Observations on the World’s First RFP for Social Impact Bonds

BIG NEWS FROM DOWN UNDER

The Treasury Department of New South Wales (NSW), Australia, recently issued the world’s first Request For Proposals for a “Social Benefits Bonds Trial.”  “SBB” is the latest entry in the continuing search for a commonly-accepted name for Social Impact Bonds (SIB), otherwise referred to (primarily by the U.S. and some state governments) as Pay-for-Success (PFS) Bonds or Contracts.  (Thankfully, I won’t be wading into that debate and will use “SIB” here.)  As a former government lawyer who has litigated more than $2 billion in public procurement and contracting disputes, I’m happy to report that the NSW Treasury has drafted an excellent RFP that deserves wide consideration.  



The RFP offers an incisive approach to structuring the relationships with the SIB intermediary and nonprofit providers, phasing the contract negotiations, setting the general parameters for evaluation of SIB outcomes, and avoiding unintended consequences such as favoring programs that serve “easier” populations and displacing existing funding sources.  NSW appreciates the critical differences between traditional government contracts and SIB partnership agreements, and formulates a deliberate and collaborative process for developing promising pilot projects.

(For the benefit of the uninitiated, “procurement” refers to the formal process for soliciting contract proposals and “contracting” refers to the negotiation, drafting and execution of an agreement that results from the procurement process.  An RFP is often referred to as a “competitive solicitation.”)

AN OVERVIEW OF THE NSW RFP

As the Treasury Department explains in the RFP, an SBB, just like an SIB, “is a new financial instrument that pays a return to private investors based on the achievement of agreed social outcomes. Under a SBB, an investor provides upfront funds to a partner (non-governmental organisation (NGO) or intermediary) to provide services that will, if successful, reduce future costs to Government. Part of the Government savings are used to repay this investment and provide a reward payment commensurate with the outcomes achieved.” 

Like SIBs, “SBBs aim to provide an expanded source of private upfront funding for early intervention and prevention services that mitigate the escalation of social problems,” and that “directly rewards outcomes rather than specifying how they are delivered.”  Both instruments assume the benefits of market discipline:  “It is expected that investors will require some review of the evidence behind any proposed intervention as well as ongoing monitoring of performance, increasing the likelihood of positive social outcomes.”


Importantly, SBBs and SIBs are also designed to enhance governmental performance management and accountability:  “Because SBBs require a sound performance management framework to be established to measure outcomes prior to payments being released, agencies and service providers will need to develop and enhance methodologies and skill sets in program design and outcomes tracking ...”  (For additional SIB tools and resources, see the Social Impact Bond Learning Hub hosted by the Nonprofit Finance Fund.)

One central issue the RFP handles well is the role of what NSW calls the “Social Benefit Partner” (SBP), which Harvard Kennedy School Professor Jeffrey Liebman calls the “Social Impact Bond Issuing Organization,” or SIBIO.  The RFP defines SBP as:

“The organisation that is [1] responsible for the improvement of the outcome for the intervention cohort, [2] holds an agreement with Government by which they are paid upon measurement of this improvement and [3] issues social benefit bonds to investors.”

Since the SBP is the sole party responsible for the outcomes, holds the contract with the government and issues the SIBs, it follows that the SBP must hire and manage the nonprofit service providers directly:

“The Government intends to sign a SBB Implementation Agreement with the SBP for each pilot. The Government will not have any contractual arrangements with investors or with the service providers (if different [from] the SBP) as part of the pilots. Such arrangements would need to be concluded separately between the SBP and its investors and providers (as relevant), although the Government may assist in the negotiation process as reasonably determined by all the parties and set out in the SBB Development Agreement.”

The RFP also successfully addresses three other concerns often expressed about SIBs.  First, the RFP guards against cream-skimming:

“The Government is interested in developing measures that encourage providers to work with the most challenging clients, and avoid perverse incentives. One way this will be done is through measuring performance with regard to all clients who are referred to the intervention, not simply those who engage with the services offered. This removes the incentive for providers to work only with the most motivated clients and avoids measurement bias due to self-selection.”

Second, private investment may not be used to offset current government budgets for social programs:

“SBBs are intended to attract new resources to the delivery of public services. While successful SBBs should reduce the need for future public spending on acute services, SBBs are not intended to replace existing upfront government expenditure.”

Third, while small nonprofits will likely find it difficult to handle the substantial performance demands that SIBs impose, NSW tries to facilitate their participation:

“The Government acknowledges that smaller service delivery contractors may not be able to submit a proposal and the Government is therefore open to a larger organisation or consortium submitting a proposal in relation to these contracts collectively. Any such proposal, however, would need to demonstrate that all affected service delivery contractors support the proposal and that there is no impact on overall service levels.”

