What are Social Impact Bonds?

These are a recently designed social investment instrument that aims to earn a return for investors based on the cost savings to the UK government gained by funding preventative measures in social and healthcare services.

A captivating start for SIB’s in the UK 

After months of preparation, a pilot scheme for a social impact bond, recently launched in the UK, looks set to be oversubscribed. In partnership with the UK government, a social investment organisation called Social Finance is raising £4.9 million for the scheme to reduce re-offending rates among a category of prisoners in Peterborough. The bond will be providing funding for support by the voluntary sector for 3,000+ prisoners over the next six years.

The social outcome of the project will determine the returns to investors. For example, suppose the rate of re-offending by the prisoners after they leave jail goes down by at least 7.5% compared to previous statistics. In that case, the investors will pay the investors a return made possible by the government’s future cost savings. Therefore, the return on investment will increase in proportion to the reduction in the re-offending rate, up to a maximum of 13%.

 Reallocating public sector organisations efforts

The opportunities for cost savings from preventative measures arise because of the government’s spending on many health and social issues. It focuses on dealing with the consequences of social problems rather than their cause through expensive interventions to deal with urgent health and social matters.

The idea behind the SIBs is to tackle the causes of the social problems behind the headline health and crime figures, getting to the root of the issues. This, it is hoped and expected, will deal with many problems before they become critical. In addition, this will generate financial returns for the investors by reducing the need for long-run government expenditure in dealing with the acute social and health problems that would otherwise arise further down the line.

Funds made available by investment in SIBs will reverse what is seen as the negative cycle of government spending – the lack of resources available for early preventative intervention leads to adverse social outcomes and ultimately to higher government spending to intervene as crises arise at a later date.

Social finance – Getting the sums right

SIBs are based on a contract negotiated by the issuers with the UK government. Importantly, the agreement must precisely define a target population, the criteria for success of the project for which funding is being made available, and the value to be put on this success in terms of the cost savings, leading to a calculation of the return investors.

For example, the recently-launched SIB defines the target population as a certain group of prisoners at Peterborough serving less than 12 months. The success matrix would relate to a reduction in the re-offending rate by at least 7.5%.

The trickiest calculation is the valuation to be put on cost savings if this goal is achieved – the reduced long-term government spending, in terms of protecting the government’s machinery of justice due to the reduced re-offending rate.

We must compute the savings for a range of different project’s successful outcomes to calculate investment returns. If the required level as defined in the contract is not achieved, the investors do not receive any return on their investment.

Everyone’s a winner

The UK would use the investment to fund a range of interventions. While traditional government funding focuses on certainly required outputs such as numbers of prisoners attending a training course or volunteering for a work exercise, the funding from the bonds will support suitable measures concerning the outcome of the project. Success is not measured by the number of prisoners attending a course but by the number who do not re-offend after finishing their jail term as a result of several different initiatives.

This focus on the project’s outcome enables the funding to be used on various interventions that work towards the targeted result. In addition, the upfront funding provided by the bonds allows even smaller, local service providers to participate in projects. In contrast, their participation would normally be limited owing to their lack of funding.

The UK government is in the enviable position of only being required to pay a return to the investors if a successful outcome is reached. In contrast, the investors have a reasonable expectation of a reward based on the project’s development, combining a social and financial return on their investment.

Going straight

Although investors in the recent bond issue were mainly organisations with social objectives in mind, the long-term aim is that social impact bonds will become more accepted by the mainstream investment community and take their place in the portfolios of ordinary investors. This would open up large social services and healthcare areas to the possibility of funding by private investors.

The scope for designing similar bonds in other areas of the social and health budgets is wide, and the possibilities for government savings (and returns to investors) are immense. According to the organisation Social Finance, future objectives for social impact bond issues could include:

  • Initiatives to reduce the number of residential placements for children in care;
  • Measures aiming to reduce the need for young people to enter pupil referral units; or
  • Projects to improve community care and reduce acute hospital admission.

The UK government is currently faced with an urgent need to decrease its spending across the board and look at new ways to involve private funding in public projects. The social impact bond could help the government to get out of jail for good.

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