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The Most Exciting 0.003% of Obama’s Budget: Social Impact Bonds

Buried deep within President Obama’s $3.7 trillion budget is a tiny little item that might just change public finance forever … if it works.

Well it’s tiny by comparison anyway. President Obama is asking for up to $100 million — less than 0.003 percent of his overall proposed budget — to pilot a brand new way to pay for public services called the Social Impact Bond. The plan uses private, profit-motivated investment money to fund public services up-front. The government only pays if the services deliver as promised, and only out of government cost savings. No taxpayer money wasted on failed programs in this plan.

Seem too good to be true? Yeah, maybe it is.

"This is the difficulty for government. They don’t want to invest twice," says Toby Eccles who came up with the idea in England with his nonprofit Social Finance. "So if you invest in prevention, and it doesn’t work, you still have to pay for the problem down the road, and then you spend money you don’t have," he says. So he created the Social Impact Bond to shift the risk to the sector more accustomed to operating under uncertainty.

"There are a whole range of social issues, where if we get better at preventing them, then prevention is cheaper than cure," Eccles says. "That’s something that is hard for government to commit to," especially in tight fiscal times like the current ones, but private investors are used to paying up front and waiting for results.

In the past, if governments tried to pay only after success, the charities carrying out the services—and they are usually charities—had to wait several years before being reimbursed, not something many could afford. The Social Impact Bond solves this prevention payment paradox by using other people’s money to fund prevention, and the profit incentive to attract that money.

In the original pilot in Peterborough, England, begun last year, investors hope to earn between 7.5% and 13% annual return. The aim of that Social Impact Bond is to lower recidivism of released prisoners, which is currently above 50% for the cohort they are targeting. If the Ministry of Justice can get that figure down low enough, then they could close a wing of a prison or cancel plans to build a new one. That’s where the profit opportunity comes in. Still, it’s important to note that the scale of this Peterborough pilot isn’t quite large enough to close any prisons, so this time it will be subsidized by a quasi-government foundation, as well as the Ministry of Justice cost-savings. Those are the "costs of building a marketplace," Eccles says.

Social Finance has rounded up $8 million from private investors, in this case mostly foundations and socially minded investors, to pay for a suite of programs including job training, family counseling, or drug treatment if necessary. And Social Finance doesn’t just fund the community groups carrying out the services. It also plays a role in designing the program and monitoring progress—in a sense, it’s behaving just like any shareholder would in a traditional equity investment. The results are carefully monitored against a control group—a side effect of a proliferation of Social Impact Bonds would be a lot more rigorous impact measurement around government services.

To get paid anything at all, the investors in the Peterborough program must reduce the recidivism rate by 10%. They get bonuses for higher rates of reduction, but the most they can earn is a 13% return. That should be enough to attract private investors into this impact investing market, not just foundations.

Kristin Giantris of the Nonprofit Finance Fund is looking to replicate the bonds here in the U.S. "We have an overall lack of money for social problems," she says. "There is no question about it. And this structure leverages different and new and outside capital." But what really excites her is the chance to do a better job at solving social problems.

Giantris suggested one area of opportunity for Social Impact Bonds in the U.S. would be something known as supportive housing: paying to keep people in homes so they don’t reach the streets where health risks—and costs—spike, among other dangers. She expects to see as many as five pilots in the next two years in this and other areas.

Both Giantris and Eccles say they are getting a lot of attention from socially motivated investors who want to see their money do good while earning a profit. Even investment banks and pension funds are exploring the idea, they say. So the biggest challenge then is creating the bond.

Picking the right local government partners and sorting out how to measure results that can straddle government agencies requires a level of cooperation some agencies aren’t accustomed to. For instance, who should pay out of savings if that supportive housing program lowers ER visits by the uninsured but also keeps extra kids out of shelters, in school, and, in the process, lowers crime? The health department? Human services department? Should it come out of the prison budget? These questions don’t have answers yet.

Social Finance just opened an office in Boston to start sorting out the details like they did in Petersborough. The Nonprofit Finance Fund is in talks with multiple local governments who want to test the idea as well. And why wouldn’t they, if the plan fails, the government doesn’t spend a dime. No wonder why Obama was willing to increase funding on this one little area.

[Image by Bill Koplitz]

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