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For years, scholars and practitioners have grappled with the problem that governments, for a number of political and fiscal reasons, do not always make cost-effective investments in prevention. Recently, some have looked to enlist private sources of capital to underwrite preventative programs in return for payment out of the future cost savings. This is the basic idea behind the social impact bond (SIB).
The first SIB was piloted in 2010 in Peterborough, England, where philanthropies have underwritten services to reduce high rates of recidivism. In 2012 in New York City, the Bloomberg administration teamed up with Goldman Sachs to pilot the first American SIB, and today governments across the globe are exploring SIB potential across a range of human service areas from homelessness to foster care.
SIBs are new public financing instruments based on the not-so-new notion that prevention pays; vaccinations are more cost-effective than treating full-blown disease, supportive housing is cheaper than shelters and emergency rooms for the homeless, crime prevention costs less than incarceration.
Yet governments often fail to make adequate investments in preventative programs. Sometimes these kinds of interventions are politically unpopular. Benefits from prevention can be difficult to observe (social ills that did not occur) or will accrue years after elected officials leave office. Typically investments are not made because budgets are tight.
For years, scholars and practitioners have grappled with ways to address the prevention conundrum. Wouldn’t it be possible, some have asked, to harness private capital – commercial investors or philanthropies – to underwrite prevention programs? If they worked, investors could be repaid out of the social savings.
This concept was first tested in in 2010 in Peterborough, England, a town with a large prison and very high rates of recidivism; each year, nearly 60 percent of the prisoners released from Peterborough prison re-offend and are reincarcerated within 12 months. The crimes are costly to the community and the reincarceration exacts another £30,000-£40,000 per prisoner per year.
This SIB pilot will demonstrate whether privately funded interventions can help reduce recidivism. In this case, the SIB contract was arranged between Social Finance, a nonprofit intermediary, the British Ministry of Justice, philanthropic underwriters, and the nonprofit service providers who will give intensive support to 3,000 prisoners following their release into their communities.
At the end of the six-year pilot, the philanthropic investors will be repaid if the interventions have demonstrably worked. The better the improvements, the better the returns: if recidivism rates have fallen by 7.5 percent or more, the British government will pay investors out of the long-term cost savings, up to 13 percent. Below the 7.5 percent threshold, the investors get nothing.
A number of features of Peterborough are instructive for further SIB development and for the larger fields of social finance and “impact investing” which seek to attract private capital – commercial and philanthropic – to bear on public purpose projects.
Pay-for-Success
Because investors are paid only for successful outcomes (unlike most philanthropic grants or taxpayer-funded initiatives), risk is shifted onto the investor. In this sense, bond is a misnomer; SIBs function more like equity investments, with returns graduated according to levels of impact. Pay-for-success goes by a number of names. In the U.S. it is also referred to as pay-for-performance. In the U.K. the more common term is payment-by-results.
Measurement and Evaluation
The SIB model hinges on rigorous measurement and evaluation. The evidence base will determine if the intervention has worked and whether and how much investors are repaid. In Peterborough, the re-offense rate will be closely evaluated in a randomized control trial, with a control group of prisoners who do not receive intervention services. This kind of focus on measurement and evaluation is a hallmark of the larger social finance and impact investing fields.
Leverage
SIBs are designed to harness untapped sources of capital. In Peterborough, this meant a consortium of foundations willing to test the concept. Another hoped-for outcome from Peterborough is proof of concept and a track record of positive financial returns for SIBs that could someday attract mainstream investors.
The Peterborough pilot has garnered the interest of cash-strapped governments around the world interested in applying the SIB model to a broad range of social services. In the U.S., enthusiasm for SIBS is part of a larger push for evidenced based policy making at the federal level, including $500 million in the President’s 2014 budget to support local for pay-for-success initiatives. States that have rolled out SIBs include Massachusetts (homelessness, juvenile justice) and Illinois, with many others taking shape. I
In August 2012, the Bloomberg administration announced that New York would be the first American city to test the model. This SIB is much like its Peterborough predecessor, aimed at reducing recidivism at the Rikers Island prison. The NYC SIB has garnered a great deal of attention, in part because its lead investor is Goldman Sachs. In addition, Mayor Bloomberg’s personal foundation, Bloomberg Philanthropies, is providing a loan guarantee, mitigating risk investment loss risk for Goldman. This guarantee was critical to incent Goldman’s participation and offers an important model for unlocking commercial capital for these kinds of deals going forward.
SIB innovations continue, both local and global. In March 2013, the City of Sacramento announced that it was testing the potential for the first “health impact bond.” 20 percent of children in Fresno have asthma, typically treated in the emergency room, which costs the city $35 million a year. This study examines whether education programs in asthma home-care management can improve patient health and lower costs of care.
In June, Goldman Sachs announced its second SIB investment, this one with the United Way of Salt Lake City and J.B. Pritzker, a private investor. The $7 million investment ($4.6 million from Goldman and $2.4 million in subordinated debt from Pritzker, more risk mitigation) will support an early childhood education program for at-risk children. Success will be repaid if there is a reduction in the need for expensive special services for these children, financed by the state, as they enter elementary school.
Outside of the U.S. and the U.K (where there are now 14 SIBs), interest is mounting from Canada (exploring the potential to address immigrant and youth employment) to Australia (two Social Benefits Bonds focused on foster care) to the Middle East, where Social Finance Israel is creating a SIBs focused on employment in the country’s ultra-Orthodox and Arab Israeli communities. There is also growing appetite for developing country applications of the model (a development impact bond, or DIB) to finance economic development in places like India and Latin America.
Despite the enthusiasm for SIBs, valid concern remains about hype and the many challenges inherent to their broader adoption. For starters, SIBs require highly capable parties to deliver on each element of the contract. The complexity of the deals also make them expensive (in some cases, more costly than if the government paid directly for the service) and hard to scale.
Finally, it is worth remembering that many social challenges simply do not lend themselves to the model; often desired outcomes cannot be measured within the time horizon or bounds of quantitative precision necessary for SIB implementation. And even when they can, the changes in incentives that come with privatized funding – positive and negative – need to be carefully monitored. All this suggests that while SIBs may not be a panacea for all the world’s problems, they have the potential to be an important tool in the poverty-fighting arsenal.
USEFUL SIB AND PAY-FOR-SUCCESS RESOURCES
Big Society Capital (http://www.bigsocietycapital.com/)
Global Impact Investing Policy Project (http://hausercenter.org/iri/about/global-impact-investing-policy-project)
Harvard Kennedy School Social Impact Bond Technical Assistance Lab (http://hks-siblab.org/)
Invest in Outcomes (http://investinoutcomes.org/)
Initiative for Responsible Investing at Harvard University (http://hausercenter.org/iri/)
Nonprofit Finance Fund’s Pay-for-success Hub (Payforsuccess.org)
Rockefeller Foundation, Harnessing the Power of Impact Investing Initiative
(http://www.rockefellerfoundation.org/our-work/current-work/harnessing-power-impact-investing)
Social Finance USA (http://www.socialfinanceus.org/)
Social Finance UK (http://www.socialfinance.org.uk/)
Third Sector Capital Partners (www.thirdsectorcap.org)
UK Cabinet Office: Social Impact Bonds (https://www.gov.uk/social-impact-bonds)
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