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.