Market view e Insights
Public funds for health, education and social services are often lacking. But there is an innovative way to close this funding gap: social impact bonds.
Social impact bonds (SIB) are public-private partnerships that finance ambitious social programs. If successful, the government repays private backers for their investment with interest. And in some cases, these SIB projects even go on to become official government programs.
Despite the somewhat misleading name, SIBs are not securities that are traded on capital markets, but complex contracts between multiple parties:
They are usually developed and managed by an experienced project manager. SIBs follow the so-called pay-for-success model: whether investors are repaid depends on whether the program that has been financed achieves the desired social goals within an agreed period following an independent assessment. These criteria are set out in detail in the contracts upon which a SIB is based. The amount of interest paid, in turn, depends on the degree of success: if the program exceeds the agreed targets, for example, the financial gains for the private backers can be quite attractive.
The exact structure of SIBs can vary depending on their application, but for the most part, they follow the above format. For this financing model, the risk associated with innovative social programs does not, therefore, lie with the government, but is outsourced to private investors. This avoids taxpayers having to foot the bill for potentially unsuccessful programs.
Another instrument in this space is the development impact bond (DIB). In this case, the role of the government is assumed by philanthropic backers, who make repayments to investors if the project is successful. This variant is particularly attractive for those developing countries where governments simply cannot raise the necessary financial resources. In such scenarios, DIBs enable philanthropic investors to minimize their risk.
The world’s first social impact bond was launched in the UK in 2010 and aimed to reduce the recidivism rate of ex-offenders by providing post-release support. Repayments were conditional on a reduction in the recidivism rate of at least 7.5 percent over a six-year period. A 2014 interim report recorded an 8.4 percent reduction. As a result, the UK government decided to introduce a standard program that includes support services for former prison inmates tested as part of the SIB.
LGT Venture Philanthropy's portfolio also contains a number of success stories. For example, together with partners, the Indian organization Educate Girls launched the first development impact bond in the education sector in 2015. The results were published in the summer of 2018. Educate Girls achieved 160 percent of the agreed learning outcomes, and had also surpassed the targets set for school enrollment rates by an impressive 16 percent. As a result, the organization convincingly demonstrated not only the effectiveness of its work, but also set a strong precedent for the potential of DIBs. Following the success of Educate Girls, LGT Venture Philanthropy supported a bond in the area of early childhood development with the portfolio organization mothers2mothers in South Africa.
According to the database of Instiglio, an experienced SIBs and DIBs manager, more than 110 bonds have been and are being implemented worldwide since 2010. Social impact bonds have raised over 400 million USD in funding since 2010.
SIBs and DIBs cannot and should not replace other types of financing. They serve as an additional tool in the social investment space – with specific benefits: they increase efficiency and effectiveness in the use of public or philanthropic funds, promote innovation and create financial incentives for new actors to engage in the social or development sector.
The structure of the bonds is rigorous and requires that progress be measured consistently. As a result, programs can be adjusted more quickly making it more likely that the desired goals can actually be achieved. In addition, experience shows that SIBs and DIBs have also given rise to new approaches. By working together, the public and private sectors are now exchanging more information and developing a better understanding of each other. In addition, the structure of the bonds forces them to place a strong focus on results.
Opinions in the market are still divided: while some experts are already referring to SIBs as mainstream and established financial institutions are now also venturing into SIBs, others have justified concerns. Criticisms include the cost of structuring the instruments and the lack of clarity regarding financial returns. There are also concerns that SIBs require the public sector to be too accommodating to financial sector interests or that SIBs could damage the ethos of public service. Over the next few years, it will become clear whether the advantages or disadvantages of this approach prevail.
LGT Venture Philanthropy (LGT VP) is an independent charitable foundation striving to improve the quality of life of disadvantaged people, contribute to healthy ecosystems, and build resilient, inclusive, and prosperous communities.
LGT VP deploys philanthropic capital to organizations with effective, innovative, and scalable solutions to social and environmental challenges, thus directly contributing to the Sustainable Development Goals.
The foundation primarily supports organizations based in emerging markets, focusing on high-impact sectors, including education, health, and environment. LGT VP is the venture philanthropy arm of LGT Group. They are also happy to forward donations to the respective organizations.