P AY - FOR -S UCCESS F INANCE FOR E ARLY C HILD C ARE AND E DUCATION 1 Performance-Contingent Finance for At-Risk Children in Alexandria Virginia: A Kauffman-PAES Progress Report to the Invest in Kids Working Group Partnership for America’s Economic Success Robert H. Dugger Managing Partner, Hanover Investment Group Advisory Board Chairman, Partnership for America’s Economic Success October 25, 2011 Washington DC

Table of Contents I.Purpose of the Kauffman PAES Early Childhood Finance Innovation Working Group Page 3 II.Overview of “Pay for Success” Social Impact Bond Financing Page 5 III.Description of PKSE Bonds and an Alexandria VA Smart Beginnings Capital Partnership Page 12 IV.Presentation of PKSE performance based on results from Perry Preschool, Louisiana LA-4, Pennsylvania PKC, and Granite School District Utah Page 22 2

Part I Purpose of the Kauffman PAES Early Childhood Finance Innovation Working Group 3

The goal of the Kauffman-PAES Early Childhood Finance Working Group is to develop ways to pay for quality early care and education that create assets which can be traded among investors worldwide and aggregated in asset- backed securities The possibility of “invest-in-kid bonds” has been discussed for many years To develop marketable “social impact” assets, we need to: 1.Establish strong statistical yield and repayment histories 2.Develop workable instrument contracts and institutional frameworks 3.Conduct intermediate “proof of concept” financings, which reveal the strengths and weaknesses of possible approaches 4.Carryout several full Social Impact Bond invest-in-kids financings To create markets for such instruments, we need to: 1.Work with major financial institution investment banking, wealth management, and philanthropic divisions 2.Attract broad investor and philanthropic interest in the assets 3.Obtain state and federal statutory recognition of the assets 4.Steadily accumulate asset performance information 5.Carryout several successful asset underwritings 4

Part II Overview of “Pay for Success” Social Impact Bond Financing 5

Motivations for using performance-contingent or “Pay for Success” funding* Improving performance and lowering costs. o Payment is based on achieving outcome targets. o Focuses government agencies and social service providers on achieving program objectives and improving performance in a way that is transparent to taxpayers. Accelerating adoption of new solutions. o Government pays only if program delivers on its promised impact. o Shifts risk of failure (and of wasting taxpayer dollars on programs that don’t work) to private sector. o Can also break down the budget silos that hinder investment in prevention. More rapid learning about what works and what doesn’t. o Ongoing measurement of a program’s impact is a fundamental component of this approach. *See Jeffrey Liebman, Social Impact Bonds: A Promising New Financing Model to Accelerate Social Innovation and Improve Government Performance, Center for American Progress, February

Criteria for successful application of this approach* 1.A potential for high net benefits. 2.Measurable outcomes. 3.A well-defined treatment population. 4.A reliable comparison group or counterfactual. 5.Safeguards against harming the treatment population. 7 *See Jeffrey Liebman, Social Impact Bonds: A Promising New Financing Model to Accelerate Social Innovation and Improve Government Performance, Center for American Progress, February

Illustrative potential areas of application* A.Corrections, including juvenile justice. B.Services for at-risk youth such as those in the foster care system. C.Homelessness prevention. D.Employment services. E.Preventive health care interventions. F.Kindergarten readiness/third grade reading levels. 8 *See Jeffrey Liebman, Social Impact Bonds: A Promising New Financing Model to Accelerate Social Innovation and Improve Government Performance, Center for American Progress, February

Standard Social Impact Bond (SIB) model* includes -- Payment of return on invested capital to investors Repayment of invested capital Government savings must cover full cost of services 9 See Jeffrey Liebman, Social Impact Bonds: A Promising New Financing Model to Accelerate Social Innovation and Improve Government Performance, Center for American Progress, February

Standard SIBs, which provide a return on investment and capital repayment to investors, face implementation challenges 1.Unclear returns on an investment intervention 2.Long years between the intervention and the return 3.Inability to link government cost reduction or revenue gain solely to the investment intervention 4.Involvement of multiple and irreconcilable government jurisdictions 5.Inability to obtain political agreement to give up cost savings or allocate cost savings to investors 6.Presence of incentive inconsistencies among parties to the financing 7.Absence of evaluation and administration experience or capacity among investor entities 10

