Social Impact Bonds: a beginner's guide

At face value my offer is fantastic news. The more sceptical amongst you might ask how certain is that future payment. For example, if it is only 50% likely then the deal is only break even (ignoring inflation). Any worse than that and you’ll lose money. At this point I’ll have to admit that the £100 isn’t a certainty. Fair enough, I say, let me sweeten the deal a little more. I’m so confident about the future saving that I’m prepared to spend the £50 myself, right now, out of my own pocket. All I ask is that you sign a contract agreeing that if the full saving does materialise you’ll pay me £60 (to cover the £50 I spent plus £10 for my trouble). This really is a no-lose situation. In the worst case scenario you save nothing, but have spent nothing. In the best case scenario you get £40 for doing nothing.

Early intervention

This week’s review of Early Intervention (PDF, 1.2MB) by Graham Allen MP is the latest report to suggest this kind of financing mechanism as a possible solution to a previously intractable set of problems. Allen focuses on the first few years of a child’s development pointing out that if a child has the right start in life this radically improves their life chances and reduces future costs to the state by breaking the connection to longer-term social problems such as joblessness, drug and alcohol abuse, family breakdown and crime. The state should be happy to agree to a contract in which the providers of children’s services today are promised a payment in the future if social outcomes are improved. In turn, the providers of those services should be happy to sign up to such a contract if they are confident that they can achieve the desired outcomes and that future payments will at least cover their costs.

How Social Impact Bonds differ from outcome-based contracts

So far, what I’ve described is an outcomes-based contract. A Social Impact Bond takes this one step further by opening up the financing of the deal to third parties. So in my original example, that’s like a rich friend of mine lending me the £50. To be fair, I would then have to pay them a share of the return as well but this might be fine if I’m motivated by doing my good work rather than making money. That, in essence, is a Social Impact Bond (‘bond’ is a misnomer as the payments aren’t guaranteed). As you may imagine, the basic model can be tweaked in as many ways as financial whizz kids can think of. For example, the savings can be split in different proportions between the different parties, payment schedules can be flexed, different sources of finance can be blended together etc. So, SIBs appear to offer the government a risk-free way of financing innovative new services. Does this mean they can help solve the financial crisis? Sadly not, as my other blog on Social Impact Bonds explains.