Social Impact Bonds – “Pay for Success” in the Social Services Arena
Philanthropy. We, optimists, see it as a way to try to fix a broken world but somehow, no matter what we do, the world just stays broken! But, then again, even assuming that we, as a society, can actually agree on which social ills need fixing… is philanthropy the way to do it? Many people would argue that society’s ills are just too great for philanthropists to tackle without massive governmental assistance. Others would argue that government creates more drag on the social system than the ills it cures. So, what is the answer?
Perhaps it lies at the intersection of philanthropy and capitalism. 
In 2010, an innovative financial instrument tied to the achievement of social goals made its appearance in Great Britain. Called a “social impact bond” (SIB) the concept combined private investment with a specific government-sponsored project designed to achieve a certain social goal. If, according to predetermined metrics, the goal was achieved, the investors would get some or all of their money back along with a rate of return. If the goal was not achieved, the investors would lose their money. Any repayment of the debt would come from the savings in costs enjoyed by the sponsoring governmental unit.
Such bonds are in the truly embryonic stage here in the United States and given their complexity and risk profile, may have a hard time gaining traction as real investments. At this point, Massachusetts and New York lead the nation in their development but, even there, the concept is experimental and little more than a dip of the toe in the water. Nevertheless, if some of these projects can be even partially successful, the way could be paved for the development of a new form of social investing.
Now, of course, such funding is not philanthropy, since a positive rate of return is expected and desired. Instead, SIBs are profit-driven investments whose success is based on the attainment of socially desirable goals. For those of us who believe in the financial market, it is the possibility of this rate of return that makes the very idea of SIB’s a potentially viable alternative to plain, old fashioned “tax and spend” government social programs. Let’s use New York City’s Social Impact Bond, the first operational SIB in the US, as an example. Its goal was to fund a program called the Adolescent Behavioral Learning Experience (ABLE) at the city jail at Rikers Island. ABLE aims to equip incarcerated adolescents between the ages of 16 to 18 with the social and emotional skills needed to help them make better life choices when they leave jail. The theory is, the ability to make better life choices will lead to reduced recidivism, which will lead to reduced financial and other costs to the City. To be sure, I would call this a true “BHAG” (Big, Hairy, Audacious Goal) but certainly one worth pursuing at some cost. In a nutshell, here’s how it works:
- In this case, the commercial lender/investor is the Urban Investment Group of Goldman Sachs Bank USA. Their investment of $9,600,000 was turned over for administration to the intermediary, MDRC, a nonprofit social policy research organization. MDRC worked with the various partners to identify the project and negotiate the terms of the SIB. In addition, it currently oversees the day-to-day implementation of the program.
- Bloomberg Philanthropies is the philanthropic investor, which has provided a grant of $7,200,000 to partially repay Goldman Sachs if the project fails. If the project is successful, the money will be rolled forward and used to backstop future projects.
- The Osborne Association and Friends of Island Academy actually administer the ABLE program at the jail. They are the boots on the ground, so to speak.
- The New York City Department of Corrections has agreed to repay the loan based on the inmate participation rate and the resulting rate of reduced recidivism (as defined).
- To keep everyone honest, the Vera Institute of Justice serves as the independent evaluator who will determine whether the project has achieved the desired goals.
The project was started in 2012 with a five year window. Several things have to happen in order for Goldman Sachs to be repaid:
- Over the first four years, there must be a minimum of 9,420 participants in the program
- If recidivism does not decline by at least 8.5%, there will be no payback
- Reductions in recidivism between 8.5% and 10% will cause one half of the investment to be repaid
- A 10% reduction will be the investor’s “breakeven”, with the full $9,600,000 being repaid, but with no additional rate of return
- Above 10% will cause “success payments” to be made, which essentially represent the rate of return on the investment
Interestingly, even with a 10% reduction in recidivism, the cash savings to the taxpayer are estimated to be less than $1,000,000. On a purely financial basis, this does not make sense. In fact, the financial investment breakeven from NYC’s viewpoint occurs with a recidivism reduction of around 15%. While the hardheaded financial analysts among us might find this “new math” a bit hard to swallow, one must realize that a successful social program will produce many other, not-so-easily-quantifiable benefits, such as safer neighborhoods and a more productive workforce. Certainly an argument can be made that these goals are just as important as the hard dollar cost savings enjoyed by Rikers Island. At this point, however, the jury is out on its overall effectiveness.
What struck me in a negative way about this project was the sheer audacity of the goal compared to the extraordinarily meager investment. I mean, c’mon – $9.6 million from Goldman Sachs? It’s barely a rounding error on their balance sheet, so where is the real risk? Nevertheless, I am rooting for its success. The fact is, as a society we need to employ out-of-the-box thinking to more seriously address such social issues, which is pretty difficult in these resource-constrained times. Investing a few bucks to reduce recidivism? Let’s give it a shot – it’s gotta beat banning large sugary sodas at the bodega!
