Understanding the Social Impact Bond

This blog post was researched and written by Michael Pelts, a summer intern at the Gateway Center for Giving and student at New York University.

What is a Social Impact Bond?

The Social Impact Bond, or ‘SIB’, is one of the many types of innovative investing for social benefit. Other innovative investment strategies include:

  • Socially Responsible Investing (SRI): investors only buy the stock of companies that share their values (ie, environmentally friendly, consumer friendly etc.).
  • Impact Investing: investing in companies that are looking to create both social benefit and financial gain.
  • Pay-For-Success: government enters into contract with a nonprofit service provider and promises to pay the nonprofit if they achieve a specific outcome within a set amount of time.
  • Program Related Investing: foundations invest, through loans, loan guarantees or lines of credit, in charitable work or projects. The investments count towards a foundation’s 5% payout requirement.
  • Mission Related Investing: foundations invest in social enterprises that share or match the mission of the foundation. It is structured much more like a financial investment than Program Related Investing. There are no legal requirements to qualify an MRI and they don’t count to a foundation’s payout requirement.

A SIB is both a form of pay-for-success and impact investing. However, unlike most forms of impact investing, the SIB does not involve investing in a for-profit company. Rather, the SIB is a way for the private sector to seek financial gain through the funding of a nonprofit service provider, and is a way for the social sector to shift the risk of funding innovative, often prevention-based programs to the for-profit sector, and away from the government.

Employing prevention programs makes sense for a government because solving an issue before it happens is more effective and less expensive than indefinitely treating the symptoms of the problem. However, governments are disinclined to use taxpayer money on expensive prevention programs that may or may not work. In response, they have started to use pay-for-success models, where they give a nonprofit service provider a contract that promises to pay them if they succeed in some measure outlined in that contract. However, some nonprofits cannot get their programs off the ground without upfront capital.

In response to this challenge, a London-based organization called Social Finance created the social impact bond, in order to both protect the taxpayer from the risk of a prevention program and provide working capital to nonprofits.

How SIBs Work

In a SIB, an intermediary receives a contract from the government to make some kind of social impact, or outcome; social outcomes that prevent later government costs tend to be most attractive for SIBs (e.g. a reduction in the re-incarceration rates at a prison).

To achieve this social impact, the intermediary identifies nonprofit service providers with proven results in that field. At the same time, the intermediary identifies investors to provide the upfront capital needed by the nonprofits to fund the programming.

After the programming has been implemented, and if the nonprofits are successful in achieving the measurable outcomes outlined in the contract, the government will pay the intermediary, who (after taking a portion of the money for their services) will then redistribute the funds to the initial investors. The investors are paid based on the total social value, including the amount of money the government will have saved by not providing services for the prevented issue down the road.

 Image

This graphic taken from Social Impact Architects that was adapted from Social Finance US

Benefits and Issues

The benefits of SIBs include:

  • There is no risk to government and tax payers
  • Nonprofits receive upfront, stable funding
  • Investors potentially receive financial gains and create social benefit
  • SIBs provide funding for innovative prevention programs

The potential issues of SIBs include:

  • SIBs are largely untested
  • SIBs bring together partners that do not usually work together
  • SIBs are more expensive than other pay-for-success programs

The Future of SIBs

Including the Peterborough Bond (the initial SIB made by Social Finance), there are currently 13 SIBs in the United Kingdom, one in the United States and one in Australia. Preliminary results have been positive, but non-conclusive from the Peterborough SIB. President Obama’s fiscal year 2014 budget proposal has allocated $500m to Pay-For-Success programs of which $300m is supposed to go directly to SIBs. Many jurisdictions are interested in the idea. The mechanism will be thoroughly tested in the coming years.

Resources include:

“An Overview of Social Impact Bonds in the United States” from Social Impact Architects

“Socially Responsible Investing: What You Need To Know” from Michael Chamberlain in Forbes

“Global Impact Investing Network: Impact Investing” from the Global Impact Investing Network

“Glossary of Terms – Contact Fund, LLC” from Contact Fund LLC

A telephone interview with Jane Hughes of Social Finance on July 24, 2013

“Impact Investing” from the Rockefeller Foundation

“The Evolution of Microfinance” from Rob Kreiger on PBS Frontline

“Unscrambling ‘MRIs’ and ‘PRIs’” from David Levitt in the Philanthropy Journal

“SIBs” from Ashley Pettus in Harvard Magazine

“The Promise of SIBs” from Tina Rosenburg in the NYTimes Opinionator

“SIBs: White House Budget Drives Pay for Success and SIBs Forward” from Sonal Shah and Kristina Costa at the Center for American Progress

The City of New York website SIB presentation

“Pay for Success – Frequently Asked Questions Third Sector Capital Partners” from Third Sector Capital Partners

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