Pay For Success Contracts and Social Impact Bonds

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Presentation of NISE! Impact Delivery Model. The NISE! social and environmental impact delivery model has as its primary objective the mainstreaming of Social Impact Bonds so that they become attractive as an asset allocation in the diversified portfolio of a prudent investor and, therefore, become a readily available source of capital.

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Pay For Success Contracts and Social Impact Bonds

  1. 1. 1 Pay for Success Contracts and Social Impact Bonds Presentation of NISE! Impact Delivery Model NATIONAL INSTITUTE FOR A SUSTAINABLE ECONOMY Building businesses for a 21st century economy that are... Sustainable. Equitable. Profitable.
  2. 2. 1NISE! SIB Delivery Model © 2011 Summary Benefits of NISE! Delivery Model The NISE! Delivery Model for effectively utilizing Pay for Success Contracts and Social Impact Bonds has the following benefits and advantages relative to the traditional model: It will be more attractive to investors. Our objective is to mainstream Social Impact Bonds so that they become attractive as an asset allocation in the diversified portfolio of a prudent investor and, therefore, become a readily available source of capital. As a result, our model focuses heavily on the alignment of risks and rewards for the investor by emphasizing: Competitive commercial returns. A financial structure that resembles more traditional ones. Earlier, interim return of capital. Multiple, diversified sources for the return of capital. Sharing of the downside risk. The Impact Delivery Organization will be better structured to succeed. Another objective of our model is the proper capitalization of Impact Delivery Organizations (IDO) so that they have a higher probability of delivering the desired social or environmental impact. Consequently, our model emphasizes: An expanded role for the IDO as both a manager of service providers and a financial intermediary capable of attracting and managing capital. Multiple, diversified sources of revenue for the IDO. Government is not the sole source for repayment of SIB’s. The third key objective of our model is making government a partner in
  3. 3. 2NISE! SIB Delivery Model © 2011 the payment for desired outcomes, rather than a sole source. As a result, our model is designed to stimulate the growth of new, private sector for-profit businesses that: Generate revenues as they provided a product or service delivering a social or environmental impact. Contribute to the repayment of investors. Proposed Area of Implementation: Energy Efficiency We propose that energy efficiency be one of the initial target areas to apply the use of the NISE! Delivery Model for the following reasons: Greater energy efficiency in Massachusetts’ private and public homes and buildings is critical in order to meet the State’s goals in reducing energy usage and CO2 emissions. Under nation-leading energy efficiency plans established by the Patrick-Murray Administration, Massachusetts has chosen energy efficiency as its “first fuel” – what is looked to first to meet the State’s energy needs. While the State utilities have invested in home- sealing, insulation, efficient lighting and appliances, the State Executive Office of Energy and Environmental Affairs (EEA) and the Massachusetts Clean Energy Center (MassCEC) continue to recognize that the private and public housing sectors still have not been active in implementing energy efficiency measures and that help is needed in finding new ways to assist these sectors in advancing energy efficiency. The State’s energy efficiency goals are connected to green community planning and green jobs, and is a regional sustainable solution to a nation-wide energy crisis and national security issue. The first uses of Pay for Success Contracts and Social Impact Bonds need to succeed. Applying the NISE! Delivery Model to energy efficiency has the advantage of beginning with an initiative that: Can be established quickly. No special legislation is required and the delivery mechanisms can be readily assembled. Is more easily measured in terms of impact. Baselines can be established quickly and measurement methodology and related devices are already well known. Can demonstrate positive results in a relative short period of time -- less than 1 year. Can have an impact that scales up quickly within the Commonwealth or in other areas of the nation. Accelerated energy efficiency efforts will be a significant economic driver. It will: Expand new and existing markets. Create new jobs. Stimulate new business opportunities. i
  4. 4. 3NISE! SIB Delivery Model © 2011 Introduction NISE!, the National Institute for a Sustainable Economy LLC, initially presented the delivery model discussed in this document in its response to the Request for Information issued by the Patrick-Murray Administration through its Executive Office of Administration and Finance. NISE! is a for-profit business based in Boston, Massachusetts, and was founded in 2010 in response to President Obama’s challenge to the private sector to lead a new era of innovation and growth on the cutting edge of our economy by finding new ways to tackle the intertwined problems of energy and the environment. The founder of NISE!, Edward Dugger III, who was among many from whom the Obama Transition Committees sought advice regarding fresh ideas and policy recommendations, decided to pursue this challenge by establishing NISE! The