by Katie Braggins
In the current political climate, many complain that the government is wasting precious taxpayer dollars while others advocate that the government should be doing more. Social Impact Bonds (SIBs) provide a flexible financial framework that can be used to target contemporary issues without the risk of wasteful government spending. SIBs are not like the traditional municipal bond with a fixed rate and term, and are (unlike a traditional socially-motivated grant) contracts between government agencies, private investors, intermediary organizations, and service providers. This works when public-sector agencies determine a measurable goal impacting a target population to occur within a set period of time. The agency then pledges financial returns to impact investors, recognizing that these returns will only be paid out if the desired outcome is achieved. This is commonly known as a “pay-for-success” contract. Impact investors provide capital to the intermediary organization, which in turn provides service providers with working capital and management. These providers deliver services to the target beneficiaries, and the financial return is determined by an external evaluator, who rigorously evaluates the impact on the target population.
SIBs have thus far only been piloted in the US, the UK, Australia, Canada, Ireland and most recently, Israel. The first SIB was launched in the UK in August 2010, targeting prisoner recidivism in Her Majesty’s Prison Peterborough. The Peterborough SIB, as it became known, was designed to close the gap in voluntary services provided to offenders serving less than a year, a previously underserved population. The results of the Peterborough SIB were positive, but ultimately inconclusive, as the UK Ministry of Justice announced the Transforming Rehabilitation program in January 2013. This new program subjected offenders serving less than one year to “mandatory supervision and tailored rehabilitation on release from prison,” thereby rendering the Peterborough SIB unnecessary.[i]
The first SIB in the United States was financed in 2012 by Goldman Sachs, which invested in a New York City project at Rikers Island to decrease prisoner recidivism by 10 percent. Bloomberg Philanthropies provided a loss-guarantee of 6 million on Goldman’s $7.2 million investment, thereby transferring the risk to private investors instead of taxpayers.[ii] This SIB, however, has been largely criticized, as the initial operator of the prison intervention was MDRC, a policy research non-profit with no prior history of operation at the Riker’s Island prison MDRC contracted the Osborne Association to offer Cognitive Behavior Therapy, rather than offer a job placement program. The NYC SIB failed to reach its initial target, decreasing recidivism by only 8.3 percent instead of the targeted 10 percent.[iii]
In August 2013, the first SIB that focused on early childhood education was launched. As a result, children in Utah flagged as potentially needing special education services in the future were provided high-quality preschool education.[iv] To fund this, The Pritzker Family Foundation invested $2.4 million along with $4.6 million from Goldman. Unlike the Riker’s SIB, the results were deemed a success, because only one student required special education services after the intervention – even though the program lasted one year and only included a mere 110 students. Goldman Sachs will receive an annual return of about 5 to 7 percent if the program continues to succeed, but will not be paid if it fails.
The main reason the Utah SIB was successful is that it funded an existing program that had already been tested at other preschools in Salt Lake County. The key difference between the Utah SIB and that at Rikers Island was that it scaled a project with a proven track record of success rather than fund a new program.
While SIBs have only been piloted in developed countries, Development Impact Bonds (DIBs) are their theoretical counterparts in developing countries. DIBs present a potential opportunity to utilize impact investments on a global scale, despite the inability of governments to guarantee financial returns on investment. This gap in funding would be accounted for by private donors, development agencies or charitable foundations instead of government agencies. In new investment instruments like SIBs, private investors typically provide the upfront capital; however, international aid agencies or philanthropies are more likely to provide the capital initially for potential DIBs.[v]
There are several legal challenges to integrating traditional philanthropies based in the United States in the structure of investing in DIBs abroad. An impact investment is usually classified under US tax codes as a program-related investment (PRI). To be legally considered a PRI, the investment must meet three criteria: that the PRI furthers the purpose of the foundation, that its main purpose is not to generate financial returns, and that it does not influence legislation or political campaigns. If the DIB met these criteria, it would allow philanthropies to count their impact investment towards the 5 percent minimum requirement of their assets that they must distribute to maintain their legal status.
As SIBs continue to build a successful track record going forward, private investors could take over the current role of philanthropies and provide the capital for DIBs as they have for SIBs. The ultimate end goal would be that successful programs previously undertaken by service providers in the pay-for-success model would eventually be taken over by government agencies themselves. SIBs are revolutionary because they allow for private investors to bear the burden of risk of innovative interventions, rather than taxpayers. It allows for governments to be more flexible and adaptable to test how programs could be expanded, without needing upfront monetary and political capital.
[I] “TRANSFORMING REHABILITATION – CRIME, FEWER VICTIMS, SAFER COMMUNITIES,” UK MINISTRY OF JUSTICE, 9 JANUARY 2013, WEB.
[II] ESME E. DEPREZ AND MICHELLE KASKE, “GOLDMAN SACHS INMATE BET FUELS SOCIAL-IMPACT BONDS: MUNI CREDIT,”BLOOMBERG BUSINESS, 21 AUGUST 2012, WEB.
[III] DAVID BANK, “THE PRISON REFORM #FAIL THAT IS SHAKING THE SOCIAL-IMPACT BOND MARKET, IMPACTALPHA, 6 JULY 2015, WEB.
[IV] NATHANIEL POPPER, “FOR GOLDMAN, SUCCESS IN SOCIAL IMPACT BOND THAT AIDS SCHOOLCHILDREN,” THE NEW YORK TIMES, 7 OCTOBER 2015, WEB.
[V] “INVESTING IN SOCIAL OUTCOMES: DEVELOPMENT IMPACT BONDS,” CENTER FOR GLOBAL DEVELOPMENT & SOCIAL FINANCE, OCTOBER 2013, WEB.
[VI] SHAWN COLE, RAWIA ABDEL SAMD, MATT BERNER, AND RALUCA DRAGUSANU, “SOCIAL FINANCE, INC, ” HARVARD BUSINESS SCHOOL, SEPTEMBER 2013, WEB.