Social Impact Bond

What Is A Social Impact Bond? 

A "social impact bond" is a payment contract based on results or success, which connects financiers with social interests and operators or social organizations to provide public and/or social services to the vulnerable population efficiently and innovatively. 

The financial instrument disburses resources from private investors to improve the quality, coverage, or results of the assistance services that government entities are obliged to guarantee. 

On the other hand, activities are contracted in traditional contracting schemes for state social programs, hoping that the final results will occur, but with no guarantee.

Examples of measurable results in these bonds are:

• The employability rate

• Percentage of non-recidivism in prison

• Coverage

• Improvement of health services, among others

In this sense, the State entitles that contract will only pay for the successful results obtained. The risk of unsuccessful results is transferred to the financiers, not the service operators.

This scheme makes it possible to align the incentives of each of the actors involved in the operation of the Bonds, which is reflected in the fact that the Government manages to solve social problems efficiently and on the required scale. 

Finally, investors can find a space to generate social impact, which otherwise would never generate these opportunities, and monitor their investments to improve their performance and achieve the desired result and impact.

The main benefits and uses of the model are to test new intervention schemes to solve social problems, where the public sector is aware of the costs required to attend to it and is part of the prioritized agendas.

It also allows the scaling of existing solutions with evidence of positive results achieved, where cost efficiency opportunities can be recognized when implementing the project on a larger scale.

A new form of financing assistance services

A new form of public-private association has been structured to finance public policy programs worldwide.

These are payment contracts based on results or success, which articulate financiers with social interest and operators or social organizations to provide public and/or social services to the vulnerable population efficiently and innovatively.

Although the implementation of these bonds has not been massive, as it is a figure that seeks to solve complex social problems with the participation of the private sector, its implementation is inevitable; hence the importance of understanding what it is, what its structure is and what advantages it brings to society.

It is important to clarify that they are not necessarily bonds in their common sense; they may not be the security massively placed in the stock market and have a fixed interest rate in addition to the return on investment. 

These seek to obtain private financing to develop government programs of a social and preventive nature aimed at vulnerable people or communities or those with specific needs. 

The entity makes your repayment using a new financial instrument called Social Impact Bond. The private sector is financing, structuring, and implementing programs to improve the performance of public services, such as wealth and education. 

It is a new device starting to be developed worldwide that could positively impact the most vulnerable communities or sectors without public funds being disbursed in advance. 

Indeed, even though the State makes a repayment, the same is subject to verification of the improvement of metrics for the performance of the public service in place.

Participation of the private sector in state activities has been successful in most cases; having it involved in finance and the design of social programs should have equal results.

For example, through a public-private association of this nature, the private sector commits to the government entity to reduce the rate of adolescent pregnancies by 7.5% over the next three years through the implementation of prevention programs financed with private resources.

If the goal is achieved, the private party has the right to be paid the agreed price by the government entity, which may include an interest rate. Otherwise, the private party loses the investment.

Background of the social impact bond

The first bond of this type was launched in the United Kingdom in 2010. It consisted of a pilot scheme to reduce criminal recidivism rates among prisoners in Peterborough jail who were released after being sentenced to less than 12 months. 

The bond, worth £5 million, was used to design a welfare program to help ex-convicts find employment, health care, training, and a place to live. 

The benefit was clear: as the Social Financing organization (FS) explained, "fewer delinquents will commit fewer crimes, which would imply fewer jails that would cost less." 

According to an investigation, an 8.4% decrease in the recidivism rate was achieved through the project.

Since Peterborough, the use of these types of bonds has expanded globally. According to FS data, there are 70 projects under structuring, and 89 bonds have been issued in 19 countries, which include:

• The United Kingdom (33) 
• The United States (16)
• The Netherlands (7)
• Australia (6)
• Canada (4)
• Portugal ( 4)

Which have obtained USD 322 million, of which 113,643 people have benefited.