NISE! Mission Our mission? Bringing to market new business solutions for environmental and social problems that are… Sustainable. Equitable. Profitable. We pursue our mission by identifying a specific need or demand and re-imagine a business model that will address it. We then assemble a team of business collaborators to implement the business model and the necessary resources. Often the NISE! solution will also support the implementation of government policy for which a private sector partner is needed. For instance, we believe that energy conservation is our nation’s most effective strategy for a reduction in the emission of C02 and other greenhouse gases into our atmosphere. Historically business and government have focused primarily on conservation in the industrial and commercial sectors. Energy conservation in the residential sector has lagged due to the perception that the business opportunity is much more limited and requires subsidies to be attractive. NISE! examined the barriers that have prevented homeowners in particular from making homes more energy efficient and concluded that the business opportunity was very large and what was needed was innovation. The NISE! and Massachusetts Clean Energy Center Partnership NISE! has developed a new business model in conjunction with its collaborating partners that is designed to unlock the value of conservation for consumers. In September 2010 our new business model was recognized for its innovative approach to energy conservation in residential homes by the Massachusetts Clean Energy Center (MassCEC), a national leader in promoting innovative initiatives in the areas of renewable energy and energy efficiency. As a result of its competitive process, MassCEC awarded NISE! a $250,000 working capital grant to further develop its business model, complete its strategic plan and prepare for a launch into the market. Innovations in Financing Social and Environmental Impact In the same spirit of seeking solutions through innovation, NISE! welcomes the challenge and opportunity to assist in the development of a new financial instrument that will advance improved outcomes in the areas of social and environmental impacts. The founder of NISE! has over 25 years of experience in the fields of venture capital and private equity and is acknowledged as an early pioneer in social impact investing. NISE! A Catalyst for a Sustainable Economy
  5. 5. 4NISE! SIB Delivery Model © 2011 The Initial Request for Information The Patrick-Murray Administration has an ongoing commitment to changing the way government does business and to finding savings and efficiencies across state agencies. They recognize that many of the solutions they seek to reduce costs to taxpayers and accelerate innovation in ameliorating social problems will result from the Commonwealth partnering with entrepreneurs from the nonprofit and private sectors. As a result, the Commonwealth is considering whether to enter into a limited number of pay for success contracts for the delivery of certain government services. In preparation for the issuance of a Request for Responses, the Patrick-Murray administration through its Executive Office of Administration and Finance (EOAF) has solicited information from potential partners and interested citizens regarding: Areas of government activity where success-based contracting strategies have the potential to improve outcomes and/or reduce costs. The use of social impact bonds to support pay for success contracts. Social impact bonds are defined as financing arrangements where third party investors and intermediaries provide service providers with operating capital and other expertise to support pay for success contracts with the government. The Basic Social Impact Bond Delivery Model (SIB) As illustrated in the diagram, the basic Social Impact Bond is a contract with the public sector in which it agrees to pay for improved social outcomes. On the basis of this contract, investment is raised from socially motivated investors. This investment is used to pay for a range of interventions to improve social outcomes. If social outcomes improve, investors will receive payments from government. These payments repay the initial investment plus a financial return. The financial return is dependent on the degree to which outcomes improve. Background 2Model ry Model Social Impact Investors Impact Delivery Organization Government Subcontractor Subcontractor Outcome Based Agreement Outcome Based Payment $ Payment $ Payment $ Assignment of Cash Flows From Outcome Based $
  6. 6. 5 Discussion The major challenge of the basic SIB delivery model is the alignment of incentives and risks. As indicated in the chart below, each of the key players in this model have a unique set of challenges to overcome to be motivated to engage as collaborator. Investors. In the current economic environment, investor interest in competitive financial returns is particularly high. New financial instruments that have no track record and have an unknown of particularly long timeframe for the return of principal and interest will generate little interest even within the social responsible investment community. Investors are likely to respond best to a new financial instrument that resembles a traditional one, has a competitive return, provides for the early return of capital and has its downside risk mitigated. Impact Delivery Organization. Whether or not a for- profit or not-for-profit, the challenge of producing a targeted social or environmental impact usually