Commentary: What Social Impact Bonds Really Mean for Philanthropy
In President Obama’s budget request for FY 2012, philanthropic leaders should pay attention to an innovative proposal to partner with government. Called “pay for success,” this initiative would test social impact bonds in the United States.
With a social impact bond, a foundation identifies a promising service provider and raises money from private investors who believe that service provider can achieve positive social outcomes. A few years later, if the service provider achieves its desired outcomes, the government reimburses the foundation for the cost of the program, plus a potential bonus based on how well the service provider did. If the service provider does not achieve its desired outcomes, the government pays nothing.
Last week, The New York Times reported on the United Kingdom social impact bond program, which has received support from both the Labour and Conservative governments. To illustrate how the program works, consider the example of Social Finance, a British organization that bought a social impact bond from the UK Ministry of Justice. Both Social Finance and the Ministry agreed upon measures of success. Then, Social Finance lined up private investors who believe that specific service providers can improve outcomes for prisoners in a certain prison. For the private investors (and Social Finance) to get back their initial investment, the recidivism rate of prisoners must fall at least 7.5 percent, compared to a control group, in 2014. If the rate falls more than 7.5 percent, the private investors will get a return on their investment in proportion to how high the rate falls. This is essentially a bonus if the program has better than expected outcomes. If the rate does not fall at least 7.5 percent, the private investors do not get any money from the government.
With a focus on objectives, social impact bonds have the potential to save taxpayers money. Harvard economist Jeffrey Liebman applauds social impact bonds for incentivizing outcomes. This innovative financing model, he says, can spur social innovation and improve government performance. Instead of prescribing a specific model to use, government sets the objectives to meet. This means that successful programs will receive both private and government funding, and programs that aren’t successful won’t receive government funds, though they may receive funds from private sources. Social impact bonds allow government to encourage innovation without having a financial obligation to unsuccessful programs. The way it works now, government continues funding social programs, even when they do not produce intended outcomes. By requiring that programs meet specific outcomes, government gets an exit strategy, and taxpayer dollars stop flowing to unsuccessful programs.
The Rockefeller Foundation is one of Social Finance’s private investors. The Foundation got involved because of the chance to get back its investment, which the Foundation can use again to support another project. Another motivating factor was the opportunity to encourage private investors to finance social programs. The more financers—public, private, and nonprofit—interested in financing programs with a double or triple bottom line, the more resources will be available for discovering innovative programs and maintaining successful ones.
The idea of achieving more than one type of return is not new to philanthropy. Since 1986, The John D. and Catherine T. MacArthur Foundation has awarded more than $377 million in program-related investments, including low-cost loans and equity investments, to charitable organizations. From interest payments and repaid principal, the Foundation earned $140 million to support other projects. The W. K. Kellogg Foundation has committed $100 million of its endowment assets to pilot a mission-driven investment program.
Both foundations offer these investment options in addition to grantmaking. With more than 120 foundations and social investors in the PRI Makers Network—a forum for those interested in expanding their use of program-related investments—philanthropy has long since signaled its interest in impact investing.
What is new is the idea that a partnership between government and philanthropy can align financial incentives to social policy outcomes. In his budget request, President Obama encourages “pay for success” bonds across several departments, including Education and Labor. Last week, The New York Times reported that the budget would include a total of $100 million to pilot seven “pay-for-success” bond programs. To abide by the president’s non-security spending freeze, the $100 million would come from the budgets of other programs and fund job training, juvenile justice, education, and care of children’s diabetes. Both nonprofits and for-profits could apply for bonds, just as Social Finance has in the United Kingdom.
While social impact bonds have high potential, they have distinct limitations and cannot solve every social issue. For one, private investors concerned with making a return on their investment will flock to programs that target easy-to-serve populations because they are likely to achieve positive outcomes. This leaves risky investments to investors willing to finance unsuccessful models in the process of discovering a successful one. Since the program relies on whether or not prescribed outcomes are achieved, another challenge involves deciding which outcomes to select, which goals to set, and how to measure those outcomes. To evaluate outcomes, researchers will need a comparison or counterfactual group to identify whether the outcome would have occurred without the program.
In addition to programmatic challenges, financing obstacles could hinder the program’s success. First, government contracts often provide payments that don’t cover the full cost of services, have complex reporting requirements, and result in late payments, as the Urban Institute reported last fall. Second, since social impact bonds invest in preventative programs that aim to reduce expenditures for multiple government agencies, the question remains which agencies foot the bill, and whether one agency should pay more than another. Lastly, current appropriations laws provide funds for a one- or two-year period, which is far less time than some programs will need to achieve outcomes. If Congress withdraws funds, instead relying on the social impact bonds program to provide all the support needed, there is no guarantee Congress would restore funding, even if bond funding falls short or disappears entirely.
While there are important concerns to consider, it is exciting to hear about new opportunities for public-philanthropic partnerships. At the very least, including this proposal in the budget should raise the profile of social impact bonds. Already, New York City and Massachusetts are considering the idea. The Council’s Public-Philanthropic Partnership Initiative looks forward to working with government and philanthropic leaders interested in taking on this new opportunity.
- February 14, 2011