Research Report #34 April 2017 Social Impact Bonds: A Potential Innovative and Effective Solution for Social Problems Blair Donner Chien-Chung Huang Within the past decade, there has been an increased interest in utilizing social impact bonds (SIBs) to finance social service initiatives. SIBs are essentially a public-private partnership that re- ly on private investor capital to deliver a public service. While some SIBs have successfully gener- ated investor returns, others have been terminated in earlier project stages. This paper contributes to the growing literature and understanding SIB models by analyzing their development and struc- tures as well as three significant case studies in Peterborough UK, and New York and Chicago, USA. It also considers the potential for SIB models in the China context. The findings ascertain the effectiveness of SIBs, highlight its innovative features, and suggest areas for further development. Keywords: Social Impact, Bonds, Innovative, investment, private, capital. 1 Introduction advantage of the SIB financing model tolerance, a successful program can In the past, service organizations, is that it harmonizes the incentives of lead to generous repayment from the or organizations that aim to make pro- all three entities involved (donors or involved donor or government. Advo- gress within a critical social issue, have governments, service organizations, cates of SIBs argue that they empower followed a traditional financing frame- and investors) (Bridges Impact+, 2014). outcome payers and service organiza- work. Under this framework, the ser- Figure 1 demonstrates this dynamic. tions to channel the majority of their vice organization first secures funding SIBs accordingly follow a performance resources toward solving critical social from individual donors, foundations, -based or pay-for-results (PFS) model, issues and encourage less operational or federal and state governments and meaning that only social programs distractions (Bridges Impact+, 2014). then implements a program to tackle a which achieved a desired result are In short, SIBs solutions approach critical social issue of interest. The rewarded. Given the Pay for Success critical social issues through a unique problem with this method is that in- component of SIBs, they are sometimes public-private partnership. Unlike a herit structural obstacles and strained referred to as Pay for Success initia- traditional social finance model, SIBs funding often lead to inadequate pub- tives. Evaluation of the SIB project is introduce the investor component. In- lic services. More specifically, political critical because it determines how re- vestor capital is more flexible and can pressures to meet in-demand issues turns are allocated (Bridges Impact+, overcome structural barriers that deter also prevent decision makers from 2014). governments and service organiza- bringing effective public services to SIBs also unlock the opportunity tions from investing in critically need- marginalized population segments for achieving better outcomes and, as a ed social projects. Since investor re- (Dear et al., 2016). Social impact bonds result, a better social system (Bridges turns are contingent on project success, (SIBs) are a potential solution to the Impact+, 2014). Freer allocation of re- a results-oriented approach is empha- problems embedded in traditional so- sources and larger program scopes are sized during SIB projects. Given its cial financing. On the most basic level, a cornerstone of SIB success in these advantages, SIBs have become an in- SIBs are a three-way public-private areas. Through the SIB model, donors creasingly appealing option in the U.S., partnership between a donor, investor, and governments are enabled to allo- especially due to current budget defi- and service organization. It is through cate their limited financial resources in cits. SIBs have been a hot topic in Chi- the added element of an investor that ways that focus on project outcomes na recently, and have potential to help SIBs induce results-oriented service instead of project funding. Simultane- marginalized Chinese population seg- programs (Bridges Impact+, 2014, p. ously, involved donors and govern- ments. With the progression of the 15). ment entities can also pursue related twenty-first century, China has em- SIB arrangements follow similar innovative preventative services be- braced an increasing number of privat- core operating structures, though cause they not immediately pay for the ized business practices. This along slight variations exist. The flow of cap- SIB project (Bridges Impact+, 2014). with the rise of China’s nouveau rich ital usually begins with a financial pro- Service organizations are likewise ena- class enable SIBs to serve as a potential vision to a service organization by an bled by SIBs to expand the focus of outlet for private capital to be invested investor entity, which is particularly their efforts beyond the existing focus. in ways that promote domestic devel- important as service organizations of- In other words, the capital provided by opment of China. ten lack