Canadian Research Center Explores Limitations of Social Impact Bonds

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January 19, 2015;Canadian Centre for Policy Alternatives

As Social Impact Bonds have spread in terms of their acceptance in a variety of nonprofit, investment, and government circles, there are more reports from policy research centers (as opposed to SIB promoters and institutional investors) exploring the potentials and limitations of the tool. One recent report is from the Manitoba office of the Canadian Centre for Policy Alternatives. The brief report, co-authored by John Loxley and Marina Puzyreva from the Department of Economics at the University of Manitoba, provides useful data on SIBs and some provocative ideas to consider.

On the data side, Loxley and Puzyreva count 23 SIBs in five countries either being implemented or close to being implemented. Fifteen are in the UK, but the four U.S. SIBs they write about involve much more funding: The four U.S. SIBs add up to $57.1 million in comparison to the 15 UK SIBs, accounting for only $54.5 million. Social impact bonds addressing recidivism among people released from prison account for nearly 44 percent of the SIB dollar investments, programs on children 29 percent, and employment 13 percent. Thirty more SIBs are in the works.

The analysis that Loxley and Puzyreva generate hints that SIBs may be something of a new generation of public-private partnerships. They cite Heather Whiteside’s characterization of public-private partnerships “as a specific form of commodification of public services by the private sector, a form of dispossession which benefits private capital at public expense,” an intriguing approach that is just about never heard south of the 49th parallel, where public-private partnerships are viewed uncritically as an automatic good thing.

Like public-private partnerships, where much attention goes into creating “enabling fields” of “legislation, government policy, budgetary practices and institutions and lobbyists,” Loxley and Puzyreva note a similar set of activities worldwide to lay the groundwork for successful SIBs. “There is, indeed, evidence of widespread activity in the development of necessary background supports for SIBs,” they observe, “including significant government subsidization directly through the guarantee of returns to private investors or indirectly through project grants.” NPQ has noted the same in the U.S. in the form of subsidies such as grants from the Social Innovation Fund to SIB packagers and resources from private foundations such as Pritzker, Bloomberg, and Rockefeller that subsidize or guarantee returns to institutional investors.

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The two Manitoba economists share Nonprofit Quarterly’s cautiousness about the small sample size of SIBs from which SIB enthusiasts draw their conclusions: “Only six SIBs have been completed and there is information on outcomes for only two of them, but this does not deter proponents from waxing eloquent about the success of the approach.” The same probably applies to SIB skeptics, though detailed information about even the handful of SIBs with significant histories of implementation should point to new areas for research. For example, they quote David Ainsworth in an article from Civil Society, examining the first highly publicized SIB, the Peterborough prison recidivism project in the UK:

“The pricing structure for the first SIB was inevitably pretty finger-in-the-air, because no one quite knew what could be achieved. In order to tempt government into putting up the money, the first SIB made some stretching promises. And even then the Big Lottery Fund had to promise to put up much of the cash to pay for it. As far as I can see, future SIBs have been priced in a way that’s more generous to the investor, and indeed, several of them have already paid out.”

Loxley and Puzyreva conclude with a note of caution about SIBs that seems as much focused on values and ideology as the specific mechanics of SIBs. They cite the opposition of the Alberta College of Social Workers to SIBs because of their opposition to the commodification of human suffering with a concern that “the motive becomes profit, not service.” However, in public policy that frequently involves or even relies on the involvement of private capital, with both liberal and conservative governments almost equally obsequious to the owners and managers of private capital, the primary concern of policy makers regarding SIBs seems to have been making the profits for investors attractive and safe through mechanisms for reducing or virtually eliminating risk or subsidies to boost returns.

What are we testing in the current crop of SIBs? They quote David McDonald, who wrote in 2013:

“There is no free lunch with the social impact bond model. Make no mistake: the government always pays. Even if the project misses its targets, investors will be paid off so that they’ll pony up for next year’s bond. Otherwise, the house of cards collapses.”

That may be the ultimate problem. If the emphasis is to find projects that involve minimal risk and to craft mechanisms that guarantee investors’ returns, Canada, the U.S., and the UK may be missing the boat on deploying private capital to test social programs where private capital might really do good—to front-end ideas that are not so proven as to be nearly automatic, and to provide working capital to the smaller, community-based nonprofits that might have amazing innovations in the works but for their lack of access to the capital markets.—Rick Cohen

  • Terry Fernsler

    “There is no free lunch” Not only may governments be missing the boat on innovation investment, perhaps Goldman Sachs et al have found a new “bubble.” The scheme reeks of snake oil–an effort to make money from something not necessary, while the institutional investors externalize the real cost of social programs.

  • Veronica Michel

    We need to bear in mind that a market for SIBs is at a experimental phase. At this stage, the mechanism is being explored as a tool for social programs to leverage the forces of financial markets in order to scale impact. The problem is that this market is yet non-existent. Financial markets respond, in the best case, to available information that enables investors to assess risk and expected returns, and in a less optimal case, to heuristics. The small sample of SIBs that are out there does not provide enough hard data nor a good amount of experience to inform investors. In other words, the ecosystem is not yet ready to attract investors seeking solely for a monetary return. Hence, the willingness to test out this model is mostly coming from the Government or Philanthropists who want to produce social outcomes at the time they make a better use of their money (as it is put into evidence-based interventions).

    This is the status so far. And the examples of SIBs that are cited by the researchers are indeed pricing “in a way that’s more generous to the investor.” However, as the market matures and and it becomes easier to monetise social impact, every participant of the model (government/donor, service provider and investor) will be in a position to negotiate what combination of risk and benefits entailed by the model is most adequate for each of them. Indeed, the idea is that a SIB works because it aligns the incentives of each agent and balances their interests, this balance is precisely reflected in the price metric and payment schedule agreed upon.

    Above all, SIBs, as implied by the name itself, are about generating social outcomes, about paying for impact, about improving lives. This objective cannot be overlooked and outweighed by the potential financial return that could be perceived upon success of the social program. And I see how this element is being misinterpreted by some, particularly by the Alberta College of Social Workers who expressed that SIBs are turning “human suffering and conditions into commodities” and that people are making profits “from the misery of others.” This is a very limited and misleading view of the SIBs. In order to make use of financial markets to drive social outcomes, a SIB has to monetise social impact. This does not mean assigning a value to the lives of the vulnerable. It is impossible to assign a monetary value to all dimensions of the impact that a social program can have. The purpose of monetising is to enable measuring results and to assess the cost-effectiveness of a project. In other words, it is a way to make sure that what we are spending is actually improving the lives of those we care about. Thus, is also pushes governments to be accountable and transparent.

    Are investors taking advantage of the misery of others? Can we make this judgement only because they might receive a financial reward if the program achieves the expected outcomes? How should we judge then that the World Bank and other development banks charge poor countries lending rates that even reach 60% values? Not to mention that governments have to pay back these loans even if the anti-poverty program being financed does not produce the expected benefits.

    So even in this piloting stage, where investors are not taking up the full risk of program failure, the SIB comes out as a better alternative because it splits risk between investors and the government or philanthropists. However a SIB is meant to bring in investors with social objectives, who are willing to take up more risk of losing their money if the project fails, and as the market matures and SIBs a proven to work, we need to start pursuing this transition.