is complicated by the difficulty of accessing capital in sufficient amounts over time to bring the necessary resources to bear on the problem at hand. Obtaining adequate capital for Impact Delivery Organization (IDO) is critical to the success of this type of endeavor. Government Payer. Tight government budgets and limited to no growth in tax revenues will put extreme pressure on government administrators to err on the side of minimal payments for outcomes, even given successful scenarios. The approach of paying for improved outcomes will be substantially advanced by having a partner in the process. The chart below highlights the challenges of each of the key players and what we believe are the prerequisites for successfully engaging them as collaborators in this new endeavor. Prerequisites for Success Key Players Issues Prerequisites for Success Investors Desire for commercial returns. New financial instrument with no track record. Performance risk associated insufficient delayed delivery of impact by the Impact Delivery Organization. Timeframe for producing measurable impact may be long. High probability of commercial return. Financial structure that resembles more traditional financial instruments. Early return of capital. Multiple sources for the return of capital. Impact Delivery Organization Obtaining sufficient initial and ongoing operating capital to produce impact. Adequate capitalization to achieve impact. Government Payer Performance risk associated with undercapitalization of Impact Delivery Organization. Sole source of repayment. Strong incentives for the proper capitalization of Impact Delivery Organizations. Diversification of repayment sources.
  7. 7. 6NISE! SIB Delivery Model © 2011 Objectives of NISE! Delivery Model The NISE! social and environmental impact delivery model has as its primary objective the mainstreaming of Social Impact Bonds so that they become attractive as an asset allocation in the diversified portfolio of a prudent investor and therefore become a readily available source of capital. As a result, our model focuses heavily on the alignment of risks and rewards for the investor by emphasizing: Competitive commercial returns. A financial structure that resembles more traditional ones. Earlier, interim return of capital. Multiple, diversified sources for the return of capital. Sharing of the downside risk. Our model also has as its objective the proper capitalization of Impact Delivery Organization (IDO) so that they have a higher probability of delivering the desired social or environmental impact. Consequently, our model emphasizes: An expanded role for the Impact Delivery Partner as both a manager of service providers and a financial intermediary capable of attracting and managing capital. Multiple, diversified sources of revenue for the IDO. Finally, our model has as its objective making government a partner in the payment for desired outcomes, rather than a sole source. As a result, our model is designed to stimulate the growth of new, private sector for-profit businesses that: Generate revenues as they provided a product or service delivering a social or environmental impact. Contribute to the repayment of investors. Use of Social Impact Bonds The NISE! social and environmental impact delivery model anticipates a broader use of funds derived from social impact bonds than does the basic delivery model. In addition to the Impact Delivery Organizations using the capital to fund their operations and pay fees to service providers, we expect there will be a strong demand for use of the funds as financing to: Service providers to expand their working capital to fund their growth. Customers of service providers to finance the purchase of goods and services that are part of the delivery of desired social and environmental impacts. The demand we anticipate will be driven by the emergence of entrepreneurial enterprises -- both new and old -- pursuing new market opportunities for which the initial demand is uncertain, and therefore the availability of more traditional sources of capital is limited. Description of the NISE! Delivery Model The diagram on the adjacent page highlights the key components and players of the NISE! delivery model. Social Impact Investors. In our model social impact investors are both those that conscientiously want to have a social or environmental impact through their investment in social impact bonds and those that seeking portfolio diversity at competitive commercial returns. Both groups would include individuals as well as institutional investors. Bond Issuer. Although in our model the Impact Delivery Organization would usually be the entity issuing bonds, in some cases there would be a separate entity that would issue the social impact bonds in partnership with the Impact Delivery Organization. Such an entity could be a quasi-government entity such as Mass Development. NISE! Delivery Model 1 2
