Can Social-Justice Minded Investors Change How Cities Do Business – Next City

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Can Social-Justice Minded Investors Change How Cities Do Business

Are Social Impact Bonds a Long-Term Solution For Underfunded Public Programs?

Story by Esha Chhabra Twitter

Published on Jun 23, 2014

While other millennials scramble to find work in the worst job market in a century, 26-year-old Jessica Pierre is finding jobs for other people — for one of the toughest-to-employ demographics there is, in fact. Her clients aren’t recent college grads looking for office gigs. They’re men and women recently released from prison preparing themselves for life on the outside. Her latest client: a 19-year-old from Queens locked up for robbery.

“It’s a challenge,” Pierre said, “getting them to see the value in getting a job, especially when you’re young and there are other things you want to be doing.”

Pierre works at the Center for Employment Opportunities (CEO), a New York City-based non-profit, that recently received $13.5 million to help New York’s formerly incarcerated find and keep jobs. It’s a tough line of work, but rewarding. After a few hiccups, Pierre was able to direct her young client to a steady paycheck earned by answering calls for a customer service company.

“When I see people my age, going through their life struggles, I’m really amazed at what my life could have been,” she said.

Pierre is one in a growing class of non-profit professionals participating in what could be one of recent history’s more consequential experiments in public service financing: the great social impact bond test. A social impact bond, or SIB, is the next big thing in public-private partnerships, and could rewrite the rules of the game when it comes to government-funded social services. Essentially, it’s a financial instrument that enables government to partner with private investors to pay for social service programs. SIBs give the corporate world a financial stake in the well-being of the most vulnerable citizens. Perhaps most crucially, they provide the government a cushion against financial losses, allowing normally hamstrung taxpayer-funded agencies to take risks and innovate. A SIB is what delivered CEO $13.5 million to work with formerly incarcerated men and women and, increasingly, it is attracting the interest of philanthropists, commercial investors and public officials across the U.S.

What makes an SIB different from a plain old grant or loan is a unique structure that demands that all the services it pays for have a quantifiable impact. If the impact is achieved, the group that paid for the service is eligible for a return on its investment. It’s the same calculus that drives the NASDAQ, applied to “industries” that work for the greater good.

It works like this: A financial intermediary finds investors for an organization, typically a non-profit like CEO that would get taxpayer money from a government agency — the government is ultimately the “client” in this set-up — to provide public services. Everyone agrees in advance on what outcomes are expected and how impact will be measured. Once the service provider completes the job, an outside evaluator determines if the goals have been met. If they were, the government agency pays back the investors in full along with a positive return commensurate with the savings and benefits achieved by the public sector.

If the desired outcomes weren’t achieved, the agency isn’t on the hook, and the investors do not get repaid with public funds. Instead, they can write off the investment as a donation or grant. It’s a gamble on good.

The model pivots on the premise that taxpayers alone cannot pay for social services — and especially can’t afford to lose money on programs or take risks on untested strategies, and that inhibits innovation.

“This is really a way for government to do business differently,” said Eileen Neely, the director of capital innovation for Living Cities, a collaborative of 22 foundation and financial institutions that has invested in two SIBs, including CEO’s $13.5 million fund. “It is a way to make sure government is getting the outcomes it wants for the money it’s spending.”

For CEO in New York and other non-profit service providers, the difference between a traditional grant and an SIB is huge.

Center for Employment Opportunities (CEO) relied on funds secured through a SIB to hire job coaches to work with formerly incarcerated men and women. (Photo credit: CEO)

Investor dollars provided through SIBs don’t have the limitations of project grants or government dollars; they offer a new freedom.

“The unrestricted funding is what allows me to make decisions and deploy resources with flexibility,” said CEO’s director, Sam Schaeffer.

A New Financial Tool

Pierre’s work at CEO connecting the formerly incarcerated to employers typifies the work that is now being supported by the U.K.-born financial instrument. Six of the dozen American SIBs now in existence focused on keeping men and women with criminal convictions out of jail. Recidivism is a good fit for the tool because of the huge amount of money money spent remediating cycles of incarceration. The U.K.’s Ministry of Justice recently found that across the U.K. short-term imprisonments were followed by high reoffending rates, with about 60 percent of offenders sentenced to less than a year in prison ending up back in the system.

