Intro to Social Impact Bonds

This blog is part 1 of a 3 part series on Pay For Success financing, also referred to as Social Impact Bonds

In 2010, a new municipal financing tool called a Social Impact Bond (SIB) was developed in Peterborough, England. Since then, four SIBs have been launched in the United States, and another dozen or so are in the pipeline. Because this innovative financing method is poised to both improve public services and help policymakers use resources more efficiently amidst budget cuts, it’s turning a lot of heads. Here are the basics.

What’s in a name?

A SIB is NOT a municipal bond.  It is actually a type of pay for success financing contract, which is why policy makers are increasingly using the name ‘Pay For Success’ (PFS) financing instead of SIB.   PFS financing works by raising money in the capital markets and loaning that money to a social service program with a proven track record of providing social benefits AND municipal savings.  PFS financing is used to provide working capital to programs that take several years (or more) to provide municipal savings, so the PFS money acts as a bridge loan to fund the social service program until the savings (and social benefits) can be realized.  As the savings are realized, they are used to pay back the investors with an agreed-upon rate of return that is linked to the size of the savings.  If the target social benefits and savings are not realized, then the investors can lose their returns, and possibly some or all of their investment. The terms ‘PFS financing’ and ‘Social Impact Bond’ both refer to the agreement that is negotiated between the investors, the social service program that is receiving the money, the government entity that is going to enjoy the savings and pay back the investors, and the financial intermediary that is structuring the deal and managing the flow of money. To avoid confusing Social Impact Bonds with other forms of municipal bonds, the term ‘Pay For Success’ financing is gaining traction among policy makers and investors.

From a public policy perspective, the three most important features of PFS financing are:

(1) PFS financing does not use taxpayer dollars

(2) PFS financing can only be used to finance a successful, evidence-based service program

(3) PFS financing requires a whole new level of close collaboration and contractual agreement between government, private investors, and social service providers.

Pros and Cons?

Perhaps the biggest potential benefit of PFS financing is that it brings large, previously untapped sources of funding into the public sphere, and directs that potential funding towards programs that successfully address very difficult and ongoing social problems.   Even a tiny fraction of the investment capital that flows through US investment banks would make a significant change in the health and welfare of our communities if it was used to fund successful social service programs in the areas of prisoner re-entry and job training, preventative health services, and early childhood educational interventions.  This is the vision that keeps PFS financing advocates (like me) motivated to keep working.

The other big potential benefit of PFS financing is that it requires a level of stakeholder collaboration and evidence-based program management that is, sadly, not yet the norm in the world of social service programming.  This is not a cheap shot at social service providers – their work can be complex and unpredictable, and their benefits and impacts can be impossibly difficult to measure and track.  Nevertheless, there are existing models of well-developed social service programs that measure and track their impacts, and use this information to steadily refine and improve their services, and every effort needs to be made to spread the ‘best practices’ from these providers as widely as possible.  This is the other part of the PFS financing vision that keeps advocates like me motivated.

Of course, PFS financing faces some significant challenges.  The biggest one at the moment is that it is so new that there is no successfully completed PFS program that can serve as a clear proof of concept.  Since the average PFS program runs six or more years, it will take at least a few more years before completed programs can be evaluated.  Another challenge is the complexity of the contracts that are needed to satisfy all the stakeholders involved.  Investors, government agencies, social service providers, and intermediaries all need to have their financial, legal and operational responsibilities and liabilities laid out in excruciating detail, especially since there is no history to guide contract terminology.  This problem will hopefully fade over time, as successfully completed PFS program contracts become the models for future activity.  Finally, there is the less tangible but no less important challenge of making sure that the distortions and ‘unintended consequences’ of this new financing mechanism are anticipated and kept to a minimum – the old problem of ‘teaching to the test.’    How will investors’ needs for returns impact program goals and objectives, relative to the requirements imposed by other sources of funding?  How will the need to measure and track benefits and outcomes impact service providers and beneficiaries?  These are the types of questions that are on the table right now.

Early lessons from Peterborough, England

A quick look at the SIB in Peterborough can serve as an illustration of how PFS financing works in real life.  The overall mission of the Peterborough SIB is to fund training programs and support services that improve re-entry and reduce recidivism for ex-offenders coming out of the Peterborough prison. For this SIB, a financial intermediary named Social Finance UK structured the deal and is monitoring the outcomes. The investors were mostly charitable trusts and foundations with an interest in improving services for ex-offenders. They committed about US $10 million to be used over 6 years to fund a partnership of service providers working with the ex-offenders and their families. This partnership hopes to achieve a target reduction in the recidivism rate of 7.5% (versus a control group). If this target is achieved, the Ministry of Justice will pay back the investors with a return of about 5%. If this target is exceeded, the investors will receive increasing rates of return, capped at a maximum of 13% per year over 8 years. The money to pay back the investors will come from savings generated by having fewer prisoners in Peterborough prison.

In March 2013, the Ministry of Justice released early “unofficial” results citing a reduction of 12% in the recidivism rate of ex-offenders going through the SIB pilot program. Additional good news came from interviews with staff members close to the project, who suggested that the close monitoring of impacts enabled program staff to quickly identify and correct problems in program execution.  While it is too early to call Peterborough a “proof of concept” for PFS financing, these early indicators of success are encouraging potential US adopters to move forward with PFS pilots here.

For additional information on Pay For Success financing and Social Impact Bonds, please contact Diane Lynch at the Social Enterprise Greenhouse, dlynch@segreenhouse.org.

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Diane Lynch
Chair

Diane Lynch has been an SVPRI partner since June 2009. Diane was a management consultant with Booz, Allen, working with domestic and international manufacturers and retailers in the food industry. From 2009-2011, she served as Director of Social Enterprises at Amos House, working with their catering, restaurant, baking mix, and home improvement businesses. She holds a BA from Brandeis University and an MBA from Boston University. Her public service experience includes work in education, municipal planning and urban environmental planning. Diane, her husband Jim and their three children reside in East Greenwich, Rhode Island.

 

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