Can Social Impact Bonds Solve the Problems Government Won't?

Aug 9, 2011Tracy Palandjian

spending-money-150In a week-long series, prominent thinkers will look at ways to harness the private sector or extract more from a recalcitrant public sector in order to combat poverty and inequality. In the second post, Tracy Palandjian, CEO of Social Finance Inc., looks at the promise and challenges of using Social Impact Bonds to address deep issues.

Across the United States, community groups, government agencies, and nonprofit organizations are working to tackle the root causes of poverty, crime, and other disabling economic and social conditions. There are successes, to be sure, but these are exceptionally difficult days for disadvantaged individuals and communities, in part because of the current fiscal crisis, but also because multifaceted problems have become too complex for one-dimensional, prescriptive solutions. At the same time, state and local governments too often address problems only after they occur. Poor outcomes are frequently repeated, requiring the public sector to spend ever increasing amounts on crisis interventions.

Fortunately, there are encouraging signs that access to private capital markets can reverse this cycle and drive more capital toward preventive programs that can create better outcomes, lessen the need for remediation, and reduce overall costs. A new impact investment product, the Social Impact Bond (SIB), was recently launched in the UK -- the first one in the world -- to finance effective social programs.  It represents an innovative financing mechanism and a new form of cross-sector collaboration to drive systemic change.

SIBs tap a significant new funding source for evidence-based nonprofit programs. An SIB is a financial instrument in which investors front working capital to nonprofit organizations to implement preventive programs aimed at achieving specified social outcomes. If an independent evaluator determines that predefined metrics have been achieved, the government repays investors their principal and a rate of return; otherwise, investors lose their capital.

Ben Franklin's adage that "an ounce of prevention is worth a pound of cure" provides the motivation for SIBs. The savings that SIBs produce enable activities that generate social progress to be monetized into an investable asset. SIB-funded programs include preventive interventions (such as supportive housing for chronically homeless individuals) that produce better social outcomes (increased residential stability and better health) and deter costlier crisis responses (repeated emergency room visits, hospital admissions, incarceration, and use of shelters).

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Everyone benefits under a successful SIB program. The public sector sees better results for less upfront investment and only pays if social outcomes and cost savings are produced. Investors put capital to work while achieving robust financial returns and meaningful social impact. Nonprofit service providers get stability and predictability in their revenue model, which frees them up to do what they do best -- deliver critical services to populations in need. Disadvantaged individuals and their communities benefit from both increased and improved social goods and services.

Massachusetts recently became the first state in the nation to formally pursue SIBs by issuing a Request for Information (RFI). Social Finance Inc., the nonprofit sister organization of the UK firm that launched the world's first SIB, responded to the RFI, announcing its intention to develop, finance, launch, and manage high-quality SIBs over the life of the instrument. Social Finance identified a number of promising SIB applications, including permanent supportive housing for chronically homeless individuals; housing-based support for homeless families; home- and community-based aging-in-place programs for elders; community-based alternatives to juvenile detention; and alternative community corrections for adult offenders.

Developing detailed business cases for specific SIBs will be challenging, however, given the inherent uncertainties involved in producing and measuring social outcomes. Social Finance has been conducting extensive research around various evidence-based interventions, growth-ready nonprofits with strong track records of successful delivery, and the costs and outcomes of existing and proposed services, all of which must be presented in credible financial models. We know that investors will also conduct demanding due diligence in a number of areas, including nonprofit capacity, the ability of chosen interventions to increase social impact, decision-making and control, outcomes, metrics and evaluation.

Some of our current social challenges are too widespread, deep-rooted and costly to be addressed by traditional sources of private philanthropy and government funding. SIBs draw from a new pool of capital that can enable proven models of intervention to expand. In addition, SIBs advance Stephen Goldsmith's "governing by network" model, a form of shared collaboration among the public, private, and nonprofit sectors, facilitating cooperation across governmental silos, to address pervasive economic and social problems.

Tracy Palandjian is the CEO of Social Finance, Inc., a nonprofit organization dedicated to connecting the social sector to the capital markets. It is the sister organization to Social Finance, Ltd. which launched the world's first Social Impact Bond in September 2010.

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