What is a Social Impact Bond?
A social impact bond (SIB) is a contract between a private investor and a public authority, where the investor pays for better social outcomes in specific areas and the public authority passes on the part of the savings achieved to the investor as a return on investment. Savings are calculated in comparison to the conventional costs of achieving a unit of the desired social outcome.
There is always a third party involved in the contract, which is the institution that is actually rendering the social services which are intended to achieve the social outcome. This could be e.g. a charitable organization that employs a team of coaches who help criminal offenders to successfully re-establish themselves in society in order to reduce their criminal relapse rate (see below re the Peterborough Prison SIB). This third party is paid upfront by the private investor whereas the public authority is paying the investor based on the achieved outcomes at the end of the SIB’s term.
A SIB is not a traditional bond per se, especially since it does not yield a fixed income. Instead, repayment of the principal investment and additional return on investment (ROI) are depending on the achievement of the desired social outcomes. If the objectives are not achieved at all, investors receive neither a return on investment nor repayment of their principal investment. If the objectives are achieved, investors are paid back their principal investment and the amount of additional ROI is determined by the actual costs per unit for achieving the objectives under the SIB in comparison to the conventional costs.
Who benefits from an SIB?
SIBs benefit a range of stakeholders:
- Public Authority (“outcome payer”): Remove the financial risk that a public authority pays for services that prove to be ineffective at addressing social needs and improving outcomes.
- Private Investor: Give back to the community and make a purposeful investment while at the same time having the financial perspective to earn a market-rate return on investment. Note: If the private investor seeks no financial return at all, it can also adopt a purely philanthropic role and take the role of the outcome payer.
- Service Provider: Provide them with upfront funding for the delivery of their services, so they do not carry the risk of not being paid.
- Society: The ultimate beneficiary of the social outcomes is society as a whole.
SIBs derive their name from the fact that their investors are typically those who are interested in not just the financial return on their investment, but also in its social impact. Most SIBs target impact in the categories of environmental, social and governance (ESG).
Why are SIBs more effective and scalable than traditional philanthropic donations?
In the US as of 2020 there are more than 1.5 million registered non-profits, but only 5 % of them have budgets over $ 10 mn. a year. Why are so many charities doing good work on such a small scale? There are several reasons which are intertwined with each other:
- Philantrophy has for centuries been centered around making gifts and grants to charities. The outcomes created where however not measured rigorously, but instead most charities are adhering to a very qualitative form of reporting.
- This circumstance in turn made their donors spread their money more widely, making small grants for short periods and then moving on to support another organization. In essence: If you don’t really know what good impact your money is making, it is hard to fund a single organization at scale and for the long-term.
- Most non-profits are struggling to stay afloat and therefore can’t afford to take risks like experimenting with new solutions to existing social problems. Experimentation leads to occasional failure, which scares off donors. This is a chicken-and-egg problem that leads most charities to live from hand-to-mouth, unable to engage in long-term strategic thinking and development of their growths and performance.
Summa summarum, the traditional model of philanthropy has lead to huge inefficiencies and incentivises non-profits to focus on securing survival by raising grants rather than delivering impact. The root-cause for this aggregate problem is the inability to measure impact. And this is exactly where SIBs come into play: Solving all above mentioned issues by creating a win-win-win-win scenario for all fourstakeholder groups, where incentives are aligned and outcomes and return on investment are measured.
Practical examples of Social Impact Bonds
The first social impact bond was issued in 2010 by Social Finance Ltd. in cooperation with the Peterborough Prison in the UK. The bond raised 5 million pounds from 17 social investors to fund a pilot project with the objective of reducing re-offending rates of short-term prisoners. The relapse rates of prisoners released from Peterborough where to be compared with the relapse rates of a control group of prisoners over six years. If Peterborough’s re-conviction rates were at least 7.5% below the rates of the control group, investors would receive an increasing return that is directly proportional to the difference in relapse rates between the two groups and is capped at 13% annually over an eight-year period.
In 2017, the UK Ministry of Justice announced that the Peterborough Social Impact Bond was successful: compared to a control group, it had reduced re-offending of short-sentenced offenders by 9%, surpassing the bond’s target of 7.5%. As a result, the 17 investors received a full repayment of their principal investment plus a return of just about 3% p.a for the period of investment.
Other examples include the Fusion Housing SIB which is adressing youth homelessness in the UK or the Massachusetts Pathways to Economic Advancement SIB launched in 2017 with the focus of integrating immigrants into society.
Nowadays, the SIB market is scaling exponentially with > $ 420 mn. of invested capital in SIBS as of May 2020 in 182 individual SIBs across 33 countries. The most prominent social causes targeted by these SIBs are: Education, Employment, Social Welfare, Criminal Justice, Health and Environment & Agriculture.
Additional reading on SIBs: