What Exactly Is a Social Impact Bond?
Around the world, inventive financing methods are being used to tackle social issues. Programs and organizations typically funded by grants are regularly at the mercy of governments who have trouble thinking past the next election cycle.
As a consequence, when spending cuts need to be made governments typically look for the quickest fix – cutting social sets.
Think about it. In your city, you may have a $100 million budget allocated chiefly to:
– Schools: $60 million
– Emergency sets: $15 million
– Public works: $15 million
– Human sets: $10 million
Tax receipts are expected to decline by 10% next year. What do you do?
The majority of the first several categories (schools, emergency, and public works) are used on an as-needed basis. They are there to serve public needs in the moment.
Human sets, however, typically comprise both rehabilitative (immediate things like food edges or homeless shelters) and preventative (down the road things like job training for unemployed or after-school activities for at-risk youths) benefits.
Now back to our problem of decreasing tax receipts. Aside from general reductions, you’re not typically going to close a school, or cut back on your police force – they’re much too important to a town’s immediate value (not to mention the unions involved… ).
As a consequence, you would turn to social sets as an area to cut. And all things being equal, the preventative sets are viewed as a relative “luxury” compared to rehabilitative sets… again, because they provide benefits down the road, as opposed to right now.
So you’d cut those preventative sets. After-school programs, job training, and collaborative work spaces would get the ax before food edges, homeless shelters, and unemployment benefits. They’re simply easier things to cut.
Now imagine this scenario playing out in thousands of cities and dozens of states across the U.S. each of the past 8 or 9 years. Naturally, many health and human service organizations struggle due to without of funding. So despite the fact they do quality work, they are unable to provide the complete possible value of their work.
Bottom line: Results are determined not by the quality of the organizations doing the work-but by the amount of funding governments are able to grant them.
Governments fund short-term sets over long-term ones. They favor less complexity to more. And they reward risk aversion at the expense of seeking out truly inventive and high-quality programs.
The root of the problem
Social sets are funded by tax dollars (typically by government grants) and donations. They are often provided by nonprofit organizations (if not governments directly). Why is that?
They offer value in a down-the-road or not closest profitable manner.
Take a business that sells computers. It makes a product. People need the product. They pay closest for that product. Value is produced immediately upon receipt of the computer. And because that value is produced immediately, it is easily quantified and paid for by a customer, making the value realized by both seller and buyer at the same time.
Now take a mental health organization. It provides a service. People need that service. They often can’t pay for that service, already though society deems it necessary for the overall good (by increased tax revenues, lower prison costs, etc.). Value is provided immediately to a patient but not realized immediately by society. It happens “down the road.”
Naturally, investors flock toward ideas that provide easily quantifiable returns. There are demonstrable data that prove the returns they can reasonably expect, corrected for risk of course, already though some investments are extremely long-term in character (think of real estate or long-term bonds).
The further an investment is from concrete, quantifiable returns, the further it is from attracting funds. Something like mental health service is extremely hard to quantify. We know there are tangible benefits to providing this service. But who exactly benefits financially from it.
This creates the great divide in funding. There needs to be a way to bridge the gap from social returns to commercial returns on investment.
How do we solve this?
Traditional methods of funding rule to sets delivered in isolation from each other, with inadequate focus on preventative sets known to produce better outcomes.
Coupled with inadequate resources and rising need, many cities and states are seeing rising poverty, growing need for job training, and a large number of other negative social outcomes, many of which could be prevented with adequate investment in prior stages of these problems’ development.
Introducing: pay for success.
Also known as pay for performance, this describes service payment models that offer financial reward to providers who unprotected to or go beyond stated quality, cost, and other benchmarks. In other words, you only get paid if you do good work.
These models offer a blended return, accomplishing both financial and social payback.
Return on taxpayer investment
Governments use billions of taxpayer dollars each year on crisis-pushed sets. These programs help a great number of people, but fail to make much headway in solving social problems that have become too complicate for one-dimensional, prescriptive solutions. Although they recognize the economic and social benefits of prevention, government agencies generally cannot provide early intervention sets as their funds are already committed to high-cost remediation programs.
already if they fund prevention, governments risk having to pay for both prevention and remediation if their chosen prevention programs fail to enhance participants’ outcomes. The short-term imperatives of the election cycle strengthen this inclination to shy away from potentially risky, longer-term preventative investments.
Economic recession and shrinking budgets have forced governments to cut many programs providing prevention sets, and as a consequence, nonprofit providers and their clients are struggling to survive.
The social impact bond
The social impact bond (SIB) is a financial device that integrates the needs of governments, service providers, and charitable investors under one concept: pay for success.
The bond is an outcomes-based contract in which government officials commit to paying private service providers for meaningful improvement in social outcomes (such as a reduction in offending rates, or in the number of people being admitted to hospital) for a defined population.
Funds are raised by charitable investors looking to make a difference, and their return on investment is defined by the degree of success in the program invested in. If a program is successful, the government repays the investment plus a variable rate of return based on performance. If the program fails, no payment is earned.
The government repays investors only if the interventions enhance social outcomes, such as reducing homelessness or the number of repeat offenders in the criminal justice system. If improved outcomes are not achieved, the government is not required to repay the investors, thereby transferring the risk of funding prevention sets to the private sector and ensuring accountability for taxpayer money.