It may be possible to address the implementation challenges facing standard SIBs by taking intermediate steps to demonstrate the ability of pay-for-success financing approaches 11

Part III Description of PKSE Bonds: “Spend for Pre-K to Reduce Special-Ed Cost” Alexandria VA Smart Beginnings Capital Partnership 12

The Alexandria Smart Beginnings Capital Partnership is an intermediate step in demonstrating the effectiveness of pay-for-success finance An intervention to improve school readiness and monetize a net benefit which has been heavily researched Clear linkages between investor intervention and government cost savings A short time period between investment and measurable return A means to integrate budget benefits of multiple jurisdictions with political acceptance A framework for contractual commitments among investment entities and governments A means to unify business and philanthropic support for the intervention All government cost savings are re-invested back into the intervention that generated the savings The savings accumulate steadily, increasing the resources invested in the intervention and clarifying that pay-for-success financing works 13

The Alexandria Smart Beginnings Capital Partnership sets up a PKSE program to pay for quality prekindergarten to increase school readiness and reduce public school special education costs Alexandria Smart Beginnings Capital Partnership (ASBCP) proposes to provide parent mentors and “pre-k scholarships” to highly at-risk Alexandria 3 and 4 year-olds to reduce Alexandria public school special- education costs This project creates PKSE (“peek see”) asset that pay for quality-rated pre-k (PK) to reduce special education (SE) costs. The goal of this project is to examine institutional, governance and contract details necessary for future invest-in-kid asset development ASBCP “investor-philanthropists” will not receive a cash yield or repayment of principle 14

A.Investor capital contributions 1.Investors contribute to the SBCP 2.SBCP funds are used to fund PKSE scholarships and administration and parent-mentoring costs B.Special Education cost savings 1.If the SBCP PKSE program works, there will be fewer special education assignments among PKSE scholars and Alexandria special education costs will decline. 2.The reduction in special education costs due to the PKSE program are allocated to fund more PKSE scholarships. C.Virginia Preschool Initiative (VPI) 1.The VPI program provides matching funds for local area programs on a per child basis. 2.VPI funding will match the amount of PKSE scholarships awarded each year. 15 The Alexandria Smart Beginnings Capital Partnership PKSE program utilizes three funding sources

A.Grants from non-profit philanthropic institutions 1.Charitable institutions can make grants directly to SBCP 2.Grants pay no interest or return of capital to the grantor B.Project related investments (PRIs) from non-profit entities 1.Charitable institutions can make PRI grants, loans, and bond and stock purchases to invest in the SBCP 2.Interest and dividends can be paid and capital returned 3.PRI investments have to satisfy Section 4944 of the Tax Reform Act of a.Primary purpose of PRI investments must be to accomplish charitable purposes b.No significant purpose of PRI investments is income or the appreciation of property c.No purpose of PRI investments is to accomplish any political purpose forbidden to private foundations. C.Investments from private for-profit entities 1.Investors can make loans and buy the bonds and stock of the SBCP 2.Interest and dividends can be paid and capital returned to investors 16 The Alexandria Smart Beginnings Capital Partnership PKSE program can accommodate investments from several kinds of investors

A.Scholarships 1.From all economically at-risk children (as defined by the Virginia Preschool Initiative) in Alexandria City, potential PKSE scholars are chosen at random. 2.If parents of the selected children agree to participate in the PKSE program, the children become PKSE scholars. 3.Media coverage of the program will strengthen area awareness of early learning importance. B.Mentoring 1.Mentors are provided to assist parents become better at caring for and teaching their children. 2.The mentors help the parents choose the pre-k provider that is best for their children. 3.Mentor guidance is shared among parents of young children and has positive external effects on other parents and families. C.Parent choice 1.Parents can choose only from quality-rated providers. 2.Parent choice strengthens parent involvement in the care and education of their children. 3.Choice incentivizes pre-k providers to obtain quality ratings, which strengthens the Alexandria pre-k system. 17 The Alexandria Smart Beginnings Capital Partnership PKSE scholarships are based on the Minnesota Early Learning Foundation model

