The Rise of Social Impact Bonds (Highbrow Magazine)

By Annie Castellani

Private investors seeking alternatives to traditional charitable donations might consider social impact investing. This catchy investment philosophy has a dual purpose: make a positive impact on social and environmental issues and reap positive financial returns. Philanthropic foundations like Rockefeller and Robin Hood and global financial institutions like Goldman Sachs and Bank of America Merrill Lynch are already on board. These strange bedfellows are using public-private partnerships to finance efforts targeted at fighting chronic and rampant societal problems such as insufficient access to education, healthcare, affordable housing and employment.

The en vogue vehicle for social impact investing is the social impact bond (SIB). Social impact bonds typically involve an agreement among multiple stakeholders, including government agencies, investors, service provider organizations and an intermediary that brokers the project. Government and investors coalesce around a common social or environmental objective like reduction in recidivism rates among young men. The government identifies a target population and defines expected outcomes, while service providers and the intermediary implement projects focused on achieving these goals.

If the desired outcomes are met, the government or intermediary acting for the government repays the initial capital. There might also be positive returns. If the project fails to meet the agreed upon objective, investors risk losing everything. As summed up by the progressive think tank, the Center for American Progress, “Social impact bonds are new and innovative financing mechanisms for social programs in which government agencies pay only for real, measurable social outcomes—after those results have been achieved.”

 

To measure the social or environmental impact, third-party evaluators can assess progress in the quality or quantity of services and compare rates to demonstrate a reduction in societal problems. For instance, if the prison population goes down due to efforts of a nonprofit organization or socially-minded company focused on reducing recidivism through employment training or behavioral therapy, and the rate is lower by a predetermined measure than it would be through a government program, then the government will refund the initial investment. The idea here is that government has saved in prison costs. Other initiatives that have the potential to save government costs include partnering with service providers focused on improving energy efficiency for public housing, or reducing foster care placements through better access to family therapy and early intervention.

Investors can choose varying types of involvement, risk and return on a particular investment. They can participate in the early states of a social enterprise or they can chose to expand an existing business model with a proven track record. Depending on the contractual agreement between parties, investors may recoup a certain amount of their initial investment in a failed project through partial guarantees from philanthropic loans. And there may be a sliding scale of pay-out agreements by which returns are increased as performance increases, as well as a cap on returns.

According to Social Finance, an active UK nonprofit in this space, in the first four years of operation there were 25 social impact bonds worldwide. In the United States, states such as New York, Massachusetts, Utah, Illinois and Ohio are experimenting with SIBs to address recidivism, early education and literacy, and homelessness. Currently, there is a bipartisan bill before Congress, theSocial Impact Bond Act, which proposes the establishment of a $300 million Treasury Department fund that would support state projects nationwide. And countries such as the UK, Canada and Australia are using SIBs to address similar problems.

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Recidivism is the most common and well-documented topic for social impact bonds, also known as “pay for success financing.” Not surprisingly, the first experiment with SIBs aims to reduce recidivism rates among males in England. In 2010, the UK government partnered with a group of investors, including Social Finance and the Rockefeller Foundation, to address re-incarceration rates at the Peterborough prison. These investors provided approximately $8 million to a consortium comprised of six organizations focused on rehabilitation of former prisoners through access to housing, training and employment, medical services, benefits and financial advice, and family support. The government has agreed to repay the investors if rates drop by 10 percent in four years or stay above 7.5 percent for six years. Though the project did not yield a payout in 2014 – reoffender rates dropped by only 8.4 percent compared to a national control group – it is on track to pay investors in 2016.

The first social impact bond in the U.S. also tackles recidivism. In 2012, Goldman Sachs pledged $9.6 million to the Adolescent Behavioral Learning Experience (ABLE) Program, which seeks to reduce incarceration rates at Rikers Island in New York City through behavioral therapy. The four-year initiative permits MDRC, an intermediary working for the City government and nonprofit service providers, to return Goldman’s capital investment if the number of jail days avoided by young men who previously spent time at Rikers is reduced by at least 10 percent. If the rate exceeds 11 percent, then MDRC will give a financial return to Goldman. A $7.2 million grant provided by Bloomberg Philanthropies guarantees a large portion of the investment.

In 2013, Bank of America Merrill Lynch launched a similar five-year program in collaboration with partners including the State of New York and Social Finance. It pledged $13.5 million to fund the Center for Employment Opportunities, a nonprofit focused on prisoner rehabilitation through training and employment services. Investors can earn as much as a 12.5 percent return if the center hits its targets -- at least an 8 percent reduction in the recidivism rate or an increase of at least 5 percent in the employment rate. Similar to the Bloomberg Philanthropies, the Rockefeller Foundation has provided a $1.32 million guaranty on the initial investment.

Similarly, Massachusetts has experimented with the use of SIBs to drop recidivism rates. In 2014, Goldman Sachs and five foundations pledged $18 million in support to Roca, a nonprofit operating in this space for over 25 years. To measure the impact, third-party evaluators will compare the performance of men enrolled in a four-year program – in which they have access to counseling and behavior modification classes, as well as vocational training, reading and math education – against a control group of men who are not enrolled. If the men spend 40 percent less time incarcerated, the government can return the initial investment. The more time spent away, the greater the additional return up to $1 million for Goldman and Roca. Investors also get annual interest rates of 5 percent for Goldman and 2 percent for funders the Kresage Foundation and Living Cities.

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As recently pointed out by David Brooks of the New York Times, proponents of social impact investing see it as a viable alternative to gridlocked government and unreliable financial markets. Public-private partnerships that form the foundation of social impact bonds are a response to ineffective and underfunded efforts by government to solve social and environmental problems. Not only do they capitalize on innovation spurred by private investment, they can save taxpayers from paying for failed government policies. SIBs can give nonprofits and social entrepreneurs a steady source of capital for overhead and expansion, as opposed to traditional grants with program-focused restrictions. And they may generate strong financial returns to investors.

In the other corner, critics of social impact investing and bonds fear that this hybrid approach puts too much power into the hands of corporations and the wealthy to solve societal problems. The government should be the key decision-maker on social services, and it should not outsource their care and control to corporate titans like Goldman Sachs. There are practical critiques as well. It may be difficult to measure the efficacy of the actual investments and to properly attribute them to specific sources of capital.

Regardless of one’s vantage point, however, social impact investing seems here to stay. For better or worse, financial institutions are taking a whack at rehabilitating their images through social impact bonds. The jury is still out on whether SIBs can do good for society; but until government can prove that it is capable of running effective, efficient programs to address systemic social and environmental problems, support for this public-private experiment may continue to grow.

Annie Castellani is a contributing writer at Highbrow Magazine. Follow her on Twitter: @SustainCapit.