Social Impact Bonds: Do Benefits Outweigh the Drawbacks?

December 13, 2013

Through some combination of interest and luck, I have been listening to a lot of discussion of Social Impact Bonds, which are also known as Pay for Success programs, recently (see below for sources/more information).  Social Impact Bonds are a form of nonprofit financing where a group of investors fund a nonprofit program which then reduces future government costs.  When the nonprofit succeeds, the government repays investors under the terms of a pre-negotiated contract.
Like most people (especially, perhaps, people my age (30, this year!) and others who generally believe in the power of “new” ideas born in our generation), I have maintained an optimistic, if skeptical, opinion of the promise of Social Impact Bonds.  We have heard a lot about the benefits of SIB programs.  Although I won’t expand on these too much (you can find more discussion elsewhere), I’ve compiled some that have been repeatedly mentioned to me:
1) They bring new sources of capital to nonprofit programs (private investment, government funds, and foundation endowment capital), providing social programs with an opportunity to grow to scale.
2) They increase incentives for nonprofits to focus on productivity and outcomes.
3) When state budgets are tight, SIB programs are something that Democrats and Republicans can agree on and sell to constituents.
However, despite these benefits, I have also started to think about potential drawbacks of this type of financing, and especially the drawbacks of promoting it as a particularly promising solution to social problems.  These drawbacks are mentioned far less; in fact, if I had not been weaving together subtle comments made by several of these sources, they may not have stood out to me at all.
1) Nonprofit programs vary in their appropriateness for SIB programs. This is because SIB requires results that are easy to quantify and write legal contracts around.  Furthermore, these results need to be observable in a relatively short period of time to satisfy bond holders who prefer quicker returns. Finally, since programs rely on government cost savings to repay investors, certain types of nonprofit missions are better fits (especially those related solely to special education and criminal justice outcomes).
2) SIB programs require significant up-front costs and contracting expertise.  Initial study of the program must include rigorous statistical studies (indications of likely results or “proof-of-concept”) to quantify the risk and negotiate contracts.  The number of parties involved in the deals adds to the difficulty.  In addition to the nonprofit, SIB programs require political will (which entails political “champions”) and sophisticated partners in the government department that will provide the return.  Furthermore, there must be a group of investors willing to accept below-market returns (who may be harder to find if the number of SIBs increases and this type of project becomes less marketable or trendy). Finally, the projects require philanthropists to provide start-up funding. As any person who has worked in the nonprofit or public sectors knows, difficulty rises exponentially as the number of players grows.
3) SIB programs change the government-nonprofit relationship. If SIBs change expectations regarding the “standard” of government support for nonprofits, the nonprofit sector may face a permanent change in the types of benefits that government officials expect from them.  In effect, nonprofits may be giving up the old arrangement of grants and contracts forever, furthering a marketization of the sector. (This may be an avenue for research: Does SIB funding crowd out other types of government funding in the long term?)
While these drawbacks may not be novel to those most heavily involved in the world of Social Impact Bonds, I believe it is useful to make the potential drawbacks of these financing streams more apparent to those on the fringes of the discussion, such as policymakers and nonprofit board members.  These leaders are often called on to make decisions about new financing options but have little time to study the deeper issues involved.  It is up to the experts and leaders of this field to be transparent about both the benefits and costs when promoting this type of “new” and “exciting” financial arrangement.
** This topic has been raised briefly at several Foundation Impact Research Group (FIRG) seminars this fall.  In addition, Sanford’s Center for Child and Family Policy recently welcomed Jeff Liebman, a Harvard economist who has consulted with several governments implementing these types of programs.  The topic has been of interest to the Human Capital and Economic Opportunity Global Working Group (HCEO), which I follow. And, it came up in discussions of nonprofit finances and income stream resilience during the recession at the most recent Association of Researchers on Nonprofit Organizations and Voluntary Associations (ARNOVA) conference this November.
 

Blog Topics

Danielle Vance-McMullen

Events

Oct 05

Rip Rapson
President and CEO
The Kresge Foundation