By leveraging SIBs, governments can move the financial risk of prevention programs to private investors based on the expectation of future recoverable savings. They also provide the motive for multiple government agencies to work together, capturing savings across agencies to fund investor repayment.
– shared belief that prevention is less expensive AND more effective than remediation
– Prevention also takes longer to realize tangible benefits and is naturally harder to measure
– SIBs move the risk of funding preventative programs from the government to private investors – government (and taxpayer) payment is contingent on success
See the complete list of all active social impact bonds going on today.
1. An intermediary issues the SIB and raises capital from private investors.
2. The intermediary transfers the SIB proceeds to nonprofit evidence-based prevention programs. Throughout the life of the instrument, the intermediary would coordinate all SIB parties, provide operating oversight, direct cash flows, and monitor the investment.
3. By providing effective prevention programs, the nonprofits enhance social outcomes and reduce need for more expensive safety-net sets.
4. An independent evaluator determines whether the target outcomes have been achieved according to the terms of the government contract. If they have, the government pays the intermediary a percentage of its savings and retains the rest. If outcomes have not been achieved, the government owes nothing.
5. If the outcomes have been achieved, investors would be repaid their principal and a rate of return. Returns may be structured on a sliding extent: the better the outcomes, the higher the return (up to an agreed cap).
How it works
Future State wants to invest in programs to reduce prison recidivism – the number of people who re-offend and end up back in prison once released.
The obvious benefits include:
– Lower prison costs. clearly fewer prisoners method lower expenses spent on prison facilities, staff, sets, etc.
– Increased income tax revenue. Fewer prisoners method more people obtainable in the workforce. Ultimately this assistance is realized only if the majority of those released from prison do in fact re-go into the workforce, instead of staying unemployed.
While not necessarily easy to quantify, you can ballpark it. Say each prisoner has a variable unit cost of $25,000 per year when behind bars. Say also that Future State loses out on $1,000 a year in income tax with each prisoner not working. These figures alone equal a net $26,000 per year cost of a prisoner.
The state releases 2,000 of its total 10,000 inmates each year. Those released have a 50% chance of re-offending and ending up back in prison within 3 years. Reducing one year’s released inmates’ recidivism rate to 40% would reduce the number of people returning to prison by 200 by year 3.
This carries with it an additional 200 people eligible for work in the state. Assume in this case that everyone who remains out of prison becomes employed.
JobTraining Corp has a program that promises to reduce recidivism by the moderate 10% described above. This includes job training and re-integration sets for prisoners. The annual cost to run such a program at the extent required to unprotected to this 10% reduction is $3,000,000.
Every 10% reduction ends up benefiting the state $5,200,000 over three years.That equals a 20.1% annual return on a $3,000,000 investment.
What this method
In this example, the net assistance to society, or in this case the government, is 20.1% per year.
These benefits are tangible from a financial perspective. They just take multiple years to materialize. That’s why these programs are typically funded by governments in the first place.
Take an outside investor now. Say they want to invest $3,000,000 into this prison recidivism program. For a social investor like this one, they may be enticed by a 5% return on investment for their funds.
By year 3, with Future State realizing $5.2 million in total benefits, it can provide to pay out an investor the 5% annual return plus initial investment for their efforts. This equals $3.5 million.
This leaves $1.7 million net profit (in the form of higher tax revenues and lower prison costs) to the government.
The beauty of this arrangement
Circling back to the earlier concept, pay-for-success, this kind of deal only gets paid out by the government if the program succeeds. No matter what happens, the investor fronts the money to a service provider (in this case, JobTraining Corp). The service provider has no other obligation in the financial workings of this deal-merely to provide a service.
The government then reimburses the investor if, and only if, success is achieved.
Because in this case success was defined by hard outcomes with real financial rewards attached to them, it is easy to see that the government will realize the gains in its own bottom line.
The government can subtract from these gains and pay out the service provider a cut of the “profit.”
If however, the outcome isn’t achieved (in this case, recidivism doesn’t drop 10%), then the government is off the hook. Nothing is returned to the investor. The funds keep with the service provider.
The service is nevertheless provided, which method positive outcomes could nevertheless be achieved, but probably at a lower rate of return. In this case, the government nevertheless earns some financial assistance without being required to reimburse the investor.
The investor is on the hook for any risk associated with delivering on these outcomes.
In other words… a government can fund a public service with no up-front capital.Additionally, it needs only to truly pay for such a service if the financial reward it sees is tangibly greater than the cost. A typical win/win.
This example is a very simplified form of a social impact bond. It assumes a straight yes/no basis for successful outcome triggering repayment. In reality, a social impact bond will have a extent of returns an investor can unprotected to based on a sliding extent of outcomes.
As more of these deals pop up across the United States, it is important to determine how effective they are at not only providing a social service, but also providing a return on investment.
The more success that is achieved on the ROI side, the more investors will ultimately flock to these types investments. Governments, if planning properly, can fund outcomes completely risk free. If they have good data to sustain the financial impact of social outcomes, they can prove to investors a financial return on their end.
Until data exist in the quantity and quality that sustain these outcomes though, investors will bear a greater risk in funding these types of deals. In these early stages of this industry, it is more likely to be seen as a donation than an investment. But once deals start proving financially viable for all sides, the social impact bond industry has the chance to really take off and make a difference across the world.