Meanwhile, the prison capital of the world, the United States, releases about 700,000 individuals from prison each year, according to the Bureau of Justice Statistics. More than two-thirds of these individuals are behind bars again within three years. Simultaneously, prison spending is on the rise: It’s the second-fastest-growing state budget item following Medicaid. That doesn’t even count, of course, the billions of dollars in social services spent to assist the formerly incarcerated who come home and don’t return but can’t find steady employment or support their families.

But need alone isn’t enough to make the case for impact bonds. SIBs are also known as the “pay for success” model, and what distinguishes recidivism as particularly suitable for the tool is its wealth of metrics. A state can determine the hard costs of sending an offender back to jail and it can count the savings reaped if that same offender, instead of returning to a state bed, gets a job and begins supporting himself.

The very first social impact bond in the U.S. is financing a recidivism project at Rikers Island prison in New York, where half of the men released on a given day can expect to eventually return to a cell. Launched in 2012, the $9.6 million SIB aims to reduce the rate of recidivism by at least 10 percent over four years.

SIBs give the corporate world a financial stake in the well-being of the most vulnerable citizens.

Backed by Goldman Sachs and Bloomberg Philanthropies with a 75 percent guarantee (of $7.2 million) from Bloomberg Philanthropies, Goldman Sachs will, even if the project fails, lose only a little less than $3 million because of the guarantee from Bloomberg. If the project succeeds in reducing recidivism by 10 percent, Goldman Sachs will be repaid the full amount. If recidivism drops in excess of 10 percent, Goldman Sachs could make as much as $2.1 million in profits.

As word of SIBs spreads, interest from the commercial financial sector is growing. In late 2013, Bank of America Merrill Lynch established its first SIB: the bond to support CEO’s work in New York. In 60 days, Bank of America managed to raise money for the $13.5 million fund — an impressive pace for an investment without any certain return. A whopping 90 percent of the investor fund is reserved for CEO to use to achieve its goal of reducing recidivism by least 8 percent and/or increase employment by at least 5 percent. The remaining 10 percent goes to overhead costs bore by Social Finance US, the financial intermediary that manages the bond and the American cousin of Social Finance UK, the social impact investing group that created the first SIB to serve a prison outside of London, in the town of Peterborough.

The money came from foundations and wealthy individuals, including former U.S. Treasury Secretary Lawrence Summers, Utah philanthropist James Sorenson and Bill Ackman of Pershing Square Foundation, and is backed by a 10 percent loan guarantee from the Rockefeller Foundation. (Rockefeller is also a supporter of Next City.) The five-and-a-half-year project could yield returns as high as 12.5 percent for these investors — return that is proportionate to the savings and benefits achieved by the public sector, Social Finance US says.

The largest social impact bond in the U.S. to date is financing another recidivism reduction program, this one a partnership between the Commonwealth of Massachusetts and Roca, a non-profit organization with a track record of keeping young men out of prison. There, success will mean achieving a 40 percent reduction in days of incarceration. According to the state, that level of impact would generate budgetary savings for Massachusetts equivalent to the cost of Roca’s services, and if that is achieved, investor Goldman Sachs will make back its initial investment of $9 million plus five percent annual interest. The other two investors — Kresge Foundation and Living Cities — will be repaid their principle investment of $1.5 million each and a base annual interest rate of two percent. (Grants from the Department of Labor and foundations will cover the project’s remaining costs.)

Ronald Birkmire Jr. is one of millions of Americans who faced a difficult time finding work after release from prison. Through a program supported by the city of Philadelphia, he eventually found employment. (AP Photo/Matt Rourke)

In the past year, interest has moved beyond the sphere of criminal justice with Goldman’s third SIB supporting early-childhood education in Salt Lake City. In Cambridge, the Harvard Kennedy School’s Social Impact Bond Technical Assistance Lab is working with 10 governments — Chicago, Colorado, Connecticut, Denver, Illinois, Massachusetts, Michigan, New York, Ohio, South Carolina — to develop strategies for using SIBs. South Carolina, for instance, is keen on using an SIB to help lower the state’s high infant mortality rate. America’s Health Rankings placed South Carolina at the bottom of a national ranking in infant mortality.

Meanwhile in May, Washington, D.C. announced a partnership with Social Finance US. The city hopes it will lead to the development of an SIB that would be used to finance services aimed at reducing teen pregnancy and improving education outcomes in the District.

“A social impact bond has the potential to catalyze significant improvements in some of our most pressing social challenges by scaling up solutions that require considerable up-front capital to implement,” D.C. Mayor Vincent Gray told reporters when he announced the initiative.

Even President Obama is jumping on the bandwagon. Obama’s 2014 budget allocated $300 million for a pay-for-success incentive fund that can be used to support social impact bonds. The federal support would be a step toward a U.K model. There, the federal government takes the lead in providing financial and structural support for SIBs, while in the U.S., each state and locality deals with the bonds on their own.

The Market’s Invisible Heart

The social impact bond is the child of Egypt-born, England-raised venture capitalist Sir Ronald Cohen. Heralded as the father of social investment, Cohen got his start at McKinsey as a consultant, after studying at Harvard Business School. In 1972, he left McKinsey to help establish one of Britain’s first venture capital firms, Apax Partners. The firm went on to fund companies such as AOL, making an enormous amount of money in the first dotcom boom. Eventually, Cohen left the firm to establish Bridge Ventures, a private equity fund specializing in social impact investing. The firm took off. In 2007, Cohen decided to take what he learned through Bridge and create Social Finance UK, a non-profit focused on creating financial structures to connect the market, government and society for the greater good. The flagship product for Social Finance quickly became SIBs. Cohen talks about impact bonds as a tool to unveil what he terms the “invisible heart” of markets: a beneficent alternative to the much-maligned “invisible hand” of markets.

Venture capitalist Sir Ronald Cohen parlayed a fortune made in the first dotcom boom into a second career as a social impact investor. He created the first social impact bond to service a prison in the U.K. (AP photo/KEYSTONE/Alessandro della Valle)

“All of a sudden, the non-profit realizes that it can access capital markets. It transforms the mindset of the non-profit,” Cohen said.

The first SIB brokered by Cohen attracted 17 investors who together came up with five million pounds (almost $8 million U.S.) to launch a “rehabilitation pathway” program in Peterborough Prison.

A collaboration between four organizations, the programs consists of seven steps that help those who have been in prison readjust to life on the outside and locate a job and, if needed, a place to live. In order for taxpayers to repay the investors, the reoffending rate must drop by 7.5 percent or more (within one year of prisoner release). If that happens, investors will receive increasing returns topped off at a maximum of 13 percent per year, spread out over eight years. Thus, a 10 percent reduction would mean 7.5 percent annualized return.

The Peterborough experiment has been widely hailed as a success. In April, the Ministry of Justice announced that while the pilot would end in June 2015 because of logistical demands, it had achieved its goals and reduced reconviction rates by 11 percent. During the same period, the national rate of reconviction rose by 10 percent, ministry officials noted.

“This is the most responsive resettlement service I have seen in my 25 years as a prison manager,” said Nick Leader, director of the Peterborough prison. “We are better informed on ‘what works’ and are translating this to broader resettlement strategy for all prisoners leaving Peterborough.”

As these bonds catch on around the world, Cohen, who chairs the G8’s social impact task force, is fixated on speed. Governments currently take about 12 to 18 months to commission a bond — a sluggish rate when bonds should really only take three to six months to authorize, he said. “We have to do a better job making the impact value equation clear to governments. That’s the selling point.”

Cohen envisions that the next big thing for SIBs will be mixed funds that allow investors to put money in a pooled fund made up of multiple projects. His company, Bridge Ventures, already offers one such SIB fund and so far, indications are positive. “People don’t just want to invest in one project,” he said.

In the meantime, Cohen’s invention is spreading internationally at a surprisingly fast pace. Already, SIBs are in use in Pakistan, India, Holland, Germany, Australia, Rwanda and Mozambique.

