Government Role: Human Capital Performance Bonds

• Human Capital Performance Bonds are a way to begin a financing system that attracts new investment capital while also holding nonprofits and government accountable for generating quantifiable economic value from its social programming. We can then reward the accomplishment of positive long-term outcomes rather than simply increasing our outputs (e.g., the number of people served by a program), which is what we typically do now.

  Once nonprofits start demonstrating economic value and government captures it in higher tax revenues and lower costs, government can interest private investors in providing long-term capital to finance even more economic (and social) gains.

  Here’s how it works: Nonprofits whose programming leads to meaningful economic gains would qualify for a “pay for performance “payment. The size of the payment would be directly related to the size of the incremental economic value the state receives from increased tax collections, lower public subsidies and lower prison costs. Government has millions of examples of value being created as incomes increase and subsidies go away. That incremental value has the same financial value as cash flow in a business. Businesses use the promise of future cash flow to borrow long term or sell securities to finance even greater growth. Governments could do the same from these new incremental funds.

  The mechanism would likely be a government “moral obligation” bond that is either taxable or tax exempt. Investors would purchase these “Human Capital Performance Bonds” based on their assessment of risk and return, much like any other investment. Government would establish the economic value equation for non profits (i.e. a share of the incremental value that is created) and set up a mechanism to measure, capture and pay a performance pool for interest and principal reimbursement. A reputable third party administrator such as an accounting firm would pre-qualify nonprofits to participate based on their likelihood to create value from their programming, oversee the operations of the performance pool, and report on results. Underwriters and rating agencies also would weigh in to assure the fidelity of the investment.

  Is this financing system possible to accomplish? Yes. Government already borrows large sums from private investors through bonding for a wide variety of purposes including infrastructure projects. In the case of a bridge, a tunnel or stadium the lenders are paid back from future tolls or special taxes. A Human Capital Performance Bond would work similarly. Moral obligation bonds have precedents as well. The Minnesota Housing Finance Agency, for example, has $2 billion outstanding for low-income housing bonds.

  But can social value be translated into economic value? Yes, in most areas of social spending. A successful working “pay for performance” model has existed for more than 13 years in the state of Minnesota.

  TC RISE! is a Minnesota nonprofit dedicated to alleviating chronic poverty. RISE! works primarily with people whose families have been poor for generations, most suffering from homelessness, poor job histories, low academic achievement and criminal convictions. After an intensive year-long focus on remedial education, skills training, coaching, internship and  empowerment (in other words, a  transformation into accountable and hopeful human beings), graduates are placed in jobs that average $25,000 plus benefits, an increase of almost $20,000 from the time they entered the program. One- and two-year job retention averages  82% and 73%, respectively. These long-term outcomes create the economic value that enabled TCRISE!, with the help of economists at the Minneapolis Federal Reserve Bank, to approach the state of Minnesota to develop the pay for performance model that it employs today. Each time a TCRISE! graduate is placed in  a  job above $20,000 with health benefits that is at least a $10,000 improvement in their income, TCRISE! is paid a performance payment at placement and another one a year later if the person is still employed in at least as good a job. TCRISE! shares the economic value that its programming created with the state and takes all the risks of success; there is no payment for failure. Since 1997 when it was first enacted, the state of Minnesota has enjoyed a return of $5.42 for each $1.00 it has paid TCRISE! That’s a 452% return on its investment.

  TCRISE! is not unique in its ability to generate economic value from the social good it performs. Any social enterprise whose quality programming creates incremental tax revenues and/or reduces public subsidies in the short to medium term could create high returns for the state and payments for itself.  Examples are workforce programs, drug treatment programs, health care, subsidized housing and higher education, among others. Some non-profits are doing it already; they (and the government) just don’t know it because it isn’t being measured.

  While an overwhelming number of areas could apply a Human Capital Performance Bond financing system, it won’t work everywhere -- for example, where there is no direct link between social value and economic value as in museums, zoos, or public media, or where social investment takes many years to pay off as in early childhood education.

