Social Impact Bonds: Private Capital for Public Services?

In times of financial belt-tightening, social programs are often the first to find their budgets significantly reduced. These budget reductions are often justified by the belief that social welfare programs are just not a good value for governments—in some cases, these programs can receive funding for years before an evaluation reveals an unsuccessful program model. However, in the wake of the Great Recession, policymakers have been paying more attention to an idea which funds social programs, traditionally paid for by taxpayers, through private investors. If the program fails, the investors lose their investment; but if the program succeeds, the investors get their money back, and possibly more, from the government who has just bought a social program which has been proven effective.

This idea is known as Social Impact Bonds (SIB), or Pay for Success Bonds, which is a funding model which allows for private investment to fund social programs without risking taxpayer dollars. Although called “bonds,” these really operate more as venture capital operations.

Put simply, the process works by having private investors buy bonds from a bond issuing agency, which raises enough funds for the proposed social program. The program is then given certain agreed upon goals, and if the program meets or exceeds these goals then the government (through the bond-issuing agency) repays the investors—sometimes with a return on the investment, depending on the success of the program. However, if the program fails to meet these goals, the government does not have to pay the investors back, and taxpayers are spared picking up the bill of an inefficient social program.

Social Impact Bonds are currently being used in the United Kingdom, where a pilot SIB program has been set up to reduce the recidivism rates of inmates at the Peterborough Prison. To accomplish this goal, the Ministry of Justice sold £5 million in bonds to private investors, and if recidivism is reduced by 7.5% for six to eight years, the investors will see modest returns on their investment; if the recidivism rate is reduced even more, investors will see an even greater return. Overall, investors can earn a profit anywhere from 2.5% to 13% in their initial investments—or nothing if the program fails. So far about a year old, a report shows that researchers following the Peterborough program seem uncertain but optomistic about the eventual outcome. 

Domestically, SIBs have been generating interest at the federal, state, and local levels. The White House has already shown a strong interest, proposing an upcoming 2012 budget that allows up to $100 million in SIB pilots. Likewise, Massachusetts has been edging towards the implementation of SIB pilot programs, and at the local level, the mayors of New York and Baltimore have reportedly shown interest in SIB pilot projects.

For a more in-depth explanation on SIBs, see Jeffrey Liebman’s white paper (released by the Center for American Progress), which can be accessed here.

4 thoughts on “Social Impact Bonds: Private Capital for Public Services?”

  1. I don’t agree that the introduction of Social Impact Bonds in the UK represents a desirable new model of social investment. These Bonds aim to attract for-profit private investments into public sector social programs, with a return on investment for the investors if the programs yield savings for the government.

    The model is based on a profoundly naive assumption that private sector investors can generate positive social impacts (in this case, reduced demand for foster care and lower re-offending rates among former prisoners) if they are offered incentives to apply their financial investment to public sector social programs, using a “payment for results” framework.

    Social relationships are the key to reduced demand for foster care and lower re-offending rates. The people who can make these relationships happen are not private investors. They are people in civil society – family and friends, neighbours and communities, mentors and teachers. Many such people have worked tirelessly for decades to get governments to recognise that managerial approaches in foster care and ex-prisoner rehabilitation do not work. Yet governments have relentlessly pursued failed programs until …. now, when proposals for private investment with a return for budget savings come along. It is really quite offensive that private returns from budget savings should flow into the pockets of for-profit investors, when individuals and groups have been calling for radical change in foster care and ex-prisoner rehabilitation for many years, with no expectation of any financial reward, yet have largely been ignored by successive governments.

    That governments have yielded to investors on topics of such sensitivity and complexity as foster care and recidivism, and not listened to voices in civil society who are immersed in the relationships that potentially make a difference, is disappointing to say the least for these individuals, families and communities. It reflects a radically higher valuation of private capital than of civil society relationships.

    It is very easy to distinguish between failed social programs and effective ones. When governments continue the failed ones, it is usually because vested industry interests lobby successfully against change. Governments should do the right thing and discontinue failed programs, rather than act only when an alternative group of interested industry players appear.

    The assumption that positive social impacts can be leveraged by getting the incentives right for investors to make profitable returns can be seen as a further triumph for shallow managerial thinking on the part of governments and public policy academics, for whom social well-being can apparently be adjusted upwards or downwards by manipulating this or that program lever or amending this or that set of incentives.

    This assumption is dead wrong. Social well-being is enhanced by transferring social problems from the sphere of public sector management and disengaged officialdom to the sphere of civil society where personal and social relationships can be cultivated. To permit this transfer in setting to take place only on payment of a return to for-profit investors reflects a profound disrespect for civil society and the relationships that take place within it.

    Vern Hughes
    Centre for Civil Society

  2. Vern, I think you point about governments making hard decisions regarding funding of particular projects is indeed a major issue and I imagine this is an ongoing issue for most policy makers working in the social sector in government. It is very frustrating to see projects that are not meeting outcomes, continue to be funded because of the potential political damage that withdrawal of funding can cause. If you want a case study see the news reports in Tasmania, Australia at the moment about the State Governments attempts to restructure the health system to address the significant issues of a health system that is characterised by inconsisentent service delivery, complex and inefficient administrative systems and an a projection of increasing demand in a declining budget environment.

    I am very interested in the work around social investment bonds at the moment. A trail is beginning in NSW, Australia and I see it as a potential solution to some of the funding issue we experience. I do wonder however what type of incentives there need to be for investors to see the bonds as a good investment and what rate of return investors would find appealing. As well as what type of tax concessions might be necessary to attract investors. Any ideas?

    I am also wondering about how to ensure that this model of funding does not errode the funding required for base level social services. It would be unacceptable in my view to move towards public/private/non profit funding relationships as the basis for all funding agreements.

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