adequate funds. The investor’s investors enables the service organiza- A Brief History: Development capital enables the service organization tion to channel the maximum amount of the SIB Over Time (2010 – of time and finances towards con- to focus on delivering a social service 2016) that targets a specific cause, communi- structing innovative, results-oriented SIBs were born out of the need to ty, or population segment instead of programs and solutions. Likewise, in- overcome structural barriers that pre- on fundraising. If the service organiza- vestor participants are enabled to wit- vent important social services from tion is successful, the donor or govern- ness progress on a social cause of their reaching marginalized populations ment entity enjoys an improved social liking and obtain a return on invest- and communities. SIBs are still a rela- environment and thus makes a return ment. The payment-by-results compo- tively new concept; the first SIB was payment to the investors. In full circle, nent of the SIB incentivizes the inves- implemented less than a decade ago in the investors benefit from the initial tor to seek out the most promising so- September of 2010 (Dear et al., 2016). investment in the social project lution to a pressing social issue The first entity to introduce the SIB (Nicholls & Tomkinson, 2013). The key (Nicholls & Tomkinson, 2013). While financing model was Social Finance SIB investors must have a high risk 2 UK, an organization established in forced to follow strict austerity pro- mented, methodologies to analyze 2007 with the goal of exploiting un- grams, and so the effectiveness of lim- their social impact and evaluate relat- tapped opportunities that lie in the ited government expenditure became ed data are becoming increasingly so- relationship between social progress increasingly paramount. SIB models, phisticated. SIBs are essentially play- and capital markets. Social Finance UK under this context, are an appealing ing a leading role in forging the useful initiated the very first SIB in response option because the results-based SIB connections between data, research, to the discovery that scarce resources structure unlocks drastic savings for and decision making. Readily available prevent governments from funding financially strained governing institu- databases are being developed as a innovative social programs and from tions (Nicholls & Tomkinson, 2014). In direct result of SIB needs so that policy evaluating the methodologies and out- the less advantaged areas of China, makers can access key statistical indi- comes of their previous programs especially western regions, attractive cators during the decision-making pro- (Dear et al., 2016). This pioneer SIB SIB models might help expand the cess. One example of this is the UK was launched in Peterborough, UK scope of social services when govern- government’s Unit Cost Database, an during September of 2010 and was ment budgets leave gaps. As of June online resource which aims to support designed to reduce local cyclical recidi- 2016, a total of 60 SIBs have been the SIB movement and provides over vism patterns. It was planned for a launched in 15 different countries. Da- 600 estimates of social issue costs total of 3,000 short-sentenced ex- ta is available for the first 22 SIB pro- (Dear et al., 2016). In the future, it is offenders of Peterborough to be pro- jects, and of these, 21 projects (95%) hoped that entities and organizations vided with rehabilitation services report that the SIB yielded positive interested in implementing social pro- through investors’ private funding (see social outcomes, 12 projects (54%) re- jects can utilize the data and evaluative below case study for detailed design of port that they have made outcome techniques developed from SIB models the SIB). Currently, the case of the Pe- payments, and 4 projects (18%) claim in assessing the potential of their own terborough SIB continues to inspire to have fully repaid investor capita programs (Dear et al., 2016). countries worldwide to experiment (Dear et al., 2016). As for the remaining Despite the early successes of first with SIB financing. Shortly after the 38 projects, recall that since many of SIBs, there is still more to ascertain implementation of this first SIB, a se- these were just recently implemented about their operations, functions, im- ries of other SIBs were launched they will not reach maturity for anoth- pact, and optimal applications. Cur- throughout the UK in 2012 covering a er few years. Evaluative data and re- rently, a major SIB trend is operational range of topics from the education of sults will therefore not be available for designs that maximize investor capital disadvantaged young people to home- another few years. Since investor re- turnover rates. Already, in just the past lessness. Social Finance US was subse- turn is dependent on evaluative data, half-decade or so, there has been tre- quently founded in 2011 and Social SIB project returns cannot be allocated mendous progress in bringing returns Finance Israel was founded in 2013, until these results are made available.