Proposed Smart Beginnings Capital Partnership PKSE structure (a) 1.Alexandria Investor Philanthropists -- A group of city business leaders and philanthropists agree to establish a capital partnership to fund a PKSE performance-contingent financing approach to increase future workforce strength and improve public school efficiency. 2.Smart Beginnings Capital Partnership (SBCP) -- A 501c3 non-profit corporation. Contributors to this entity are termed “partners” and are contractually subject to annual capital contribution calls to fund next year’s PKSE allocations if previous allocations are achieving contractually agreed-upon reductions in Alexandria public school special education costs. 3.SBCP Fund – A donor-advised fund within the Alexandria Community Trust. The SBCP Fund provides the SBCP share of PKSE scholarship funding. The fund is managed by the board of the SBCP. 4.SBCP Administration and Evaluation – On behalf of the SBCP board and partners, the SBCP director oversees all aspects of PKSE scholar selection, mentoring, pre-k provision, spec-ed assignment and savings calculations, compliance with SBCP contracts and evaluates program performance. 5.Alexandria School System – Randomly selects children for the PKSE program, provides mentors, and administers the PKSE program. 18

Proposed Smart Beginnings Capital Partnership PKSE structure (b) 6.Virginia Prekindergarten Initiative – VPI matches PKSE scholarship amounts. VPI program provides 50% matching funds for quality-rated pre-k for at-risk four year olds through the school system to pre-k providers based on established risk factors. 7.Scholarships and Mentors – Following the Minnesota Early Learning Foundation model, at-risk children are selected randomly to receive a SBCP PKSE scholarships. If the parents agree to the program, mentors are provided and parents select the pre-k provider. 8.Pre-k provider -- Must be a Virginia Star Quality Initiative (VSQI) rated institution. 9.PKSE graduates – As PKSE graduates move into public kindergarten, lower special education assignments and costs are expected. If lower spec-ed assignments and costs are confirmed, SBCP will issue capital calls to SBCP partners to fund the next round of PKSE scholarship grants. 10.Reinvestment of special-ed cost savings – Using the statistical evidence available and the terms of the contract between them, the SBCP board and the Alexandria School System will agree on the amount of special-ed cost savings that will be re-invested in PKSE scholarship for the next year. 19

SBCP Fund (Donor-advised Fund in ACT) Alexandria School Special Ed Cost Savings Are Reinvested in More PKSE Scholarships for VSQI Pre-K Virginia Prekindergarten Initiative (VPI) Funds to Match PKSE Scholarships For 4-yr olds VSQI Pre-K generates Special Ed Savings for Alexandria School System PKSE Scholarships for at-risk Kids and Mentors for Parents Parents Choose Any VSQI Rated Pre-K Provider Smart Beginnings Capital Partnership Alexandria Investor- Philanthropists Alexandria School System PKSE Account SBCP Administration, Mentoring and Evaluation 20 Proposed Smart Beginnings Capital Partnership PKSE money flow

 Accurate projections of SBCP PKSE performance will require careful analysis of the unique early childhood conditions in Alexandria City.  In the meantime, a sense of the possibilities can be obtained using estimates of the effects of quality preschool on special education costs drawn from studies done in other states. 21

Part IV Presentation of PKSE Bond Performance Based on Results from Perry Preschool, Louisiana LA-4, Pennsylvania PKC, and Utah Granite School District Studies 22

Pre-K Spec-Ed Cost Effect Fundamentals Early education cost/benefit estimates are obtained in three general ways – 1.Randomized Control Trial In RCTs subjects are randomly assigned to two groups. One group receives the treatment. The other, the “control” group, does not. After the trial, the result characteristics of the treated and untreated subjects are compared and analyzed. 2.Case Control Trial In CCTs, random assignment is not used. Subjects are identified who have very similar characteristics but who fall naturally in the treatment “case” group or the non-treatment “control” group. After the trial, the results characteristics of the two groups are compared and analyzed. CCTs are used in medical research when true experiments with random assignment are impractical or unethical. 3.Statistical Projection Trial In SPTs, mental development tests or other income, health, or demographic characteristics, which reliably predict a result, are used to project the likely result outcomes for a group of subjects. After the trial, the predicted results and actual results of the treatment are compared and analyzed. 23

Pre-K Spec-Ed Cost Effect Fundamentals Randomized Control Trial (Classic studies) In RCTs, subjects are randomly allocated to receive one or other of the alternative treatments under study. One group receives the treatment. The other, the “control” group, does not. After the trial all the subjects are monitored in the same way. In early childhood research, the two most famous RCTs are the Perry Preschool and Abecedarian studies. In both studies, quality prek reduced special education assignments. 24

