Social Impact Bonds: Passing Fad or Revolutionary Innovation?

A man who declined to be identified walks past a business with an American flag in the window Tuesday, Jan. 24, 2012, in Mobe
A man who declined to be identified walks past a business with an American flag in the window Tuesday, Jan. 24, 2012, in Moberly, Mo. Many in this small town in central Missouri will watch the State of the Union address closely after struggling to create jobs and suffering from a down economy. (AP Photo/Jeff Roberson)

Imagine a conference room full of Wall Street types. Blackberries, hand-tailored suits, leather portfolios. Intermingled among the investment titans are public interest attorneys and social workers. After one of the Wall Street men stands in front of a whiteboard explaining how the bond market works, a social worker steps up and explains how a public social service program is administered. 

What could bring all of these people together?

Social impact bonds.

One of 2012's hottest ideas, social impact bonds are being talked about -- mostly enthusiastically -- everywhere from the Economist to National Public Radio. But what are they? There are lots of definitions floating around; as Kevin Starr put it in his great Stanford Social Innovation Review blog post (first in a series), "the definition of impact investing is still a dog's breakfast."

Thankfully, the Center for American Progress explains how social impact bonds work clearly and concisely in a helpful report from 2011:

[A] government contracts with a private-sector financing intermediary we'll call a 'social impact bond-issuing' organization, or SIBIO, to obtain social services. The government pays the SIBIO entirely or almost entirely based upon achieving performance targets. If the bond-issuing organization fails to achieve the targets, the government does not pay... The bond issuer obtains operating funds by issuing bonds to private investors who provide upfront capital in exchange for a share of the government payments that become available if the performance targets are met.  The bond issuer uses these operating funds to contract with service providers to deliver the services necessary to meet the performance targets.

Counterintuitively, there does not even need to be a "bond" in the traditional sense of the word.  As the Center for American Progress explains in a separate fact sheet, the word "bond" in social impact bond really describes the relationship between the bond issuer and the private investors.

There are several positive features to the social impact bond approach. Because the initial funds would come from the private sector, not the taxpayer, even when budgets are tight governments and organizations would have an incentive to use new approaches to social problems. Why?

Because the spending is deferred; the government does not pay the external organization any money until the organization achieves its targets. The emphasis on performance targets would give everyone involved in the project more incentives for success (or as Wall Street would say "skin in the game"), and would reduce the possibility of a government repeatedly funding a program that did not produce results. Also, because the SIBIO is responsible for achieving the targets-not the government -- it is easier to reallocate funds when a program isn't producing results. Moreover, if a program doesn't get results, the government does not have to pay the external organization that has issued the bonds.

What types of projects are most amenable to social impact bond funding? Let's take a look at the world's first social impact bond project, in the United Kingdom, where the British Ministry of justice issued social impact bonds to a nonprofit organization that promised to improve recidivism of prisoners at Peterborough Prison by 10 percent compared to other similar prison populations. If the nonprofit succeeds, it will receive up to $13 million over eight years. The Peterborough project is ideal for social impact bonds because of several attributes, which other potential social impact bond projects will also need to have to succeed:

Potential for reducing costs: The Ministry of Justice reasonably believes that the Peterborough project will save money for the government in the long run. For a social impact bond project to work, the external organization has to show that its methods will be cost effective.

Observable, measurable outcomes: The nonprofit organization working at Peterborough Prison is working with a definite treatment population, which means the organization will be able to track its outcomes for the life of the project-ideally, between three and eight years.

Known social interventions: Government, nonprofit, and private organizations have all worked on prisoner recidivism before, so there is a vast literature describing which approaches to the program work, and which ones do not. If the organization is not successful, however, prisoner reentry is not a core government service, so there are few negative consequences if the external organization does not reach its targets and discontinues services.

At least a few governmental agencies in the U.S. are poised to utilize these bonds. In August, New York City announced that Goldman Sachs is investing nearly $10 million in social impact bonds in a jail program at Rikers Island to reduce recidivism rates. If the program reduces recidivism by 10 percent, Goldman would be repaid the full amount; if recidivism drops more, Goldman could make millions in profit; if recidivism does not drop, Goldman would lose a significant portion of its investment. Connecticut's General Assembly recently considered social impact bonding as part of its annual budget legislation, and the Manhattan borough president would like to use social impact bonds to boost early-childhood education. Even senior County Health and Human Services directors, philanthropic organizations, and more than 100 service providers, community members and advocates in Cuyahoga County, Ohio have been discussing the concept. 

In addition, organizations are springing up to provide the vital tracking and measuring services that governments and organizations need for social impact bonds to work. One such organization, the Global Impact Investing Network, is developing "a common framework for reporting the performance of impact investments" with the support of USAID, the Rockefeller Foundation, Deloitte, and PricewaterhouseCoopers.

Keeping the limitations of social impact bonds in mind, what program areas addressing the needs of low-income Americans might use this type of financing successfully?

  • Foster care reentry prevention
  • Preventive health care
  • Homelessness prevention
  • Unemployment

While social impact bonds are not going to cure all of America's social problems, if implemented wisely and slowly, these bonds could promote the kinds of public-private partnerships that politicians are good at praising but not at creating. At the very least it's an interesting concept which deserves further consideration.

Karen Harris, Director, Asset Building at the Sargent Shriver National Center on Poverty Law, contributed to this article.