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Will the New Social Impact Bond Right Society’s Wrongs?

Lonnie Shekhtman
| Friday December 14th, 2012 | 1 Comment

Social Impact Bond

There’s a new kid on the impact-investing block: young and full of promise, yet easily susceptible to bureaucracy. I’m referring to a “Social Impact Bond” (SIB), a new financial instrument that straddles the public, private, and non-profit worlds, with a market-based approach to righting society’s wrongs.

For now, the SIB is geared towards programs that serve vulnerable populations like the chronically homeless, juvenile and adult offenders, and low-income seniors, financing only effective nonprofit programs that can’t scale through philanthropy alone.

This approach is getting a lot of attention, or maybe hype, because it targets core inefficiencies of social programs: siloed government agencies with no incentive to collaborate, ineffective and non-accountable nonprofits, wasteful use of taxpayer dollars, and expensive programs that are driven by crisis instead of prevention.

Most importantly to some, SIBs transfer the burden of risk from taxpayers to private investors: governments repay investors, who provide upfront capital, only if a program is successful. Success — like a 7 percent reduction in recidivism in a particular prison, for instance — is based on metrics agreed upon by all the parties involved, including government, nonprofits, an intermediary, investors and an evaluator.

Although each one is unique, here’s how an SIB could work: A local government releases a request for financing to expand support for chronically homeless adults in the state. An intermediary organization that’s equipped to execute SIBs — like the nonprofit Social Finance — identifies and recruits one or multiple nonprofits with proven track records, and raises capital from private investors, like Goldman Sachs.

Throughout the duration of the SIB (five to 10 years) the intermediary coordinates all the parties, monitors the investment, provides operating counsel, and reports progress to the investors.

Ultimately, an independent evaluator (another nonprofit) determines if the outcome is achieved. If so, the government repays investors with a rate of return of 2.5 to 13 percent, depending on the outcome. If the program isn’t successful, the government (a.k.a. tax payers) pays nothing and investors lose their money.

It is too early to tell whether SIBs are viable. Perhaps as a result of what’s happened in the microfinance industry — hype, boom, bust — folks currently working with SIBs warn, “It is not a panacea. We still have a lot of work to do,” every chance they get.

After all, the SIB was introduced in the U.K. only two years ago to finance a program to reduce recidivism among 3,000 prisoners at a Peterborough prison. Results from that program won’t be available for a couple of years, given that SIB-funded programs last for at least five.

Proponents say the SIB is promising because philanthropy and government just can’t do it alone, that it offers an opportunity for great nonprofits to access capital markets, and that investors impose much-needed market discipline on social programs. They also say that SIBs provide room for innovation that is otherwise too risky and expensive for governments to attempt, and raise program effectiveness by increasing coordination among nonprofits working on similar issues.

But there are major drawbacks, some of which could be mitigated with time and practice. SIBs could prove too burdensome on nonprofits and too risky for investors (“bond” is actually a misnomer, since, unlike traditional bonds, SIBs do not guarantee a return). They’re also incredibly complicated, considering the number of cross-sector parties involved and the long duration they must stay fully committed to the SIB.

There are also political risks, like government paying for programs after the fact. Might a newly elected politician, paying off a predecessor’s debts, have every incentive to say a social program didn’t work?

And what about the political uncertainty of the annual appropriations process? It allows government to set money aside every year for specific programs, which can only guarantee funding for one year at a time. This might not fly with investors who are committing to at least five years.

Despite the risks, the federal government and the states of Connecticut, Massachusetts and New York are already dabbling in SIBs. It’ll be a while before results start rolling in, but whatever happens, innovation in social impact is a good thing, so let’s hope for the best.

For more impact news and ideas, follow me on Twitter: @kuurlyq.

[Image courtesy of ThirdSector]


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  • exeng

    So what happens a few months into one of these programs when the investors claim that the government misrepresented the facts and they cannot possibly make a profit so they are withdrawing the service and filing suit against the government? And the what happens is of enormous concern to the people served by the SIB or are they just collateral-damage-in-waiting?