KEY PRINCIPLES OF GOVERNMENT PROCUREMENT AND CONTRACTING

Procurement law is designed to promote two general policies:  (1) fairness to organizations competing for the contract opportunity and (2) value to taxpayers.  The first policy is served by creating a “level playing field” on which all potential responders can compete for the same contract on the same terms.  For example, except in special cases, an RFP should not be written to favor a particular organization or an approach used by a particular organization, if the solicitation can be written on more inclusive terms.  The second policy is served by encouraging cost-efficient, innovative proposals from capable organizations.

At times, these two policies can be in conflict.  Historically, procurement law was very strict about setting an absolutely level playing field, so RFPs were required to set out all the terms of engagement in exhaustive detail, with bidders competing exclusively on the price of the good or service offered.  This approach often failed to produce much taxpayer value.  (The shortcomings were memorably expressed by the oil-driller “Rockhound” [played by Steve Buscemi] in the movie, Armageddon, as he and his fellow would-be astronauts sat on the launch pad waiting to lift off to keep an asteroid the size of Texas from hitting the Earth:  “You know we’re sitting on four million pounds of fuel, one nuclear weapon and a thing that has 270,000 moving parts built by the lowest bidder.  Makes you feel good, doesn't it?”) 

Over time, the “lowest responsible and eligible bidder” requirement has been considerably liberalized so that firms could offer innovative approaches that the government could not define in detail on its own.  But there are limits on how far this more enlightened approach can go without undermining the fairness criterion.  For example, procurement law probably would not allow an agency to issue an RFP that said, in effect, “We want to contract with nonprofit organizations to help poor people.  Please tell us how you would do that,” as there would be difficult to compare proposals in such a wide-open, apples-to-oranges “competition.”

There’s a lot of room between the two extremes of no flexibility and total flexibility, and the NSW RFP strikes a fair balance between creating a level playing field and inviting innovative approaches to developing SIB pilots.

A PHASED APPROACH

The government has certain irreducible obligations to provide a level playing field, comply with established legal requirements, and protect public safety and vulnerable populations.  However, in the novel case of SIBs, it needs to simultaneously promote cross-sector collaboration in order to maximize the chances of attracting private investment capital.

Treasury explicitly structures the procurement process as a way to select partners to negotiate SIB contracts, rather than require them to accept terms imposed by the RFP:

“Since the release of the [government’s first report on SIBs], the NSW Government has conducted further development work on a potential SBB trial, including discussions with a range of potential providers, investors and intermediaries. It is clear from this work that, while there is a high degree of interest in the SBB model and the necessary market conditions may exist in NSW, significant uncertainty will remain until a sustainable data base is established on which to measure improvements in service delivery. This is an evolving market where significant collaborative work between proponents and the Government will be required to develop a viable SBB.  The Government is therefore seeking to identify preferred proponents with whom to develop the two pilots through this Request for Proposals (RFP).”

The RFP then lays out a three-phased process:

1. an RFP which designates two priority areas (out-of-home care and recidivism);
2. “a due diligence and joint development process to be undertaken between the Government and up to two preferred proponents identified through the RFP process, in respect of up to two potential pilot SBBs”; and
3. “Contract negotiations with preferred proponents for implementation of up to two pilot SBBs.” 

This is an insightful, albeit unavoidably laborious approach that will be carried out through two separate and successive agreements.  Before the second phase begins, firms selected based on the RFP submissions will negotiate an “SBB Development Agreement” that will govern the working relationships throughout the third phase, which will then culminate in an “SBB Implementation Agreement.”

Although undeniably cumbersome, this approach accommodates the complexities and uncertainties of SIB development.  SIBs have many moving parts, so it is essential to get and keep everyone on the same page.  The SBB Development Agreement sets the stage for doing so by addressing such basic matters as: 

“the dispute resolution process; payments to the preferred proponents (if any); insurance; the nature of any involvement by the NSW Government in negotiations with investors; ownership of any intellectual property generated during the joint development phase; the process for negotiating and reaching agreement on the SBB Implementation Agreement …; [and] termination and the sharing of information between the preferred proponent and Government.”

Unless these legal, administrative and housekeeping matters are buttoned up at the outset, it might prove too difficult to resolve the more challenging substantive issues to be covered in the SBB Implementation Agreement.  But NSW recognizes the fundamental need for collaboration from the outset:  “[d]uring the assessment of RFP proposals, the Government will discuss and agree [on] the terms of the SBB Development Agreement with parties being considered for selection as preferred proponents.”

You can appreciate why NSW breaks the contract negotiations into two separate agreements when you see the daunting list of issues “envisaged” in the RFP for the SBB Implementation Agreement: 

“details of the target group, location, and referral and entry arrangements; contract duration and any extension provisions; ownership of intellectual property from the pilot; details of baselines, comparison groups and other measurement arrangements; payment triggers; a payment schedule covering all performance scenarios (below baseline, baseline, good performance and over-performance); allocation of risk between parties to the SBB; dispute resolution provisions including a mechanism for resolution of client issues; break clauses for all parties; [and] any options for recontracting at the conclusion of the SBB term details of how the program would be evaluated.”