  Here’s how such bonds could work:

  External investors buy human capital performance bonds that are linked to clear economic criteria established by the state. The state deposits these invested funds in a “performance pool,” where the money is invested and held until the payout terms are met by the nonprofit. The pool is overseen and administered by an independent trustee to insure the pools fidelity.(Working capital could be provided to non profits from this pool, too) The pool pays out to the nonprofit over the bond term, based on the nonprofit meeting the performance goals set by the state. The amount of the payment is related to the amount of value it creates (return on investment). A third party administrator annually validates the performance value (ROI) to the state and adjusts the payout formula. If performance targets are met, the state receives high ROI and cash flow to fund interest, principal repayment while retaining the residual cash returns to lower the cost of government. If performance targets are not met, the state has the use of the funds for principal repayment, interest, or other purposes until the bond period terminates since non profits are paid only when they perform. The structure ends at the end of the bond term. Alternatively, the performance pool continues operating, funded by the incremental cash returns reinvested by the state.

   Unlike other bonds the state now issues, Human Capital Performance Bonds carry considerably lower risk for the state. Only high-performing nonprofits would qualify to participate, providers are only paid once they successfully perform, and the higher tax receipts and lower state costs created by the non-profit pool provide a dedicated flow of cash to the pay interest and principal to investors. While non profits assume more risk in this scenario, they have the potential to earn considerably more financial support than under current (and future) state spending. That’s a prospect that high performers will relish.

  Obviously, we’ll need a transition structure while government and nonprofits tool up to work in this way. The benefits will be well worth the effort as each stakeholder has a lot to gain:

  State Government will have a new source of dollars to invest from private investors. Social spending could increase as outcomes improve versus the likely prospect of continuing cuts in social spending funded exclusively from state spending. Cash returns from the highest performing nonprofits will not only pay for the financing costs but also could provide incremental returns (positive arbitrage).

  The highest-performing nonprofits will have access to significant new capital for growth. The amount depends on their outcomes. They will make more strategic, higher-return investments as a bond pool life is longer term than the two-year budget cycle of government. Nonprofits will seek to improve their outcomes to participate.

  As the best-performing nonprofits grow, clients will be served by higher-quality programming, leading to better outcomes. More individuals will leave poverty, obtain quality employment and achieve higher levels of education.

  Investors will have a new quality investment opportunity that adds real value to the economy. Banks will be especially interested because Human Capital Performance Bonds qualify for community reinvestment act credit. Socially conscious investors will be large supporters.

  Taxpayers will gain greater transparency and accountability for their tax dollar. As investments pay off, the cost of government will come down.

• Rate this idea on a scale of 1 (low) to 5 (high) according to the following criteria. 

• 1.

  Human Capacity.  How much does this idea:

  * uncover and build on individual-family-community strengths/assets
  * make transparent the processes, structures, policies impacting the individual-family-community?
  * help illuminate influences of social-economic-cultural context for the individual-family-community?

  

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  Civic Infrastructure.  How much does this idea:

  * build connections, networks, collaborative structures
  * create community resources, assets, equality of opportunity
  * increase social capital, economic independence and civic engagement

  

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  Fairness / Equity.  How much does this idea:

  * have the potential for positively impacting racial, gender or other disparities beyond socio-economic status
  * provide greater and more convenient access to resources as needed along the prosperity continuum

  

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  Scope of impact and potential efficiency.  How much does this idea:

  * require accessing multiple policy areas
  * help integrate resources across areas

  

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  Rules and regulations.  How much does this idea alter use of or need for rules and regulations?

  

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  Incentives / Resources.  How much does this idea:

  * Change incentives for stakeholders
  * Focus resources along a new or different path toward prosperity

  

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• 7.

  Replicability.  How replicable is this idea?

  

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• 8.

  Scalability.  How scalable is this idea?

  

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• 9.

  Ability to impact.  How great is our ability to implement this idea?

  

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• 10.

  Palatability.  How palatable or politically feasible is this idea? 

  

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