Social Impact Bonds: What’s the deal?

They are being touted in some quarters as the solution to the funding crisis in public services. A way of bringing private sector investment to address social issues. Perhaps, even, as the successor to the Private Finance Initiative (PFI). But what are social impact bonds and how do they work?

For a start, they’re not bonds in the traditional sense. And they are still very new, so it’s a little early to say exactly how they will work. But essentially, a service delivery body (usually one or more third sector bodies) contracts with a public sector commissioner to deliver a specific and pre-defined improvement in a particular population of service users.

This could include, for example, a reduction in re-offending rates for recently-released prisoners, a reduction in the number of people being admitted to hospital with a particular condition, an improvement in the number of young people finding jobs or a reduction in the number of people sleeping rough in a particular town or city.

So far, all pretty standard. The difference with social impact bonds, though, is that the funding to carry out the intervention is provided by one or more investors. These investors will probably be from the private sector, but could equally be public or third sector organisations themselves.

The role of the investors is a bit like that of venture capitalists. They fund the intervention, but – and here’s the kicker – they only get a return on their investment if the intervention meets specific improvement targets. This is why I said that they are not bonds in the traditional sense, as bonds usually come with a fixed rate of return.

If the specific outcomes defined by the commissioner are not achieved, then the investors could lose out in a big way. But if the outcomes are achieved, usually measured on a sliding scale, then the investors earn a return – potentially up to about 12 or 13%, depending on the intervention’s performance.

This approach to financing service delivery has its advantages. It may, for example, open up a whole new area of funding by engaging with private sector investors. It also helps to manage risk for the public sector commissioner, as they only pay out if the intervention achieves the desired outcomes. And it promotes effective evaluation of services, to identify what works in achieving particular outcomes and what does not.

It does have a downside, though, too. Interventions financed through social impact bonds are likely to focus on ‘quick wins’ in order to meet quantitative targets, so may not be suitable for deep-seated problems or for working with hard-to-reach groups. Furthermore, because they focus on specific pre-defined outcomes, social impact bonds may be inflexible to changing circumstances (a criticism often levelled at PFI projects) and blind to other benefits that are achieved. They also rely on being able to measure the impact of the investment, which will be possible in some cases but not in others.

From an investor’s point of view, social impact bonds may be too small scale and in too unfamiliar an area to warrant closer inspection. They also offer very little in the way of liquidity, so unless and until a market for the bonds develops, investors will have to be in it for the long haul. It is also likely that investors will want some say in how their funding is used, which may not be welcomed by the bodies delivering the intervention.

The biggest criticism of social impact bonds, though, is ideological. Like the Private Finance Initiative, they turn the delivery of public services into a profit-making activity. They make it about money, rather than about people. This will sit uneasily with many in the public and third sectors. But if they can bring additional funding to help solve even some of the problems that we face as a society, then they might just have a place in our social investment portfolio.

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