How can governments fund programs to address urgent social problems, even with tight budgets? And how can they do so in a data-driven way that informs future policy? The answer for some municipalities is a new financing mechanism called social impact bonds or SIBs.

What Are Social Impact Bonds?

Despite their name, SIBs are not bonds in the traditional sense. Also known as pay-for-success financing, they are contracts in which governments raise funds from private investors interested in social impact investing and work with external social service providers to achieve a specified, measurable outcome. The financial risk is borne by investors: If the initiative succeeds, they receive a return with interest. If it fails, they do not.

More than 100 SIBs have been commissioned globally, from Bogotá to Boston. They focus on a diverse range of services such as training refugees, supporting micro-enterprises, preventing diabetes, and housing the homeless.

Issued in 2010, the first SIB aimed to reduce recidivism rates among former inmates of Peterborough Prison in eastern England. With funding from 17 investors, seven service providers worked with ex-prisoners who had served sentences of less than a year to address substance abuse and mental health problems. The result was a 9% reduction in recidivism rates, well above the 7.5% target, and a 3% return for investors.

In a more recent example, the Massachusetts Pathways to Economic Advancement Project was launched in 2017. It provides workforce development services to immigrants and refugees with $12.43 million from 40 investors.

It remains to be seen how effective SIBs will be over the long term.

Investing in Social Impact Bonds

A wide array of investors, from banks and individuals to donor-advised funds and foundations, participate in SIBs. Some appreciate the tight alignment of social and financial goals, as investors receive a return only if the planned outcomes are achieved. There is also the potential for returns not correlated with stock markets and other factors.

Industry experts advise that SIBs are not applicable to every government program, since projects need to have clearly defined, measurable goals. Other important considerations include the availability of historical data and the likelihood of a program to be sustained by more traditional financing mechanisms.

There are also challenges in implementing SIBs so that they make a significant impact on social problems. Critics say social impact bonds are just too complex and unwieldy. They also contend that, by placing performance requirements on service providers, SIBs may unintentionally introduce the wrong incentives; they say it is unethical to assign a financial value to improving the lives of disadvantaged populations.

It remains to be seen how effective SIBs will be over the long term. In the meantime, governments and social impact investing advocates will continue to experiment with the approach as a cost-effective way of addressing urgent social problems.

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