  8. 8. 7NISE! SIB Delivery Model © 2011 Impact Delivery Organization. Central to the success of the NISE! delivery model is the Impact Delivery Organization. Although this entity may be either a for-profit or not-for-profit organization, our model favors the IDO as a for-profit enterprise that has the capacity to: Generate revenues from multiple sources. Raise capital from private investors. Negotiate outcome based contracts with government. Hire and manage service providers. The IDO would generate revenue from three primary sources: Fees paid for services it renders as both a manager of service providers and as financial intermediary. Financial returns from providing financing to service providers and/or their customers. Payments from government for outcomes. These multiple sources of revenue would reduce the risk to investors and encourage their greater participation in this new form of financing. They would also allow the IDO to partner with government in the payment to investors their share of returns for successful outcomes. Government. In the NISE! delivery model, the role of government changes significantly. Rather than simply a sole source of payment for social and environmental outcomes and the repayment of investors, the government is a partner with the IDO in the repayment of investors and plays two distinct roles: 3 Outcome Based Payment Bond Social Impact Investors Impact Delivery Organization Government Bond Issuer For Profit Delivery Partner Impact Beneficiary Credit & Return Enhancement Agreement $ Repayments$ Payments and/or Financing $ Financing $ Note$ 5 43 2 1 6 4
  9. 9. 8NISE! SIB Delivery Model © 2011 The source of a credit enhancement that substantially reduces the investment risk to investors. The source of a return enhancement that is derived from outcome based payments and reflect successful impacts. Government would negotiate both the credit and return enhancements with the IDO in order to strengthen the IDO’s ability to raise capital on a competitive commercial basis. For Profit Delivery Partner. Assisting the IDO in achieving the desired social and environmental outcomes, the For-Profit Delivery Partner would generally be part of a group of businesses working collaboratively to produce both a high level of impact and multiple revenue sources that indirectly contribute to the repayment of investors. Specifically these businesses would be a source of revenue for the IDO in the form of management fees and a financial return for financing provided to them. Impact Beneficiary. In the NISE! delivery model the Impact Beneficiary is the end-user of the products, services or financing provided by the IDO and its collaborating organizations. In some cases the end-user may be itself an organization, while in others it would be individual or family consumers. i 5 6
  10. 10. 9NISE! SIB Delivery Model © 2011 An Example: NISE! Impact LLC NISE! Impact LLC is our example of how we would organize an effective Impact Delivery Partner (IDP) that is designed to provide comprehensive Financial Services and Impact Services. As described below, the components of each could be wholly-owned by NISE! Impact or structured as service agreements with other independent firms. NISE! Impact would have overall responsibility for the management of the Financial and Impact Service Groups and the marketing of each. It would also be responsible for structuring and issuing the Social Impact Bonds (SIB). Financial Services Services that fall into this category represent the full complement of services necessary to design, place/distribute and manage the Social Impact Bond Portfolio, as well as to management the portfolio of investments made utilizing capital generated by theSIBs. They include: Portfolio Management. This component would be an internal service group of NISE! Impact. It would be responsible for evaluating and selecting the organizations that would receive the capital made available by SIBs. Once the capital was invested, this group would also management the resulting investment portfolio. Asset Management. This group would be responsible for the placement or selling of the SIBs as well as managing the cash reserves of NISE! Impact. It would include both an asset management and broker/dealer operation. Investment Advisory. This component would be responsible for assisting portfolio companies and other businesses in raising capital for their working capital and expansion needs. In some cases it would work closely with the portfolio management group to place SIB capital and in others it would raise capital from other sources. Impact Services This category of services represent those needed to manage the impact delivery process beginning with contract negotiations and ending with the certification of performance results. They include: Contract Services. This component would be an internal service group of NISE! Impact. It would be responsible for working with prospective impact delivery organizations (not for profit or for-profit) to negotiate pay-for-success contracts with government agencies, monitoring contract performance and assisting in the evaluation of impact results. Strategic Planning. This group would also be an internal service group of NISE! Impact. t would be responsible for assisting portfolio organizations in developing high performance strategic plans for delivering the expected impact. Tactical Assistance. This component would be responsible for providing portfolio organizations with advice and assistance on tactical issues important to implementing a strategic plan and achieving the desired performance results. i NISE! Impact LLC A Unique Financial and Impact Delivery Organization 8NISE! SIB Delivery Model An Example: NISE! Impact LLC NISE! Impact LLC is our example of how we would organize an effective Impact Delivery Partner (IDP) that is designed to provide comprehensive Financial Services and Impact Services. As described below, the components of each could be wholly-owned by NISE! Impact or structured as service agreements with other independent firms. NISE! Impact would have overall responsibility for the management of the Financial