Social-Impact Bonds (SIBs) have gained a lot of attention since their launch in 2010 by UK based Social Finance. Heron’s Clara Miller weighs in with her own nuanced take on SIBs this week in the Chronicle of Philanthropy. While we love to see innovative thinking in nonprofit financing, Miller points to some potential flaws in the SIB model, including their high cost and the inherent complexity of social issues. It can be very difficult to bring all the actors involved into an agreement on things like repayment structures, allocating risk or deciding on impact metrics. Similar problems have occurred in older pay-for-success attempts such as shared-energy savings deals during the ’70s and ’80s. In these cases, a company would provide new equipment and collect some share of savings from the owner until their investment was paid off with interest:
The Achilles’ heels of the bonds are their complexity and transaction costs. People are infinitely more complex than boilers or valves, and the bonds invite as many as five — or even more — parties to a transaction in addition to the energy contractors. Those parties can include, say, ex-prisoners or low-skilled workers, the nonprofit that provides a service, a government agency, an intermediary, an evaluator, and the investors.
If the market found shared-energy savings complicated, imagine something as complex as prison recidivism: What is reoffending: the same offense? A lesser one? Where? For how long? Who decides? Who adjudicates if there’s a disagreement among the parties? What if something unanticipated happens? What if the main parties go out of business?
I fear that even skilled nonprofits and intermediaries will have trouble translating great ideas into contracts that really provide the right incentives. When you look at how the parties do the accounting, how they measure “savings,” how they decide what the return should be and to whom at various break points, it gets inelegant, to say the least.
Some deals that we have seen don’t balance the interests of the parties well. Nonprofits often take more risk than they should, and investors take less.
What’s more, nonprofits build their efforts around one transaction rather than focusing on how to strengthen their services over all. The government gets a lower return on investment, typically to court investors by offering, for example, guarantees. The group handling the transaction is often left with highly complex and difficult negotiating, monitoring, and organizing tasks for very little money.
SIBs may also open the door for incentivizing post-hoc fixes over preventing social issues in the first place:
Perhaps another reason not to see social-impact bonds as a panacea is this: They tend to focus financial resources on remedies that have the most reliable and short-term savings.
Thus, they work most straightforwardly for problems that have become so bad that the cost to help the incarcerated, the seriously ill, and others in need is the highest, the remedy closest to the incurred costs, and the financial savings high and relatively easy to measure. That’s fine unless it means that we trade this low-hanging fruit for much more desirable but tough-to-measure long-term social investments…
The real bulls-eye is for youthful offenders never to enter a prison, that they be born healthy and grow up in happy, stable families with a working parent.
It’s important that universal prenatal care, great preschool, and school, college and trade-school scholarships, not to mention living-wage jobs for parents, get the lion’s share of investments and attention, even though these investments may not “pay off” with high margins for investors and may be prohibitively expensive to track. In the words of a major investor, we don’t want social-impact bonds — or social investment in general — to be “stuck in prison.”