As of 2016, 60 of these bonds had been issued, of which 22 reported compliance information, 21 indicated positive social results, 12 made partial payments in favor of investors or allocated the resources to be reinvested, and four projects had been fully paid.

Actors in Social Impact Bonds

Different actors participate in structuring projects associated with this type of bond. In the first place, there is the government entity, which is the one that contracts the service, determines the indicators, and makes the payment if it is verified that the goals have been met.

Precisely for verifying the goals and the fulfillment of the objectives, an independent evaluating entity also guarantees transparency and objectivity, ensuring that state resources are paid to the private sector when the objectives have been met. 

There must also be an operator, manager, or service provider, who is in charge of designing and executing the social assistance program, and a private investor, who is the one who disburses the resources and receives payment against verification that the results were achieved. 

Among the most frequent groups of investors in social impact bonds are:

• Private equity funds

• Pension funds

• NGOs

• Foundations

• Investment banks

•  The community or groups of people who benefit from the program.

These funds focus on improving the situation of the same community or group of people by celebrating several contracts with government entities that pursue the same objective, with the resources obtained from private investors (such as Deutsche Bank, the European Investment Fund, and pension funds).

Intermediaries in Social Impact Bonds

In addition to the above actors in social impact bond funds, intermediaries and entities are dedicated to structuring these types of bond programs and bringing participants closer together.

Despite the models that have been adopted, there is all the flexibility to structure this type of program, even through mechanisms similar to project financing.

In this scenario, a special purpose vehicle would be constituted, which is the one that enters into all the contracts with the State, with the operator, with the evaluator, and with the investors, and who receives the payments from the State based on the success of the program to be later repaid to investors.

However, the success of the project financed through the bonds depends on the structure of the program and the operator since the private sector's payment of the resources disbursed by the private sector is only made if the previously defined goals. 

By assuming the risk of the impact sought by the financed program, the private sector becomes deeply involved in selecting the service provider, the program's design, the monitoring and surveillance of its development, and the supervision of the management of the resources.

To the extent that the design and execution of the program by the operator are effective, not only is the financing repaid, but society obtains the benefit sought through the project.

Verification of the Metrics 

First, the program must have statistical information on the problem it intends to manage to assess the results of the program. Likewise, the program must have identified the affected population that will benefit from its implementation.

The program must also allow for measuring the expected results reliably and objectively.

Finally, its implementation must represent a saving for the government entity due to the attention and early prevention of risk situations.

This requires the entity that designs the metrics and manages the program, which may be the intermediary, to be successful and reliable. Indeed, it depends on the manager or provider of the service that the program benefits the people whose situation is to be improved. 

It also depends on it to obtain the resources with which the program will be financed, for which it must adopt solid and attractive structures for investors that, in a certain way, ensure the return on their investment. 

Finally, it depends on the manager that the state entity can save resources in the correction or care of situations effectively prevented or mitigated through the public policy programs thus financed.

The Social Impact Bond in the US

In the US, some states have started implementing SIBs, including New York, Massachusetts, and Utah. The first SIB in the US was introduced in New York in 2012 to lower recidivism among newly released inmates. 

The investors would receive a return on their investment if the initiative achieved its objective. For example, SIBs have been used in Massachusetts to fund programs addressing chronic homelessness and improving at-risk youth's educational outcomes. 

In Utah, SIBs have been used to fund programs that provide early childhood education and prevent homelessness.

In Chicago,a USD16.9 million social impact bond was launched in 2014 to finance the expansion of an educational model developed by a center that provides high-quality education services (Child-Parent Center CPC).

This model was intended to benefit 2,620 preschool-age children from low-income families. The program aimed to prepare at-risk children to reach their full potential in school and life by improving the quality of early education, thereby reducing the need to provide special education services.

The bond was financed by the Goldman Sachs Social Impact Fund and Northern Trust as senior lenders and the JB and MK Pritzker Family Foundation as subordinate lenders, who will only repay their loans if students achieve positive academic results.

