Guest Post – Flaws in the Social Impact Bond Craze

A Post from Jon Pratt, Executive Director, Minnesota Council of Nonprofits

Social Impact Bonds is a concept that is definitely at a taking-off point, with some big money and very well-known supporters (Rockefeller Foundation, Kennedy School of Government, McKinsey, New York Mayor Bloomberg, Goldman Sachs, etc.).

However fast growing the Social Impact Bond promotion, there are several reasons to closely examine and question the claims made for SIBs:

First, it’s easy to see why this idea is attractive — if it could deliver more resources and better results, what public official or taxpayer wouldn’t be for it?  It is also attractive to nonprofits, who frequently feel under-compensated, need more resources, and blame their limited success on lack of funding.

Many organizations see themselves as high performing, up for the challenge and risk of contingent income based on results, and as natural scroungers always looking for new funding channels.

Sounds almost too good to be true!

While the first and most famous “bond” was issued in the UK in 2011 to reduce recidivism at HM Peterborough Prison, it has delivered no reports or results to date (financial or programmatic; those will come in 2014), an extraordinary amount of enthusiasm is building among consultants, foundations and financial services firms.

The second most famous Social Impact Bond was issued by New York City in 2012 and financed a $9.6 million social bond for prisoner rehabilitation to be overseen by the research organization MDRC and services delivered by the highly respected nonprofit Osborne Association.  Financed by Goldman Sachs, New York Mayor Bloomberg’s personal foundation, Bloomberg Philanthropies, has also provided a $7.2 million loan guarantee to MDRC and Goldman Sachs.

Since the New York City Social Bond was announced in August 2012 (with again, no results yet), this helped convince the Rockefeller Foundation to launch a national competition for state and local governments to test the Social Impact Bond approach, administered by the Kennedy School of Government at Harvard University.  Applications are due February 8, 2013 (three weeks after the competition was announced!) and successful applicants will be announced in early March 2013.

Admirable but Dreamy Claims

My concern is that the two main claims for SIBs, more resources and better results, are admirable but dreamy.

The first claim, that Social Impact Bonds will deliver new resources, is based on the idea that legislative bodies will appropriate additional funds based on a projection of future savings.  If your organization’s services reduce repeat trips to prison, saving government money, your organization (and its financiers) deserve to be rewarded with extra payments — made possible by the reduced expenditures required of government in housing these prisoners.

The argument is a good one, certainly, which is why it is used constantly in every legislative and appropriation process — that this particular expenditure for (early childhood education/crime prevention/sanitary sewers/vaccinations, etc.) is better spent to prevent a problem than to try to remediate it later.  Legislative bodies understand this, and often agree — and these intended savings across all of these areas are already taken into account in the overall appropriation process.

You can certainly make the case that your particular service is special and new, and has a superior claim to savings, but your ability to get legislative approval is almost certainly a displacement from other funding — not an actual specific addition to total expenditures.  There will be new sets of winners and losers, with SIB transactions advanced with persuasive arguments and novelty as a comparative advantage in the competition for resources.

The second claim, superior results, implies that there are two types of services:

— well-meaning and well-intentioned but somewhat ineffective amelioration services, for which SIBs would not be appropriate, and

— professional organizations undertaking upstream interventions using evidence based metrics, capable of going to scale, which will document their outcomes and be capable of proving that they meet performance goals of the SIBs.

In this view, moving funds from the former to the latter is itself a net gain, so that the failure to deliver additional resources doesn’t matter.

There are no proposed special service innovations for the work supported by the SIBs (they are understood to apply effective methods considered best practice in their field), but will get improved results through enhanced discipline by virtue of their participation in the SIB process and its restriction to only pay for results.  This high stakes carrot and stick approach is not unlike the expectations of results in the “No Child Left Behind” legislation, which had its own unintended consequences (including cheating scandals by pressured school administrators).

Campbell’s Law

Which brings to mind Campbell’s Law (after Donald T. Campbell):  “The more any quantitative social indicator is used for social decision-making, the more subject it will be to corruption pressures and the more apt it will be to distort and corrupt the social processes it is intended to monitor.”

In fact, the biggest SIB innovation is the transaction itself, and accompanying financial instruments and intermediaries, not the service method.  The total SIB package includes a dose of business incentive to deliver results and make a return that is seen as absent in the nonprofit sector.  It doesn’t hurt that many people view business managers as inherently more effective than nonprofit managers (after all — how hard can it be to run a nonprofit?  All you have to do is make sure that by the end of the year you haven’t made a profit!).

The foundation/consultant enthusiasm stage of SIBs is attracting a heavy dose of financial backing in the form of foundation grants, which are paying for the added costs of measurement/monitoring/certification of results. Beyond the pilot phase with this significant subsidy, SIBs will bear a larger burden to pay for rates of return for bondholders and for the required external services built into its model.

(For elaboration on the model, including the new roles of intermediaries, evaluation advisors and independent assessors see McKinsey’s webinar and 68 page report.)

Comments to Jon, please write jpratt(@)minnesotanonprofits.org

Jon Pratt is the executive director of the Minnesota Council of Nonprofits. He has worked at Minnesota Public Interest Research Group as an attorney and lobbyist, as regional director at the Youth Project, and as director for the Philanthropy Project. In 1982 he was campaign manager for Paul Wellstone candidacy for Minnesota State Auditor.

In 1987 he became director of MCN, an association of 2,000 organizations that sponsors research, training, lobbying and negotiated discounts to strengthen Minnesota’s nonprofit sector.

Jon has consulted with nongovernmental organizations on the development of NGO associations and services in Canada, Costa Rica, Czech Republic, Hungary, Poland, Serbia and Turkey. Pratt has a law degree from Antioch School of Law, and a M.P.A. from Harvard University.

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