Can You Make Money and a Difference With Social Impact Bonds?

There are many things you can do with your money, which is one reason why so many people want more of it.  Among your options are investing it to (hopefully) increase your wealth and donating it to charity to help other people.  The ability to both gain more money and help others, though, has proven surprisingly difficult to achieve.

That might be changing, though.  There is a new development in the funding of social programs, known as Social Impact Bonds (also known as ‘Pay for Success' Bonds, at least in the United States).  Although the term ‘bond' is used to describe them, they don't work like the bonds issued by companies or governments to fund their activities, where an investor receives interest on a regular basis until their initial investment is returned.

The first social impact bond revolved around, you guessed it, jail.

Instead, with a Social Impact Bond, the investors' money is used to fund the initial stages of a socially oriented program, attempting to solve social issue.  If the program is a success, meeting an objective measure of success (such as decreasing recidivism rates amongst a prison population, as with a United Kingdom pilot program), the government will then pay the investors back, possibly with a bonus (a bit more on that later).  If the program isn't a success, then the government owes nothing.

The Advantages of Social Impact Bonds

You can probably see one of the main advantages of Social Impact Bonds, the fact that the government only pays for success.  Rather than the current funding model, where the government spends first and hopes for desired results later (and seldom even bothers to check whether the program had the desired effect), Social Impact Bonds enable the government to only pay for successful programs.  This means that not only will the government not have to pay up front when trying to accomplish a set goal, but it might not even have to pay at all.  It's possible that a program could even be a partial success, but if it does not meet the agreed upon goal, the government would not owe anything.

Social Impact Bonds would also enable more creativity in fixing social problems.  Because they focus on the end goal, rather than the process used (as many government directed efforts tend to do), it gives entrepreneurs and others the chance to try different approaches to solving a problem.  If they can get investors to provide the money by offering a plan with a reasonable chance of success, such Social Impact Bonds could open the doors to a wide variety of approaches, many of which might not even be considered by traditional government program funding mechanisms.

Of course, there are advantages to the investors, as well.  As mentioned at the beginning of the article, normally you have to choose between giving your money to charity or having the potential to turn a profit.  If you invest in a social impact bond, though, you could do good while still having the possibility of getting your money returned to you (possibly with a bonus, even a substantial bonus, attached).  This could increase the amount of money given to social programs; if such giving turns into something more like investing, there might be more people (and organizations) who considered such investments as a valuable way to diversify their portfolio.

The Potential Downsides

With such advantages, why did it take until last year for anyone to consider this method of funding social programs?  Well, as with all good things, there are some downsides.  Firstly, it only works with social programs that have measurable, quantifiable results that can be attributed to a single cause.  The UK program mentioned above uses the recidivism rate of a population of a specific prison, which will be measured compared to the rate of similar prison populations.  Trying to create a social impact bond without specifying the population or controlling outside factors would make it difficult to ascertain whether the program funded by the bond is having the appropriate impact.

The results also have to be assessed by trusted, independent professionals.  There need to be a method for determining when results have been achieved, as well as what the results would have been without the intervention.  Given that there is incentive to both exaggerate the success (by the investors) and downplay it (by the government, seeking not to reimburse the investors), being sure to find an auditor of the results whose conclusions will be acceptable to all parties involved is necessary for these bonds to function properly.

Finally (at least of the issues I will discuss) there is the potential that the bonds could cost the government more than running the program themselves.  If the social impact bonds are seen more as an investment, and particularly a high-risk investment, then investors will likely demand a high potential return (much as you would demand more for a junk bond compared to a safer investment).  If the one-third failure rate speculated by the Center for American Progress is accurate, there might need to be rates of return on the remaining projects as high as 20+% annualized rates to induce investment in them.  Such high rates could end up costing the government a sizable amount for successful programs, and thus, lead to higher tax rates.  (On the plus side, in such a situation investors could find themselves considering social impact bonds as a sizable portion of their portfolio, greatly increasing the amount of money available for such projects.)

My Thoughts

I'm definitely quite interested in seeing what happens with social impact bonds in the future.  They seem to provide an interesting alternative to direct government funding for a variety of programs, and depending on the levels of risk and return involved, could prove a decent investment opportunity, as well.  It'll be interesting to see how many projects get funded with this mechanism in the future.

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