Sometime ago I was reading a book on innovations. In one of the chapters, the author had created a list of innovations that were great in design but were unable to sell. It was a long list of technology products such as Google Glass. A key reason for limited uptake was the high risk associated with purchasing a product whose value proposition and usefulness was not clear in the minds of its customers and stakeholders. By the time I finished reading it, I had mentally added Social Impact Bonds (SIBs) to the list.
Since the world’s first SIB was launched by Social Finance UK in 2010, there have been more than 70 SIBs launched across 18 countries. About 25 such SIBs have served populations of less than 1000 persons. The smallest SIB has served 22 people while the largest has supported about 9000 people . In general discussions around pay for success (P4S) products as SIBs, we often hear that these products are not standardized for scalability. We are also not sure of their ability to create positive impact on target populations.
In this essay, I will explore the fundamental structure of SIBs and the reasons for the above criticism. I will also evaluate their impact on different stakeholders, the challenges to scale and how best we can innovate on traditional SIB structures to make them effective.
I. What is a SIB?
SIBs are contractual agreements amongst philanthropists, impact investors, government, nonprofits and monitoring agencies to implement preventive measures for better social development. The government pays the investors based on achievement of performance targets as agreed upon in the contract amongst the parties. The structuring process is as follows:
a. Outcomes funders such as the government will commit initial capital to solve a social challenge. This initial capital is paid out at the end of each year of the program and is funded by the cost savings to government achieved through the improvement in social outcomes.
b. Investors such as philanthropic foundations pay the upfront working capital which is disbursed to service provider nonprofits. Sometimes investors are also referred to as intermediaries or an intermediary can also be a nonprofit which raises capital from philanthropic investors.
c. Service providers nonprofits deliver the required interventions and improve the outcomes for the target population over a given time period.
d. Outcomes are measured and verified by a third-party evaluator. The performance outcomes are measured using a control group experiment which runs for the duration of the program.
e. If the outcomes are achieved, the government repays the investors. If the said targets are not achieved, the government is not obliged to pay. For performance exceeding targets, the investors get a bonus which is capped to an agreed-upon limit.
In the above series of transactions, there is some value created for every stakeholder:
a. Outcomes funders/governments: SIBs transfer the risk of financing interventions, only paying for better outcomes whilst avoiding paying for interventions that fail. SIBs allow governments to have access to more data on their target populations and help them with better policymaking.
b. Investors: SIBs provide better value for philanthropic capital as the investors demand more alignment with outcomes. Though many investors do think that the financial upsides for them are very little and risky in SIBs. This has been further elaborated in Section III.
c. Nonprofits and evaluators: They receive a service fee through the duration of SIBs.
Overall, SIBs provide a system which enables diverse actors to work together and capture the best contribution from every stakeholder. Due to these reasons SIBs have been able to attract sustained attention. The structuring of SIBs around prevention rather than remediation brings better social value. By continuously focusing on program related data, financial management, and real-time management control over service delivery, SIBs are able to create better outcomes and value for money invested. These P4S instruments seem like win-win contracts for all. So, what are the challenges in scaling SIBs? Turns out, there are many.
II. Challenges in Scaling SIBs
Before we define the challenges, let us establish the meaning scale in the context of SIBs. At a program level, SIBs cannot potentially impact the entire populations. For example, the education budget of India’s public system is about $75B (3% of GDP) and there is an expected gap of another $70B to improve the quality of public education . Expecting SIBs to solve the problem at this scale of entire country would be unfair as the donors won’t be able to provide budget for these outsize costs. However, it would be ok to compare the impact of SIBs at the level of sub-populations. For example, a SIB could help to tackle the high female child dropout rates at the primary school level in a given state in India. Such a scale would be more meaningful and viable. In terms of the minimum number of people required, a SIB should at least serve 200 people such that the impact created can be attributed it and not to any external events. Adequate size of the target population is also critical for program economics to work. For example, the overhead costs that include legal fees, monitoring and evaluation costs, planning and due diligence are all fixed costs and are worth incurring if the project corpus is at least $20M (in the US). Now that we have established our definition of scale, let us look into the challenges that stop SIBs from achieving this level of scale.
a. High transaction costs: Analyzing current data, picking an intervention to focus on, implementing the intervention and measuring outcomes require significant amounts of capital. High degree of customization required for structuring each SIB project and ensuring delivery of services to the target populations requires a large percentage of total corpus to be allocated to these activities. For example, an education SIB in India has earmarked as high as 10% of the total corpus to transaction costs. This means the investors’ payout needs to be significantly north of this cost to make this financially viable for them.
b. Rigorous monitoring and evaluation processes: It is essential to measure the outcomes as they trigger repayments for investors, but the measurement process itself is so time intensive and is often done by using randomized control trial studies which are not very ethical (in the sense that one group receives the service and the other does not). For investors, these costs may be a necessary evil when evaluated in the context of their payouts. For example, investors do not get paid if the said project achieves a 9.5% in reduction of recidivism versus a 10% reduction which has been agreed upon as the payment benchmark. This factor impedes growth in investor interest and reduces the momentum required for replicating such interventions at scale .
c. Limited provider capacity: A biggest challenge to scaling SIBs is the lack of high-quality nonprofits in the particular area or sector who could ensure quality service at scale to the target populations. Often these nonprofit providers are concentrated in different locations and work on specific items like education or agriculture. For large scale deployment, it is necessary to partner with multiple service providers or conduct capacity building for existing providers. This would increase costs and decrease the momentum of service delivery.
d. Transparency, safety and liquidity: So far, most SIBs have been negotiated as legal contracts amongst multiple parties. They are private arrangements for commercial lending with payouts dependent on certain results. This structure does not allow for much transparency and liquidity and restricts scaling and democratization in terms of retail accredited investors being able to sign up for it.
While these challenges seem huge, it would be too early to dismiss SIBs as not being able to scale as a capital solution to social problems. I propose the following changing to improve implementation and to ensure scaling of SIBs.
III. Changing the design of SIBs
The single most important factor that will allow scaling of SIBs is bringing alignment with broader reform agenda of the state or the county officials . Because implementing a SIB requires significant investments of time from these government officials, it is critical for intermediaries to find an official champion for their cause.
The other two important changes are in the areas of building trust for investors and capacity for service providers. For investors , it is critical to create financial instruments that help them feel more comfortable and secure about returns. SIBs accompanied with tranched debts will allow institutional investors to lessen their risk and invest their money into the debt class best suited for their risk-return-impact expectations. SIBs accompanied with credit ratings will enable more transparency and encourage investors who are yet to participate in this market. There could be other aspects of financial engineering to enable more liquidity and democratize SIBs for retail investors. The institutional investors could be allowed to share some of their risk with retail investors via instruments such as minibonds. Also, loss guarantee structures could be set up, in case the government is unable to pay, the guarantor could step in its shoes. These instruments will enable flow of more capital to the space and will also reduce the burden of high costs for the key investor. For solving the challenges related to scaling implementation, programmatic partnerships are key.
The nonprofits partners can train the existing public institutions for program delivery. Using mobile phones as a medium for outreach and service delivery wherever possible could be another method for scaling. Lastly, technology can also aid in easing monitoring and evaluation processes and the associated costs. For example, instead of conducting rigorous control group experiments, mobile based surveys can be used to collect data from a large group of participants. Statistical models can then be built to measure outcomes for the customers of the SIBs.
As SIBs operate in a multi-party, public-private partnership structure, aligning incentives for all the stakeholders becomes extremely important. With better financial engineering and use of technology for service delivery and outcomes measurement, these products can scale and foster better participation from public and private sectors.
2019-3-7-1551929841
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