and Impact service groups and the marketing of each. It would also be responsible for structuring and issuing the Social Impact Bonds (SIB). Financial Services Services that fall into this category represent the full complement of services necessary to design, place/distribute and manage the Social Impact Bond Portfolio, as well as to management the portfolio of investments made utilizing capital generated by the SIBs. They include: Portfolio Management. This component would be an internal service group of NISE! Impact. It would be responsible for evaluating and selecting the organizations that would receive the capital made available by SIBs. Once the capital was invested, this group would also management the resulting investment portfolio. Asset Management. This group would be responsible for the placement or selling of the SIBs as well as managing the cash reserves of NISE! Impact. It would include both an asset management and broker/dealer operation. Investment Advisory. This component would be responsible for assisting portfolio companies and other businesses in raising capital for their working capital and expansion needs. In some cases it would work closely with the portfolio management group to place SIB capital and in others it would raise capital from other sources. Impact Services This category of services represent those needed to manage the impact delivery process beginning with contract negotiations and ending with the certification of performance results. They include: Contract Services. This component would be an internal service group of NISE! Impact. It would be responsible for working with prospective impact delivery organizations (not for profit or for-profit) to negotiate pay-for-success contracts with government agencies, monitoring contract performance and assisting in the evaluation of impact results. Strategic Planning. This group would also be an internal service group of NISE! Impact. It would be responsible for assisting portfolio organizations in developing high performance strategic plans for delivering the expected impact. Tactical Assistance. This component would be responsible for providing portfolio organizations with advice and assistance on tactical issues important to implementing a strategic plan and achieving the desired performance results. NISE! Impact LLC A Unique Financial and Impact Delivery Organization NISE! Impact LLC FINANCIAL SERVICES IMPACT SERVICES Asset Management Investment Advisory Portfolio Management Strategic Planning Tactical Assistance Contract Management e 3
  11. 11. 10NISE! SIB Delivery Model © 2011 Energy Efficiency: A Public Policy Imperative Under nation-leading energy efficiency plans established by the Patrick-Murray Administration, Massachusetts has chosen energy efficiency as its “first fuel” – what is looked to first to meet the State’s energy needs. While the State utilities have invested in home-sealing, insulation, efficient lighting and appliances, the State Executive Office of Energy and Environmental Affairs (EEA) and the Massachusetts Clean Energy Center (MassCEC) continue to recognize that the private and public housing sectors still have not been active in implementing energy efficiency measures and that help is needed in finding new ways to assist these sectors in advancing energy efficiency. The State’s energy efficiency goals are connected to green community planning and green jobs, and is a regional sustainable solution to a nation-wide energy crisis and national security issue.  Greater energy efficiency in Massachusetts’ private and public homes and buildings is critical in order to meet the State’s goals in reducing energy usage and CO2 emissions. Based on one of its own business models, NISE! believes a social impact bond that invests in innovative energy efficiency management could have the ability to save 20% of current energy use in 50,000+ private homes across Massachusetts in the next three years. In addition, a Social Impact Bond associated with the State Department of Housing and Community Development and the State Department of Capital Asset Management would allow the State to also reduce energy consumption by approximately 10-20% in their public housing stock of residential homes and buildings. This effort would also serve to save the State approximately 10-20% in public housing energy cost given that the State is responsible for paying a portion or all of a public housing tenant’s energy bill. A social impact bond for energy efficiency could allow the State to meet its energy goals, provides energy cost savings for Massachusetts’ residential consumers and the State while reducing future budgetary costs for the State. A Proposed Focus: Energy Efficiency
  12. 12. 11 Key Components A model Pay for Success Contract for energy efficiency has the following components: Objective. To accelerate the adoption of energy conservation systems in residential properties throughout the Commonwealth. Metric. The number of residences with newly installed energy conservation systems that reduce energy consumption by 10% or more. Payment for Success. $500 per residence for each installed energy conservation system that achieves energy savings of 10% or more. $250,000 for every 5,000 residences that achieves metric within 18 months. Addendum Model Pay for Success Contract for Energy Efficiency NISE! 40-A Orchardhill road Boston, MA 02130 www.usnise.com For more information contact: Edward Dugger III, eduggeriii@usnise.com

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