Are Social Impact Bonds Moving into the Mainstream?

Social Impact bonds (SIBs) are financing mechanisms in which government agencies pay for concrete results in social programs. Rather than financing preventive social services upfront, the government only pays for results at the end of a contract. Known as Pay for Success, SIBs are public-private partnerships that limit financial risk for the government, also a relatively new innovation that could be the future of funding global social change. Social impact “bonds” are not bonds in the traditional financial sense of the word. Bonds have a guaranteed rate of return, while an SIB’s rate of return may vary depending on performance. SIBs are therefore higher risk, because investors can lose all of their capital if the SIB fails to perform. In addition, SIBs cannot be bought and sold like bonds. Instead of thinking of SIBs as financial bonds, it is better to think of them as a bond or a relationship between the government and an outside organization. The outside organization is responsible for a social intervention in exchange for payment. However, the organization only receives the payment if it achieves the target outcome.

SIBs are often confused with Development Impact Bonds. Development Impact Bonds have a similar structure, but they are applied to the development and aid sector. A donor agency, instead of the government, plays the role of the client.

The SIB model was first piloted in the United Kingdom. The Peterborough SIB was launched in September 2010 and generated global excitement about the SIB model. The aim of the £5m (7.8m USD) project was to reduce the reconviction rates of short-sentence male prisoners leaving a prison in Peterborough, England. The first results of the project, released in August, showed a promising 8.4% reduction in reconviction when compared to a control group. Even so, the target rate was a 10% reduction. Despite its limited success, the government cancelled the third cohort of the Peterborough SIB in April in favor of transforming the program into a new national program called Transforming Rehabilitation.

Leaving the Peterborough disappointment behind, SIBs are growing in popularity in the United Kingdom and around the world. In May, the UK government launched a new £30m (46.9m USD) package to back social impact bonds to help disadvantaged young people. Currently, there are sixteen social impact bonds in the UK; four in the U.S.; two in Australia; one in Canada, the Netherlands, Belgium, Germany and more than 100 proposals worldwide.

SIBs have been utilized on a limited scale in the United States. The model used by the Peterborough Prison inspired the United States’ first SIB, the NYC ABLE Project for Incarcerated Youth, which aims to reduce re-incarceration rates among adolescents. The approach has the potential to become mainstream in the United States. In June Representatives Todd Young (R-IN) and John Delaney (D-MD) introduced the Social Impact Bond Act, which would adapt the SIB model for use at the federal level. The act appealed to politicians on both sides of the aisle because their constituents’ tax money will not be used unless there are tangible results to justify it.

SIBs are set to spread to the rest of the Americas as well. The Inter-American Development Bank announced plans in March to test out the SIB approach with a $5.3 million program. The bank provides development financing for Latin American and the Caribbean. The Multilateral Investment Fund, a part of the bank, will be the first development finance institution to support SIBs. The project is in the process of focusing on a set of select issues and countries.

It appears that SIBs are moving into the mainstream, but there remain certain limitations and risks to the financial instrument. While investors do bear the financial risk, the government also bears risk by yielding control of the social program in question. SIBs are also sensitive to policy shifts, which cause uncertainty for current and potential investors. Another difficulty is appropriately defining target outcomes and pricing them, and the negotiation process contributes to the costs of an SIB. Those costs, in combination with performance regulation costs, typically cause SIBs to be more expensive than a direct contract between the government and an outside organization. The benefits must therefore outweigh the added costs for an SIB to be worthwhile for all players. With that said, it is important to keep in mind that risks are inherent in most forms of investment. Despite its risks, SIBs have indeed shown great potential to undertake seemingly intractable global issues, and should not be easily dismissed.