visits dropped because of the project. However, if a minimum savings hurdle is not reached by the project, investors do not get paid. If it is reached, investors get paid on a linear payment scale, Reimers said.

Thus, the maximum yields for the investment have been high enough in these programs to compensate investors for the risk. A project in England could yield as much as 13.5% and another in New York tops out at 11%.

Collective Health is leading the project in Fresno that will start with a small test to show that the project can reduce the cost of treating asthma-afflicted children.

Fresno was chosen partly because it is one of the communities in California most in need of help.

In a 1 to 10 index by the American Human Development Project that uses factors such as education, life expectancy and salaries, with 10 as the best score, West Fresno scored 2.83. That compares to a score of 9.35 by the Palo Alto and Mountain View area of California, according to a report by researchers at the University of California at Berkeley and Collective Health.

The report said Fresno County has an estimated 200,000 individuals living with asthma, who each year account for more than 6,000 emergency room visits and 1,100 hospitalizations, plus follow-up care and doctor office visits.

The annual cost of asthma, including lost worker productivity, in Fresno County totals $87 million, the report said.

Brush said they hope to start the test within the month with 200 children. He estimates net savings are around $5,000 per child per year from preventing emergency room visits and hospitalizations.

The savings would be achieved by putting a health care worker in the home of the children to educate them and their family and reduce problems in the home, such as air quality, that trigger asthma emergencies.

Once the cost savings are proven using medical claims, payments to the investors in the program would come from those that benefit from the savings, such as the health care companies that administer the state’s MediCal program.

Brush said the hope is to increase the size of the project to at least 1,000 children in two years once the cost savings can be proved. In the larger program, payments to investors could also potentially be secured from self-funded or self-insured employers that also see savings.

“We know there are a lot of requirements to make this work,” Brush added.

The project also plans to enlist an advisory group of local and state politicians to help guide them through potential legal issues that may pop up, such as the ability of MediCal to pay investors for savings, he said.

The push for private investment in social programs already has some steam in the state Legislature.

Sen. Curren Price, D-Los Angeles, has introduced a bill that would create the California Office of Social Innovation and Entrepreneurship, which would help foster the use of the bonds to tackle social problems in the state, such as homelessness, recidivism rates, and now potentially health care issues.

“We have been dormant in generating solutions that would reduce homelessness, improve delivery of critical health care and reform our criminal justice system, and inaction has only exacerbated these problems,” Price said in a statement. “It’s essential that we create private-public partnerships to leverage our limited resources.”

The Fresno project is also following in the strides of other new attempts at private social welfare financing.

One of the most far along examples comes from England, where, according to the report, the first social-impact bond was created to address a recidivism rate of 60% among prisoners in the Peterborough Prison.

Seeded with money from a United Kingdom lottery and the MacArthur Foundation, private investors invested in bonds to support several nonprofit organizations that will try to prevent repeat offenses by parolees.

Since one repeat offender can cost the U.K. government as much as $126,000, the Ministry of Justice will pay out up to a 13.5% rate of return to the bond investors for housing fewer prisoners, the report said.

Another example started earlier this year when New York City and Goldman, Sachs & Co. announced a program that would use a similar financing structure to try to reduce recidivism rates of youth on the city’s Rikers Island Prison.

In Massachusetts, the state is trying to use the funding mechanism to help reduce youth crime and homelessness.

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