One of the more promising experiments is happening in India. Unlike the many recidivism projects that first took root in the U.K. and U.S., the country’s first SIB-in-the-works, established in June 2013, tackles girls’ education.

Led by Instiglio, a Boston-based non-profit social enterprise, the project, entitled Educate Girls, is going to measure success (and payment) by the number of girls retained in school.

Instiglio’s partner is Dasra, a Mumbai-based impact investor who has provided the capital to put a veritable army of girls’ education activists in 500 schools across 200 villages in the western state of Rajasthan. The project has been estimated at just $500,000, a modest sum given the size of the first social impact bonds in the U.K. and the U.S.

Across the world in Israel, Social Finance UK is beginning to experiment with how to use SIBs to tackle the tiny nation’s vast inequalities. It’s outlined four areas for future SIBs: increasing employment opportunities in ultra-orthodox Jewish communities, increasing employment opportunities for Israeli-Arabs, reducing recidivism, and tackling the growing number of diabetic cases by providing preventive care. They’re quite similar to projects being piloted in the U.S. and the U.K., only in the Israeli context.

Meanwhile in Latin America, the Inter-American Development Bank (IADB) announced a $5.3 million SIB fund for countries where it already operates. The money has been divided: $2.3 million will be allocated as grants to craft the SIB ecosystem in Latin America and the Caribbean, and $3 million will be for investments used to launch specific pilots.

Instiglio, too, has significant global ambition. In Mexico, the company is working with the Mexican Social Security Institute to create an SIB for control of diabetes, a leading cause of death in the country. In Colombia, Instiglio worked with a regional government agency on a study of school dropout rates and teen pregnancy. At the end of the study, the company advised the government on setting up an SIB to combat both problems.

Not a Cure-All

James Perry leads the U.K.-based foundation Panahpur, which means “place of refuge” in Hindi. A 107-year-old charitable organization, Panahpur decided about a decade ago to “realign” its investing with its philanthropy through social impact investing. The foundation, with Perry at the helm, set out to invest in people and projects that were reducing the inequality fed by Wall Street.

“The financial markets were operating in a way that was contributing to the need for charitable investments,” he said. “Simultaneously, charities didn’t have enough access to capital and didn’t have accountability.” Perry was among the first investors in on the Peterborough SIB and in the years since, has emerged as a vocal champion of the tool, continuing to work with Omidyar Network and Big Society Capital, a social investment bank chaired by Cohen, to set up a fund devoted to social impact bonds called the Bridges Social Impact Bond Fund.

The model pivots on the premise that taxpayers alone cannot pay for social services.

Still, he is not afraid to acknowledge the limitations — and unknowns — of the still-in-infancy financial tool.

“Not everything that counts can be counted, not everything that can be counted counts,” he said, quoting Albert Einstein. “We need to be very clear that social impact bonds are not a messianic solution,” he said. Vineet Bewtra, the London director of Omidyar Network, shares that concern. Though “the gamble seems to be paying off,” he worries about SIBs being “overhyped and untested.”

Others recall the financial meltdown of 2008 and fear that the new bonds could give rise to murky assets that would allow profiteering under the guise of social good. “There are a lot of social ills that SIBs should not be used for,” said Social Finance US’s director of knowledge management, Jane Hughes. “We worry about too much excitement, if that makes sense.” Still others question the government’s ability to ensure that deals are saving them more money than they are costing.

“There is a risk that improved outcomes won’t necessarily translate into cost savings for government,” said Living Cities’ Neely. “It requires discipline for government to change their spending habits once the outcomes have improved.”

The success of the bonds will depend on how government and the private sector react to unprecedented flows of information and capital and whether leaders on both sides are willing to take risks and welcome new partners to the table. When asked how she envisions the future of SIBs in American cities, Neely was succinct. “Anytime you do anything new, there are risks,” she said. “But with social impact bonds, the potential for improved outcomes and government savings is too high to disregard.”

Our features are made possible with generous support from The Ford Foundation.

Esha Chhabra is a journalist who covers social impact, technology for development and public health.

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