Pre-K Spec-Ed Cost Effect Fundamentals Case Control Trial (Chicago and Louisiana) The most well-known study comparing “case” and “control” groups is the Chicago Child-Parent Centers. In the Louisiana pre-k program for 4-year olds (LA 4) evaluation, a “case” represents a participant in LA 4, and a “control” represents a child with similar characteristics who was not a participant in LA 4. Researchers found that participation in LA 4 is associated with reduced special education placement for both Free and Reduced Lunch (FRL) eligible children as well as those ineligible for FRL. 25

Pre-K Spec-Ed Cost Effect Fundamentals Statistical Projection Trial (Pennsylvania) Comparing statistically predicted results with actual pre-k graduate results was used to estimate the effects of PA’s Pre-K Counts (PKC) program in reducing special ed costs. 80% of PKC children met critical early school success competencies in the Pennsylvania Early Learning Standards (OCDEL, PAELS, 2005) at transition to kindergarten. The gains of PKC children exceeded the kindergarten transition skills of same-aged peers on the BSSI-3 national norms in spoken language, reading, math, classroom behavior, and daily living skills. The projected PKC special education placement rate was 2.4%, significantly lower than the 18% historical special ed placement rate of PA school districts. 26

Pre-K Spec-Ed Cost Effect Fundamentals Statistical Projection Trial (Utah) Comparing statistically predicted results with actual pre-k graduate results was used to estimate the effects of Granite School District’s pre-k program in reducing special ed costs. The Peabody Picture Vocabulary Test (PPVT) given to 3 and 4 year-olds is used to predict placement in k- 3 special education in many regions. A PPVT score of less than 70 is a strong indication that a child will be placed in special ed. Of 696 Granite School District 3 and 4-year olds given the PPVT test, 238 scored below 70 and were projected to almost certainly be assigned to special ed. However, as a result of attending Granite’s prek program, only 7 were assigned to special ed onJuly pdf

The following PKSE financial performance projections do not include – Declines in number of PKSE scholars in K-12 due to out-location, illness or death Declines in special education costs due to successful entry of spec-ed students into regular classes In-locations of k-12 students from other regions with PKSE-like programs 28

29 Twenty-Year PKSE Performance Summary Based on Perry Preschool Results PROGRAM ASSUMPTIONS Economic cost and effect assumptions Initial cost of VSQI pre-k per socio-economically at-risk child per year $10,000 Expected growth rate of cost for a pre-k child per year 3.0% Initial cost of Special Education per socio-economically at-risk child per year $15,000 Expected growth rate of cost for a pre-k child per year 3.0% Based on 1960s Perry Preschool Randomized Control Trial Results Expected % of socio-economically at-risk children assigned to Special Ed 38% Expected % of PKSE children assigned to Special Ed 17% Program PKSE scholarship assumptions Scholarship contribution per investor per year equals cost of pre-k per year $10,000 Percent increase in contribution 0.0% Program PKSE operating cost assumptions Initial administration costs $60,000 Expected growth rate of administration costs 3.0% Initial mentoring costs per child per year in PKSE $1,000 Expected growth rate of mentoring costs 1.0% Initial monitoring costs per child per year in K-12 $100 Expected growth rate of monitoring costs 1.0% Discount rate 3.0% Investor contribution assumptions Initial number of investor-philanthropists75 Number of years of investor contributions5 Average investor contribution per year for scholarships and operating costs $11,005 PROGRAM RESULTS Alexandria and Virginia school systems Present value of special ed cost savings$24,362,100 Present value of VPI contributions$2,625,528 Present value of spec ed savings as a % of PV VPI contributions928% Investor results Present value of total investor contributions$3,753,748 Present value of spec ed cost savings as a % of PV investor contributions649% Present value of spec ed savings as a % of PV investor and VPI contributions382%

