Massachusetts $27M Social Impact Bonds Aim at Recidivism

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Massachusetts' $27 million "Pay for Success" social impact initiative wasn't just another deal for veteran bond lawyer Navjeet Bal, and not because it represented the nation's largest funding vehicle of its kind.

At Gov. Deval Patrick's press conference in late January to announce the program, frequent offender Ralph Bonano shared how Chelsea, Mass., nonprofit social service organization Roca Inc. helped him avoid going back to jail.

His words resonated with Bal.

"He spoke from the heart and said if it hadn't been for Roca, he'd be in jail or dead. What hit me hard was that he was 19 or 20 years old. I have a 20-year-old daughter and I could relate to that. He was quite profound," said Bal, a counsel with Boston-based Nixon Peabody LLP and former Massachusetts commissioner of revenue.

"It was really rewarding to use my skills and expertise as a bond lawyer to work on this project."

Under the pay-for-success program, often called a social impact bond - bond is a misnomer though supporters find the buzzword catchy - the Bay State has earmarked up to $27 million for a seven-year initiative designed to reduce incarceration for at-risk men aged 17 to 23 in the juvenile justice system.

Roca serves nearly 1,000 such people.

The partnership includes financial intermediary nonprofit advisory firm Third Sector Capital Partners and a variety of financial backers, including Goldman, Sachs & Co. through its social impact fund.

Funders assume up-front financial risk, and taxpayers pay only if a third party evaluator and validator determine that the initiative has achieved defined outcomes.

"It's not your typical credit risk," said Bal.

The private investors loan money to the nonprofit and are paid only if a program achieves goals. If so, Massachusetts will pay them out of savings through the program's success at reducing incarceration rates.

Although only three years old and modeled on a program to reduce recidivism in Peterborough, U.K., the concept is gathering steam amid a tight financing landscape. Washington state lawmakers, for instance, have begun debating such a program.

One major challenge is uniting disparate groups, said John Grossman, Third Sector partner and general counsel.

"You have providers, guarantors, philanthropists and Wall Street, sectors that are not used to working together, certainly not as a group working in this way," said Grossman. "It's definitely the good fight, but it will continue to be something that isn't easy."

Bal said pay-for-success is still a work in progress.

"I think it's still got a ways to go," she said. "From a lawyer's perspective I'd like to see it more routinized and more replicate."

According to Goldman analyst David Gorleku, the timing couldn't be better. "We're in a place now where philanthropic dollars can't cover all the need, and government is in a place where it cannot fund all the services that it wants to," he said.

The U.S. Department of Labor awarded Massachusetts an $11.7 million grant. In 2012, the state legislature authorized the secretary of administration and finance to enter into pay-for-success contracts, with up to $50 million backed by the commonwealth's full faith and credit.

Patrick, an eight-year governor who has said he will not seek a third term this year, has pushed to overhaul the juvenile justice system throughout his tenure.

Third Sector secured $9 million from Goldman Sachs, $1.5 million each from Kresge Foundation and Living Cities, and a combined $6 million from the Laura and John Arnold Foundation, New Profit Inc. and the Boston Foundation.

Kresge is a $3 billion foundation out of Detroit suburb Troy, Mich. Living Cities is a philanthropic collaborative of 22 of the world's largest foundations and financial institutions. The Arnold Foundation supports programs to improve the criminal-justice system, while Boston-based New Profit and Boston Foundation are well-known in that city.

"We have a pretty good lineup," said Grossman.

It's the third venture into the pay-for-success initiative for Goldman. Its other ventures include an early-childhood partnership with the United Way of Salt Lake City and philanthropist J.B. Pritzker, with Goldman and Pritzker committing $7 million apiece; and a $10 million infusion into a New York City program aimed at adolescent officers at the Rikers Island correctional facility, in conjunction with the city, Bloomberg Philanthropies and social services provider MDRC.

Activist Molly Baldwin in 1988 founded Roca, whose headquarters sits across the Mystic River from Boston. Roca also serves Western Massachusetts through its Springfield office.

The organization, which runs an intensive two-year program followed by two years of less intensive support, touts "rigorous data tracking" among its attributes. Through pay for success, Roca will provide its intervention model to nearly 1,000 "high-risk" young men.

The program is about changing the odds for them, according to Baldwin.

"The financing model allows [us] to scale in a way that we could never have imagined before, and as we demonstrate more and more success, this financing model, this scaling model, will help us go to other places and help more young men change their lives," she said.

Roca expects 248 people to avoid incarceration, or a 45% drop among the targeted population, measured through a randomized controlled trial evaluation. The project's target goal is 40%, at which level the project would save the commonwealth money.

"Roca is an ideal organization to be working with for a number of reasons," said Grossman. "They are extremely data-driven, as much if not more so than any organization of this kind out there. That makes funders feel comfortable. They have an amazing management team that's goal driven.

"If you're a venture capitalist or a social entrepreneur, Molly's the person you want to lead."

If the project achieves its target impact, Goldman Sachs would be repaid its principal funding and a base annual interest rate at 5%; Kresge Foundation and Living Cities would get the base plus 2% interest; and Roca and Third Sector would be paid their deferred service fees. In addition, at higher levels of impact, Roca would receive up to $1 million, Goldman Sachs roughly the same and Kresge Foundation and Living Cities would get up to $600,000 combined.

Any remaining pay-for-success payments, which could be up to $6 million depending upon level of impact achieved, could recycle philanthropic funding.

Bal, working pro-bono, represented the commonwealth. She is no stranger to innovative financings, having served as Massachusetts bond counsel when it issued its so-called green bonds last June to finance energy saving and other environmentally sensitive projects statewide.

Other pro-bono advisors were Goulston & Storrs PC, Goodwin Procter LLP and Ropes & Gray LLP on behalf of Roca, New Profit and Third Sector, respectively.

According to Bal, the actual paperwork was a collaborative effort. Bal, a 22-year public finance veteran, consulted with the Kennedy School of Government officials in determining success factors and the state executive Office for Administration and Finance for payment information.

Bal said she is also working on a smaller initiative to benefit programs that serve chronically homeless people.

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