1D. Can payment by results transfer risk?

One of the reasons that commissioners are attracted to the concept of payment by results is that it allows them to transfer practical and financial risk to providers; by linking payment to defined results, commissioners ensure they do not pay for poor performance.

The provider (or, in the case of Social Impact Bonds, a third party investor) is often expected to cover early start-up and running costs until payments for success reimburse this outlay. This transfers the financial risk of setting up a new scheme from the commissioner to the provider. The use of social investment (both the Peterborough prisoner resettlement and the London rough sleepers PbR pilots were funded by Social Impact Bonds) allows commissioners to invest in new approaches without needing to find new money from budgets already under pressure.

But can PbR schemes really transfer risk?

Transferring risk is not straightforward

However, the Audit Commission, in the first thorough UK examination of PbR,  emphasised that it is not possible to transfer all risk, be that risk reputational, practical or financial. Commissioners retain their responsibility for local citizens receiving a good quality and effective service. They must also be diligent in ensuring that the terms of a PbR contracts are not too generous so that the public continues to receive good value for money.

Certainly, politicians have made much of these risk transfer advantages, enabling them to argue that new government PbR initiatives will ensure proper value for public money. Chris Grayling, the government minister responsible for both the Work Programme (as Minister of State for Employment) and the Transforming Rehabilitation new probation contracts (as Justice Secretary) argued consistently that one of the core advantages of PbR is that new providers would not be paid in the case of poor performance.

Yardstick competition

Perhaps the best example of how risk can be transferred is the Work Programme which compares the performance of 18 prime contractors operating 40 contracts in 18 contract package areas (CPAs) – there are two to three contracts in every CPA. This “yardstick competition” allows providers to be more fairly judged and commissioners to reward successful providers by allocating them a greater share of the contract. In the case of the Work Programme, the DWP regularly reviews performance and shifts market share as a result; for instance, in August 2013 substantial components of the contracts in 10 of the 18 CPAs were transferred from poorly performing providers to companies achieving better outcomes.

One of Clist & Dercon’s 12 principles for payment by results in international development is that risk transfer is not a rationale for PbR per se; they argue that the primary purpose of transferring risk should be to sharpen performance incentives for the provider, and not for the commissioner to offload risk.

Conclusion

The National Audit Office cautions that although PbR transfers some risk to providers, commissioners need to be aware of the risks they retain, in particular overall responsibility for a public service, and recommends that, wherever possible, commissioners pilot new PbR schemes.

Commissioners should bear in mind that the more risk they ask providers to bear, the more they are likely to have to pay for providers to shoulder that risk. As in any form of investment, risk is closely correlated to returns. There are examples in the literature of commissioners asking for too much risk for too low a price and having to abandon the competition for lack of bidders.

Providers should undertake their own risk assessment and decide what level of risk they are prepared to take on and to calculate what level of remuneration they would need to justify this risk and safeguard the financial security of their organisation.