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Mass. Companies Encouraged By Call For Social Impact Bonds05:01

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A small item in President Obama's recent budget plan is generating a lot of interest, especially in Boston. It's essentially an experiment with a new way to pay for social programs by getting private investors involved. The experiment uses what are called "social impact bonds" and two new companies have started in Boston to give the experiment a try.

To explain what a social impact bond is it helps to start with what it might pay for: social programs that work on things such as dropout prevention or helping young mothers. Here in Massachusetts, a program known as Healthy Families works with more than 3,000 young mothers. The program involves having a worker check in — usually weekly — with a new mom and her child.

Healthy Families' Maureen Riser recently visited 18-year-old Markeesha Kelly and her 2-year-old daughter, Lenaiyh.

"Lenaiyh hasn't been in daycare, why?" Riser asked.

"Because the bus isn't running this week," Kelly said.

Scientific data show that when new young moms like Kelly receive regular visits like this, it reduces the rate of child abuse and keeps kids on track developmentally. That track record makes these visiting programs good candidates for social impact bond funding.

"It's been shown in several rigorous studies that this not only leads to better health outcomes, but it also leads to less spending on Medicaid and other government programs," said Jeff Liebman, professor of public policy at Harvard University's Kennedy School. Liebman has been researching how the government might use social impact bonds to pay for programs like Healthy Families. He points out that even though we've known since the late 1970s that these programs are effective, the government did not start providing funding for some of them until just last year.

"It can't take 33 years between the time we discover an intervention that works and the time we get the benefit from that intervention more broadly," Liebman said.

Simply put, the way social impact bonds work is that private investors put up the money for a program and agree on how to measure its success. If success is achieved, the government pays back the investors. If the program is not successful, the government does not pay and the investors lose. It's actually a complicated financial instrument that recently jumped from Liebman's academic world of economic theory into the real financial market world when Obama got on board.

"When it comes to programs we do need, we're making them work better by demanding accountability," Obama said in his budget address last week. "Instead of spending first and asking questions later, we're rewarding folks inside and outside of government who are delivering results."

Included in the president's budget plan is up to $100 million for pilot programs funded with social impact bonds, most of them for education.

The president is not the only one jumping on the social impact bond bandwagon. Tracy Plandjian recently opened the United States office of Social Finance in Boston.

"We are six weeks old," Palandjian said. "We commenced operations on the first of this year and we now have a team of five people in Boston. We're still unpacking boxes."

This office is part of Social Finance in the United Kingdom. The company is piloting the first-ever use of social impact bonds for a program designed to reduce recidivism rates at a U.K. prison.

"You might ask, 'Why is this complicated thing necessary to pay for something the government should pay for by itself?' " Palandjian said. "'There are effective programs out there for prisoners and the government should just fund that.' What we're hoping to do is not to overcomplicate but to bridge the gap in terms of time and investment risk for government."

In the U.K., private investors put forward about $8 million for the prison program. If the recidivism rate is reduced by 10 percent in a year, the investors get back their capital — and potential bonuses between 7 and 13 percent. That experiment has gotten the attention of others on this side of the pond.

"All of a sudden everyone has come out of the woodwork saying, 'Maybe this can work,' " said George Overholser, a longtime venture capitalist who is launching another Boston company — Third Sector Capital Partners — that will focus on social impact bonds. He sees them as a way to make big changes.

"Unfortunately too much of our money as a country goes toward programs which maybe once worked but which are no longer as effective as they could be," Overholser said. "So the concept here is to take what we're calling a 'grand misallocation of resources' to see if we can prompt a reallocation of the resources."

Because both of these businesses are in Boston, it's likely the first pilot program using social impact bonds in this country will be in Massachusetts. Neither Overholser nor Palandjian would be specific, but both say they've approached the Patrick administration. State officials only say it's still early, but they're exploring how this might work in Massachusetts.

This program aired on February 25, 2011.

Deborah Becker Twitter Host/Reporter
Deborah Becker is a senior correspondent and host at WBUR. Her reporting focuses on mental health, criminal justice and education.