The RFP does a nice job of balancing the need for a level playing field with progressive collaboration to promote benefits to taxpayers and program beneficiaries.  Terms to be negotiated include the nature of the contractual relationships, the capital draw-down requirements, and the investor repayment schedules, subject to the non-negotiable requirement that investors bear the entire risk of loss if the agreed metrics are not met.  Treasury is willing to consider financial incentives for SBPs “to share in the possible upside return,” but does require that “the bulk of the financial risk (and potential returns) should reside with investors.”  Proposers can also recommend outcome measures and ranges, effect sizes, target cohorts, comparison groups, service locations, payment triggers, and measurement periods.

As SIBs are entirely dependent upon the achievement of defined outcomes, data collection and evaluation are critical success factors.  However, government data collection systems are constrained by privacy laws, so it is noteworthy that the RFP states that “the Government will provide support in constructing and implementing the measurement system, including thorough access to administrative data.”  Indeed, proposers are encouraged to “indicate any requirements of NSW Government agencies in the proposed identification, screening and referral process,” which could be crucial in terms of access to data about program participants.  (Presumably, such measures could include removing all personally-identifying information from program participant data provided to intermediaries.)

NSW anticipates that the term of the pilots will be five to eight years, but recognizes that “SBB terms must balance the time needed to demonstrate maintenance of statistically significant effect sizes with investors’ interest in receiving a return within a reasonable timeframe.”  Five- to eight-year terms are probably reasonable, if we assume that services will be delivered to multiple treatment cohorts of 6-18 months each, and that audits/evaluations of 12-24 months will follow each treatment period.

The RFP also does a good job of establishing a useful and feasible framework for measurement and evaluation.  The primary requirement is that “an independent auditor (or auditors) will be commissioned and will be responsible for verifying whether outcome targets are met during the life of the SBB.”  Specifically, “the auditors will approve and monitor the outcome targets, measurement approach and payment triggers for the two pilots, … [and] determine whether the agreed targets have been met and therefore whether government payments should be released.”  This is a sensible approach because the outcome metrics should be expressed in unambiguous and directly measurable terms, allowing an auditor to essentially verify the data (including any backup records) to determine whether the contract conditions have been satisfied.

One area of possible concern, however, is that “the Government’s preferred measurement methodology is randomised control trial (RCT), although other approaches may be considered if RCT is not feasible or appropriate for a particular intervention.”  RCTs can be a useful tool for the selection of evidence-based intervention models, although other approaches, such as “quasi-experimental” designs using matched comparison groups, have been valuable in demonstrating the effectiveness of innovative prevention programs such as permanent supportive housing.  In addition, RCTs often will be infeasible or inappropriate for evaluating SIBs designed to serve the kinds of “most challenging clients” the RFP has in mind.  For example, it would be extremely difficult (at best) to make random selections among chronically homeless individuals with severe mental health problems, or high-risk youth aging out of foster care, and it would be even more onerous to track such members of the comparison group who did not receive program services.  In some cases, the use of RCTs might deny effective preventive services to the people who need them the most.

The RFP also provides a useful explanation of its thinking about out-of-home care and recidivism.  It offers extensive discussion and analysis of each of the proposed pilot areas “that can be used in the development of proposals,” including detailed examples of SIB models based on this information. Importantly, the RFP states that “the examples are purely illustrative and the potential financial benefits have not been tested against any specific interventions – this aspect is left entirely to proponents.”

In sum, the RFP assigns the right responsibilities to the intermediary, provides the autonomy necessary to meet those responsibilities, and leaves essential contract terms open for negotiation so that the parties can jointly structure a SIB that investors will accept and intermediaries can implement with confidence.  The “Service area information” section provides reasonable assumptions about participant cohorts, outcomes and measurement, and “indicative benefits” that help bring newbies up to speed and level the playing field for comparing proposals.  This information also offers a practical way to get the ball rolling in a nascent market that, as yet, has no benchmarks from the field.

CONCLUSION

The particulars of drafting RFPs often depend on local market conditions, such as characteristics of the service provider industry, legally-mandated and customary procurement and contracting practices, and economic and social circumstances that give rise to the need for services that the government does not provide directly.  In the case of SIBs, there will surely be a range of viable approaches that state and federal agencies will take to soliciting proposals, with no clearly superior way to bring this novel financial instrument to life.  That being said, the NSW RFP is a worthy starting point.

Australia’s Treasury Department has done the embryonic market for Social Impact Bonds a great service by developing a procurement and contracting process that balances fairness, innovation and collaboration.  While no government can abdicate its responsibilities on matters of legal compliance, protecting public safety, and serving vulnerable populations, it is in the government’s own interest to encourage the private and social sectors to take a seat at the drawing board to help devise more effective ways to finance proven prevention programs.  NSW’s efforts show that the procurement community, broadly defined, has an important role to play in bringing SIBs to market.