What’s the Real Impact of Social Impact Bonds?

In the past ten years, social entrepreneurship has grown from a theoretical model to an outright trend. We’re seeing more and more techniques from the business world applied to resolving cultural, social, and environmental issues. This hybrid model is, in concept, a win-win – creating a profitable business that changes the world for the better. The emergence of high-profile Social Impact Bonds in recent years is part of this trend. While they’ve created a lot of buzz, a lot of us in the nonprofit world have wondered how – and how well – do Social Impact Bonds work?

What Are Social Impact Bonds?

Historically, city and state governments have issued municipal bonds to finance construction on public infrastructure like roads, schools and bridges. In return, the government offers a generally low but relatively secure rate of return to the investor.

Social Impact Bonds (SIBs) take this model and apply it to social programs. They are inspired by the idea that effective social programs are investments which save the government money in the long run. In the face of increasing budget cuts, private investor funds present a possible solution to dwindling government support of nonprofits.

For example, a local government agency (or sometimes a private investor fund) may identify an area of need – for example, unemployment. Working together, the city or state government and investor fund might issue a bond for $5 million to fund a workforce program for 500 unemployed people. The metrics to determine success would be put together by the government, the investor fund, and the nonprofit contracted to do the work.  That bond could then raise the $5 million from the private investors, and pay the nonprofit to run the program that helps to find those 500 people jobs. If the first year of the program was successful, and those 500 people found jobs, the program would save the government unemployment costs - assuming they would have paid out $20,000 per year to 500 people it would be $10 million - and so would pay out the bond to the investors, including interest.

Investors need a measurable return on investment, so the range of what they are able to support through SIB’s is limited. So far, they have mainly been used in education, reducing prisoner recidivism, and other measurable programming like workforce inclusion.

The History of Social Impact Bonds

In concept, it seems promising. But how does it perform in the real world?

The first SIB was issued in the United Kingdom in 2010 and addressed prisoner recidivism. Funded through the Lottery Fund, an intervention group called One Service provided post-release support to adult male prisoners who had recently ended their sentences. The goal of the bond was to measure the reduction in re-offenses and to pay out investors if the reduction was greater than the general population, as a reduction would save taxpayer money spent on prisons, court costs, and other expenses associated with recidivism.

Originally scheduled to impact 3,000 prisoners and to run through 2017, the program ended early in 2015. While the program was successful, the government adopted many of One Service’s post-release support protocols the throughout entire prison system.   This made it very difficult to gauge how the SIB group was doing against the general population.  The investors were paid back their funds, but this highlights one of the biggest challenges of these bonds – the difficulty of measuring success.

The first Social Impact Bond in the United States to pay out investors was issued in Salt Lake City. Launched in 2013, this SIB provided 595 low income children with pre-K programming to reduce their later need for special education, which is more expensive than mainstream classes. At the outset, 110 of these children were identified as being at-risk of needing special education. Of those 110 children, only one utilized special education services in by the time they reached kindergarten. It was estimated that this saved over $281,000 a year in special education costs. Investors received a payment equal to 95 percent of these first year savings and the program has been expanded to include even more children in the future.

While this seems like a clear success, there has been some concern that the results are somewhat misleading. Many children identified as at-risk did not have learning disabilities, but rather came from immigrant families where English was not their first language. These children most likely would not have needed special education services once they reached kindergarten anyway, skewing the results. The program may not have actually saved taxpayers as much as was claimed.

In 2014, Chicago issued a bond almost identical to the one in Salt Lake City. It is one of the largest Social Impact Bonds in history, and raised almost $17 million in SIB financing to provide pre-K programs to 2,620 children over the next four years. Investors will be reimbursed based on enrolled students showing greater than average academic success.  Similar to Salt Lake City, Chicago investors earned the maximum initial payout at the initial program benchmark. While the Chicago SIB uses a control group to ensure that participants are succeeding at a higher level than average, it also excludes many children (such as those impacted by autism) from the program.

Potential Drawbacks

Looking closely at the Social Impact Bond model, we can see some major areas of concern that need to be resolved:

• In order for there to be a payout, SIBs require measurable results. But that raises the question - who determines the metrics for the payout?  As we saw in Salt Lake City, the parameters for payout can be set in a way that potentially overstates the benefit of the program.

• The SIB model also may result in many issues being deemed “unprofitable” if they are difficult to measure. Work that isn’t quantifiable, or which takes longer than 5 years to see measurable results, could become increasingly underfunded.

• There is a real concern that nonprofits will adjust their work to fit the Social Impact Bond. This is especially troubling given the role that the investment firm plays in setting the initial metrics and measures of success.  The investment firm also typically serves on the board or committee that oversees the implementation and administration of the SIB.

• In addition, the development of a measurable SIB requires a great deal of overhead. There are concerns that this might not be the best use of government funding – funding that could be applied directly to the program being financed.

• Finally, since investors are understandably wary about programs failing, these bonds are increasingly being structured so that the nonprofit performing the work has some accountability for the funds. As more of these bonds mature, lawsuits or other methods of demanding reimbursement from the nonprofit performing the work could become more common.

Even with these concerns, it’s likely that cash-strapped governments and nonprofits will continue to seek investors. Investors will likely continue to find the idea of supporting societal change while seeing a return on investment appealing.  Long-term success will depend on the ability to accurately determine if Social Impact Bonds provide a real rate of return – both financially and in actual social impact.

What do you think?  Are Social Impact Bonds here to stay? Join the discussion in the comments below or on Facebook, Twitter, or LinkedIn.