Social Impact Bonds Could Influence Nonprofit Fundraising

(Part one in a three part series on social impact bonds)

A pioneering system for enacting social change yielded its first results late last year, answering few questions as to its efficacy, cost-effectiveness, and future import.

Social Impact Bonds (SIBs) – a transatlantic phenomenon with enthusiastic support in both the United States and Great Britain – first emerged on the philanthropy scene in 2010. Writing for Harvard Magazine at the time, Ashley Pettus describes SIBs a means to “offer governments a risk-free way of pursuing creative social programs.”

The “risk-free” nature refers to the use of private investment for social spending, thereby eliminating the public’s financial liability in the event of the project’s failure.

In theory, this is how an SIB functions: it involves an intricate arrangement, spanning government, nonprofit, and private sectors. First a government defines a social issue and policy objective, replete with a measurable outcome and a timeline for the project. The government then contacts a nonprofit intermediary whose job is to secure investors for the project. With funding secured, the intermediary then employs and manages front-line service nonprofits to pursue the project’s objectives.

The contract delineates the terms of success. If the project meets or exceeds its goals, a predetermined metric dictates the return-on-investment for the project’s backers. This means that – in the event of success – the government guarantees the upfront investment, paying it back in full, and additionally rewards the investors for sparing the government future social spending costs. If the project fails, the investors suffer losses and the public is (theoretically) off the hook.

According to supporters, the appeal is manifold – SIBs limit the taxpayer’s risk in social spending, encourage innovation in solving social issues, and also incentivize investment in pro-social causes by rewarding investors for successes.

In the United States, the enthusiasm and intellectual backing for SIBs stems largely from the faculty at Harvard. Jeffrey Liebman – Malcolm Wiener professor of public policy at Harvard and former acting deputy director for policy of the Office of Management and Budget for the Obama Administration – released a report in conjunction the Center of America Progress in 2011 that extolled the virtues of SIBs. Liebman went on to found the Harvard Social Impact Bond Technical Assistance Lab, funded by the Rockefeller Foundation. The institute pairs government agencies with Harvard fellows who assess agency capacity for implementing SIBs.

The model has broad political support, with the Obama Administration (the president himself a Harvard alum) budgeting $300 million for future SIB-related projects. A bipartisan group of Representatives introduced the Social Impact Bond Act, which would implement the president’s SIB allotment.

If SIBs take hold, there are huge implications for the nonprofit sector, according to Key Elements Group President and CEO Lynette Zimmerman. “This has the potential to become a major shift in the way non-profits provide programs and leverage public grant dollars,” Zimmerman explains. “Over the past several years public dollars available to non-profits have decreased. Monies set aside for SIBs could be a new funding source for organizations quick to position themselves.”

Currently, the national value of SIB investments in United States is small. There are approved or pending projects in 16 states, plus Washington, DC. New York and Massachusetts have pursued the model most aggressively. The city of New York struck a $9.6 million deal in 2012 with Goldman Sachs and the nonprofit MDRC to reduce youth recidivism at Riker’s Island. Gov. Deval Patrick of Massachusetts introduced the nation’s first competitive bidding program for SIBs in 2012.

For all of the enthusiasm and slow-but-steady proliferation of projects, there are virtually no results available in order to access the model’s effectiveness. The only available results are from the very first SIB, initiated in the UK, which had its first review in August 2014.

The results were inconclusive. The project is sponsored by the Ministry of Justice, with funding from the national lottery. Social Finance UK – intermediary SIB booster funded by big philanthropies such as the Rockefeller foundation and the Omidyar Network – raised 5 million pounds from private individuals and hired two nonprofits with the goal of reducing recidivism at the Pertersborough prison in East England by 7.5 percent by 2016. If the rate fell by 10 percent by late 2014, the investors would enjoy a first round of payments.

Recidivism rates fell short at 8.4 percent. If the project continues at this rate, however, investors will receive their money back by the end of the program, with an additional 13 percent profit.

These modest gains were deemed insufficient by government officials, who cancelled the third trial group for the project. The individuals that would have been in the program will instead be a part of a national program that functions similarly to an SIB except for one major component – it will not have any investors anticipating financial rewards. These sort of policy shifts are one of the chief dangers that analysts predict could curtail the effectiveness of SIBs, which are data-driven projects that accumulate actionable information over time.

There are other criticisms. Some specialists argue that the projects do not actually save or free up public money, since the amount raised by investors is budgeted and set aside by the government. Additionally, the metric for deciding returns on investment could pose steep loses for taxpayers and arbitrary earnings for investors. Budget analyst Kyle McKay testified about Massachusetts SIBs before the Senate Budget Committee that while private backers are providing only $12 million in SIB funding, the state is on the hook for $27 million in payments.

Lastly, if SIBs become a dominant means for funding social spending, investors could use data to cherrypick projects that are likely to succeed, thus neglecting the very pressing and more challenging social issues that the model was designed to address.

This is all speculation, however. With only one data set describing only a portion of a long contract, the Peterborough project does inspire concrete conclusions. What is for certain is that with bipartisan support, intrigued investors, and groups such as Bloomberg Philanthropies willing to backstop loses on some SIB projects, the model will be around for the foreseeable future. We’ll stay up-to-date on the issues, looking at what the growth and mutation of SIBs means for nonprofits.

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