30 Twenty-Year PKSE Performance Summary Based on Louisiana LA 4 Results PROGRAM ASSUMPTIONS Economic cost and effect assumptions Initial cost of VSQI pre-k per socio-economically at-risk child per year $10,000 Expected growth rate of cost for a pre-k child per year 3.0% Initial cost of Special Education per socio-economically at-risk child per year $15,000 Expected growth rate of cost for a pre-k child per year 3.0% Based on Louisiana LA 4 Case Control Trial Results Expected % of socio-economically at-risk children assigned to Special Ed 14.5% Expected % of PKSE children assigned to Special Ed 8% Program PKSE scholarship assumptions Scholarship contribution per investor per year equals cost of pre-k per year $10,000 Percent increase in contribution 0.0% Program PKSE operating cost assumptions Initial administration costs $60,000 Expected growth rate of administration costs 3.0% Initial mentoring costs per child per year in PKSE $1,000 Expected growth rate of mentoring costs 1.0% Initial monitoring costs per child per year in K-12 $100 Expected growth rate of monitoring costs 1.0% Discount rate 3.0% Investor contribution assumptions Initial number of investor-philanthropists75 Number of years of investor contributions5 Average investor contribution per year for scholarships and operating costs $10,928 PROGRAM RESULTS Alexandria and Virginia school systems Present value of special ed cost savings$3,431,025 Present value of VPI contributions$849,325 Present value of spec ed savings as a % of PV VPI contributions404% Investor results Present value of total investor contributions$3,728,472 Present value of spec ed cost savings as a % of PV investor contributions92% Present value of spec ed savings as a % of PV investor and VPI contributions75%

31 Twenty-Year PKSE Performance Summary Based on Pennsylvania Projections PROGRAM ASSUMPTIONS Economic cost and effect assumptions Initial cost of VSQI pre-k per socio-economically at-risk child per year $10,000 Expected growth rate of cost for a pre-k child per year 3.0% Initial cost of Special Education per socio-economically at-risk child per year $15,000 Expected growth rate of cost for a pre-k child per year 3.0% Based on 2008 Heinz Foundation Pennsylvania PKC Statistical Projection Analysis Expected % of socio-economically at-risk children assigned to Special Ed 18% Expected % of PKSE children assigned to Special Ed 2.4% Program PKSE scholarship assumptions Scholarship contribution per investor per year equals cost of pre-k per year $10,000 Percent increase in contribution 0.0% Program PKSE operating cost assumptions Initial administration costs $60,000 Expected growth rate of administration costs 3.0% Initial mentoring costs per child per year in PKSE $1,000 Expected growth rate of mentoring costs 1.0% Initial monitoring costs per child per year in K-12 $100 Expected growth rate of monitoring costs 1.0% Discount rate 3.0% Investor contribution assumptions Initial number of investor-philanthropists75 Number of years of investor contributions5 Average investor contribution per year for scholarships and operating costs $10,977 PROGRAM RESULTS Alexandria and Virginia school systems Present value of special ed cost savings$13,707,720 Present value of VPI contributions$1,766,038 Present value of spec ed savings as a % of PV VPI contributions776% Investor results Present value of total investor contributions$3,744,718 Present value of spec ed cost savings as a % of PV investor contributions366% Present value of spec ed savings as a % of PV investor and VPI contributions249%

32 Twenty-Year PKSE Performance Summary Based on Granite School District Projections PROGRAM ASSUMPTIONS Economic cost and effect assumptions Initial cost of VSQI pre-k per socio-economically at-risk child per year $10,000 Expected growth rate of cost for a pre-k child per year 3.0% Initial cost of Special Education per socio-economically at-risk child per year $15,000 Expected growth rate of cost for a pre-k child per year 3.0% Based on 2011 Granite County Utah Pre-K Statistical Projection Analysis Expected % of socio-economically at-risk children assigned to Special Ed 20% Expected % of PKSE children assigned to Special Ed 1.0% Program PKSE scholarship assumptions Scholarship contribution per investor per year equals cost of pre-k per year $10,000 Percent increase in contribution 0.0% Program PKSE operating cost assumptions Initial administration costs $60,000 Expected growth rate of administration costs 3.0% Initial mentoring costs per child per year in PKSE $1,000 Expected growth rate of mentoring costs 1.0% Initial monitoring costs per child per year in K-12 $100 Expected growth rate of monitoring costs 1.0% Discount rate 3.0% Investor contribution assumptions Initial number of investor-philanthropists75 Number of years of investor contributions5 Average investor contribution per year for scholarships and operating costs $10,997 PROGRAM RESULTS Alexandria and Virginia school systems Present value of special ed cost savings$19,964,250 Present value of VPI contributions$2,279,773 Present value of spec ed savings as a % of PV VPI contributions876% Investor results Present value of total investor contributions$3,751,037 Present value of spec ed cost savings as a % of PV investor contributions532% Present value of spec ed savings as a % of PV investor and VPI contributions331%

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