The Right Rewards: The Implementation Challenge of Social Impact Bonds

Matthew Higgins

The social impact bond (SIB) is a new form of social investment that has just recently made landfall on Canadian shores via the UK. Toby Eccles and his team at the London based organization Social Finance devised the SIB scheme as a way of providing charities and social enterprises with “sustainable revenues and investment to innovate and grow.” With the federal government preparing for its first foray into the world of social finance, it seems like a good time for public administrators to take a closer look at what is known about these newfangled financial instruments.

How They Work

SIBs are designed to harness private sector forces of innovation and efficiency by creating a market for the provision of certain types of social services. The government contracts with a social impact bond-issuing organization to deliver a social service. The government pays the bond issuer only if it meets specific performance targets for a well-defined treatment population. The bond-issuing organization gathers capital from private investors, which is then used as operating funding to hire social service providers. Private investors are motivated by the opportunity to share in the potential payout from government. If the goals are not met, no one gets paid.

Potential Benefits

If successfully implemented, social impact bonds could bring an influx of sustainable capital into chronically underfunded service areas. Policy analysts generally agree that the areas that are most underfunded and underserved are typically situated in the realm of preventative (as opposed to remedial) policy, especially with regard to health care, crime, and development services. Governments find it difficult to spend money upfront for results and savings that will accrue in the relatively distant future, whereas the private sector is rather used to that proposition and eagerly benefits from such arrangements.

Most governments recognize that an ounce of prevention is worth a pound of cure, but are unable to shift or raise resources due to various constraints. Facing reduced fiscal capacity, many are now considering the use of SIBs in areas where they believe they can save significant money. The Conservative UK government, in alignment with its Big Society manifesto, seized on SIBs and social finance more broadly as a way to potentially maintain social services while delivering deep and broad cuts to government expenditures. In the US, President Obama set aside up to $100 million in the 2011 budget to establish seven SIB pilots. In Canada, the federal government is now soliciting proposals for SIB designs. At the provincial level, Don Drummond recommended SIB pilots for Ontario, and the B.C. government is formally exploring pilots as well.

Despite all this action, SIBs are still a fledgling idea. Even in the UK, the original pilot programs are still ongoing. Like any social policy experiment, it will take time to figure out what works, what doesn’t, and why. However, one of the greatest potential benefits of SIBs is the improved rate at which programs that work are scaled up and programs that don’t work are discarded. Trial and error becomes a more efficient process. Jeffrey Liebman, in a 2011 report for American Progress, argues that “the public sector is slow to adopt new program models, even those proven to be highly effective.” He gives the following example:

Consider the new federal “home visiting” program. This grant program, which pays for nurse and social worker home visits to low-income mothers, was enacted last year—33 years after the first randomized controlled trial demonstrated the benefits of such visits. Among the benefits we put off for more than three decades: healthier children and families, and lower Medicaid costs for taxpayers.

With access to sustainable sources of adequate capital funding, not-for-profits can quickly and reliably scale-up successful programs. And since investors hate losing money, the models that fail will quickly lose funding. Failed programs, when funded by the government, tend to live on for years after they have stopped achieving net benefits.

Not So Fast: Challenges with Implementation

For policy professionals within government, the challenge of implementing social impact bonds is twofold. There is the question of which program areas are suitable to delivery through SIBs and there is the question of how to design the metrics and benchmarks by which investors will be rewarded.

SIBs are not a cure-all. This is a point that most proponents, including Human Resources and Skills Development Minister Diane Finley, agree with. Once we delve into the details of designing an SIB and the relationship between metrics and the broader social benefits that they represent, it becomes apparent that this is only one tool among many and that it is applicable to a very narrow set of policy areas that meet specific risk criteria and financial thresholds.

Several organizations, including American Progress, McKinsey & Company and, in Canada, the MaRS Centre for Impact Investing, have published research and guidelines for the implementation of SIBs. The following are two major challenges commonly identified by researchers and consultants.

Design of metrics is critical. A pay-for-performance scheme will work only if the performance measurements are strongly correlated with a program’s overall social net benefit. Metrics that are too narrow or only partially related to the comprehensive social benefits will reward investors without fully realizing savings and benefits for the government. One way of dealing with this is to base the payment on the measurable savings to government. However, McKinsey & Co. caution that this is easier said than done:

Much of the discourse on SIBs emphasizes the financial savings that government may realize by replacing more expensive remedial programs with less expensive preventive interventions. However, multiple funding streams, limited data systems, and lack of cross-agency coordination may inhibit government’s ability to fully recognize the financial savings from a SIB. While some stakeholders describe this as more an accounting problem than a savings problem, in our view, SIBs are primarily a vehicle for scaling up a preventive program that delivers significant social impact rather than a reliable source of cost savings.

Additionally, in order to credibly measure outcomes, the government may need to determine what the outcome would have been without the intervention. This requires a control group, which speaks in turn to the importance and challenge of defining the treatment population.

Interventions must have high potential net benefits. Since some interventions will fail, the rate of return to investors on successful interventions will have to be quite high. This in itself will narrow the number of policy areas where SIBs are deemed suitable and will force government to thoroughly consider the net benefits of targeted interventions to broader government programs. As mentioned above, assessing these overall benefits can be an extremely difficult accounting exercise for governments.

Last but not least, there is the critical question of what happens to the individuals in the treatment population when interventions fail. Like any private company, bond issuers will not hesitate to shutdown the whole production if it appears that they are not on track to getting paid. To deal with this risk, public administrators will have to build contingency plans into contracts so that failures do not result in excessive harm to treatment populations. This means that government may not be able to shift all of the investment risk onto the private sector, and that in order to limit potential damage, SIBs may only be feasible in areas that are not considered to be core services.

Taking it Slow

Overall, the potential benefits of SIBs are large, but the pitfalls are also plentiful. The U.K. government’s enthusiasm for SIBs may be contagious, but governments should nonetheless avoid applying this new tool as a fiscal panacea. After all, we don’t have to look too hard to find examples of the dramatic failures that can be caused by the hasty acceptance of new financial innovations. Canadian governments at all levels will be well served by partnering with social entrepreneurs to identify and implement an array of small, local pilots, while simultaneously working to further develop the measurement and evaluative capacities necessary for a more significant application of new social financing schemes.

Matthew Higgins is a 2013 Master of Public Policy candidate at the School of Public Policy and Governance and holds a Bachelor of Science in Electrical Engineer from the University of New Brunswick. Matthew has worked as an asset management engineer with electricity utilities in Toronto and as a policy analyst with the Ontario Ministry of the Environment. He spends his free time performing with Toronto/Montreal indie band The Bawdy Electric.

Further Reading:

McKinsey & Co.’s From Potential to Action: Bringing Social Impact Bonds to the US

Jeffrey Liebman’s Social Impact Bonds: A Promising New Financing Model to Accelerate Social Innovation and Improve Government Performance

The MaRS Centre for Impact Investing: http://socialfinance.ca/

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