According to the evaluation of the cohort results published in April 2016, 59% of children who participated in the CPC program in preschool achieved academic results that exceeded the national average.

A successful example of a SIB in the US is the New York State Workforce Reentry Program, which aimed to reduce recidivism rates among those leaving the criminal justice system. 

A SIB provided funding for the program, and research showed that it successfully lowered recidivism rates and saved the government money.

There have also been objections to SIBs. Some claim that they consider private investors' interests over program participants' needs and threaten to divert funding away from other crucial social programs.

While there are obstacles to their implementation, the merits of SIBs, such as the capacity to move risk away from the government and attract new sources of money, make them viable for attaining beneficial social results.

The issuance of social impact bonds in Latin America

In Peru, the first social impact bond was launched in January 2015 to help the Asháninka indigenous people of the Ene River valley grow cocoa and coffee with the quality necessary to participate in the international market so that the product could improve the quality of health, education, and infrastructure.

In Chile, with the support of the Inter-American Development Bank, through the FOMIN, and FS, the possibility of implementing the figure to meet the needs of young unemployed women, repeat offenders, and child neglect has been explored. 

Likewise, Brazil and Mexico have been working on implementing these instruments.

In Colombia, the first social impact bond was created through an alliance between the Department of Social Prosperity, BIDFOMIN, the Swiss Economic Cooperation, the Corona Foundation, the Mario Santo Domingo Foundation, and the Bolí var Davivienda Foundation.

Through this project, Colombia not only becomes a pioneer in this type of bond in developing countries, but it will allow the generation of models and knowledge to carry out projects of this type on a larger scale. For this purpose, two other social impact bonds are being implemented: 

1. One that seeks to create a market to strengthen the local capacities and knowledge of the different social impact bond actors to support the development of pilots; 

2. The other is to generate knowledge, dissemination, and scalability to systematize the experiences acquired.

If the program is successful (for example, the decrease in school dropout or the rate of malnourished children is verified), the Government saves resources that it would have to manage later to correct the problems that were not addressed on time as higher costs in the subsidized health system to care for the malnourished population.

Said savings will serve as a source of repayment for the private investor. It also allows the Government to transfer the risk of managing prevention programs to the private sector, allowing it to focus on issues that require priority attention. 

Last but not least, these bonds become one of the tools that allow the State to fulfill the essential purposes of its creation, which, in the Colombian case, is described as "serving the community, promoting general prosperity and guaranteeing the effectiveness of the principles, rights, and duties enshrined in the Constitution” (art. 2 of the Political Constitution of Colombia).

Although investment in these areas usually has nominal rates, the risk of financing unsuccessful programs should be less to the extent that the results of the programs are measurable so that the return on investment is guaranteed. 

Social Impact Bonds and their Benefit to Society

Preventive care for vulnerable and neglected communities through the management of prevention programs’ high-quality projects developed by experts, financed by private parties, and paid by the State only against successful results translate into a more inclusive, efficient, and responsible society. ¿

In Colombia, at least, countless social problems could be addressed through this type of financial structuring, such as reducing malnutrition rates, child abuse, and adolescent maternity. 

Undoubtedly, the generation of formal jobs is on the table, especially considering the reinsertion of the FARC and ELN guerrillas into civilian life, not to mention the creation of programs to improve and protect the environment. 

As these funds are just beginning, their success will depend on the results of the pilot programs. Nevertheless, it is at least encouraging to know that major investment banks are participating in this financing in addition to development banks such as the IDB and the foundations described in this column.

The initiative of the Colombian government to launch pilot social impact bonds in the region is also to be applauded. Success should be guaranteed with the level, experience, and responsibility of the public and private entities involved in this first project.

Researched and authored by Sebastian Girault | LinkedIn 

Reviewed and edited by Parul Gupta | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Bonds
• Discount Bonds
• Junk Bonds
• Sovereign Bonds
• Zero-Coupon Bonds