Now making waves in public finance circles are Social Impact Bonds (SIBs). It’s an innovative approach to finance social service programs that combines outcome-based payments and market discipline. They are designed to raise private capital for intensive support and preventative programs which address areas of pressing social need. It is a financial mechanism in which investors pay for a set of interventions to improve a social outcome that is of social and/or financial interest to a government. These are not bonds in the traditional sense. Investors are repaid, based on the level of success that the organization receiving the funding is able to achieve.
The funding concept is a type of “Pay For Success” (PFS) model where private investors invest capital and manage public projects, usually aimed at improving social outcomes for at-risk individuals, with the goal of reducing government spending in the long-term. Because payment is based on results rather than process, there is more room for innovation and greater freedom to demonstrate solutions that work.
The catch is that private investors front all the costs and will be paid back a financial return by the government if and only if social outcomes are improved based on some standard measurement. The profit-motivating component comes from the fact that some of the savings from reduced costs for the government can be used to pay back the investor contingent upon their success. If the social outcome improves, the government repays the investors for their initial investment plus a return for the financial risks they took. If the social outcomes are not achieved, the investors stand to lose their investment.
According to a Federal Reserve Bank of San Francisco paper, although PFS contracts have received widespread attention, there is nothing fundamentally new about governments paying for outcomes. What makes recent PFS initiatives distinctive is that they are focused not simply on creating additional financial incentives for contractors to produce better outcomes, but more broadly on overcoming the wide set of barriers that are hindering the pace of social innovation. For sure, these barriers include a lack of performance focus and outcome measurement, but they also include political constraints that prevent government from investing in prevention, the inability of nonprofits to access the capital needed to expand operations, and insufficient capacity to develop rapid and rigorous evidence about what works.
Under the most common SIB model, the government contracts with a private-sector intermediary to obtain social services. The government pays the intermediary entirely or almost entirely based upon achievement of performance targets. Performance is rigorously measured by comparing the outcomes of individuals referred to the service provider relative to the outcomes of a comparison or control group. If the intermediary fails to achieve the minimum performance target, the government does not pay. Payments typically rise for performance that exceeds the minimum target, up to an agreed-upon maximum payment level. Payments are funded at least partially by the cost savings to government achieved through the improvement in outcomes.
The intermediary obtains operating funds by raising capital from independent commercial or philanthropic investors who provide up-front capital in exchange for a share of the government payments that become available if the performance targets are met. The intermediary uses these operating funds to contract with service providers to deliver the interventions necessary to meet the performance targets.
In 2010, Social Finance UK launched the first Social Impact Bond in the United Kingdom — targeting reducing reoffending. By linking a social target to financial success, the Peterborough pilot generated worldwide interest in whether innovative finance can make an impact on the world’s most difficult challenges.
Following the announcement of the world’s first SIB in the United Kingdom in 2010, countries as varied as the United States of America, Australia, Canada, Columbia, India, Ireland, and Israel have started exploring SIBs. Proposed projects target social problems ranging from recidivism to homelessness, unemployment, youth outcomes, and early childhood education. 60 SIBs have launched in 15 countries, raising more than $200m in investment to address social challenges, as of June 2016. 4 projects have fully repaid investor capital.
Why do Social Impact Bonds resonate so widely? Social Finance thinks that it is the values of partnership and collaboration, flexibility and responsiveness, and a focus on data, outcomes, and measurement which all stand at the heart of the model. Investors, whose interests are aligned with other partners to achieve outcomes, play a key role. It is exciting to see an idea move from conception, to exploration, to implementation so quickly and so broadly. Most importantly, it’s making positive impacts.