Social Impact Bonds Explained

Social Impact Bonds Explained

Tom Scrivana

Last Updated: 03/04/2022

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What Are Social Impact Bonds?

First things first. What are social impact bonds? Well, the first thing you should know is that these aren’t actually bonds. These financial instruments are basically contracts. Social impact bonds, or SIBs, are arrangements that allow investors to fund social services through performance-based contracts.

If you need a refresher on bonds you can check out an article I wrote covering bonds and ESG investing right here!

There are a few key players involved with social impact bonds. This whole process starts with a commissioner. This is usually the government. This commissioner identifies a social issue and establishes specific goals to address that issue.

A social service provider (usually an established non-profit organization) then develops or scales a social service to improve social outcomes and to address societal issues.

The last of the key players are the investors. Impact investors who are seeking to generate both a positive social return and a positive financial return have the opportunity to finance a specific cause through a social impact bond. This funding allows the service providers to deliver the services designed to improve social outcomes.

An important aspect of social impact bonds is that they are performance-based contracts. These impact bonds are only considered successful when the original goals laid out to improve a social outcome have been met. If those goals are met then the investors receive a return on their initial investment. But if those goals aren’t met then the investors receive no financial return and could potentially lose their initial investment.

This means social impact bonds are higher risk investments compared to traditional bonds. Even so, I really like the idea of social impact bonds because of the fact that they are performance-focused and they give investors a very tangible and visible way to create impact with their investments.

Besides commissioners, service providers, and investors, a lot of times there are also other groups involved in SIBs like intermediaries and independent evaluators that may help design or oversee impact bond projects. I’m not going to go into this only because these third-party groups aren’t always involved and I didn’t want to make this article overly complicated. But if you are interested in learning more about this then check out the references below the article to learn more!

I know this is a lot of information and I think these bonds can be a little confusing so let’s go over a specific example so we can see how social impact bonds actually work.

Prisoner Released

The First Social Impact Bond

The first social impact bond was created in the United Kingdom in 2010. So these types of bonds are still a relatively new type of investment. The first social impact bond raised 5 million pounds from various trusts and other foundations (That’s about 6.7 million US dollars for those of us who are only familiar with the type of pounds on the scale).

The goal of this impact bond was to reduce the reoffending rates of short-term prisoners in Peterborough Prison in the UK. The reoffending rates of prisoners in this area were extremely high. About 60% of this prisoner population were convicted of at least one offense within the first year of their release. What’s worse is that individuals who reoffended after their initial release were then even more likely to be convicted of further offenses in the future.

There just weren’t enough support services in this area and many people left prison with no money, no job, and nowhere to live.

This social impact bond funded the services needed to bring additional support for short-term prisoners after their release from prison. The social services provided by this impact bond lasted for 5 years and positively impacted around 2,000 prisoners.

So what were the results of the world’s first social impact bond? This impact bond successfully helped reduce the reoffending rates of short-sentenced offenders by 9% overall. These results actually exceeded target goals and expectations. This meant that investors received both a financial and a social return on their original investment. The financial return came out to about 3% per year. And from an ESG investing perspective, these investors were also able to help create a positive social impact with their investment.

Social Impact Bond Examples

The first social impact bond had to do with the criminal justice system and providing resources to help reduce the reoffending rates of prisoners in the UK. But there are a lot of different areas where social impact bonds can do some good.

Impact bonds can positively impact sectors like health, education, employment, social welfare, and environment and agriculture. This is obviously extremely broad so let’s just look at a few more examples of social impact bonds.

Let’s start by looking at my home state of Colorado. The city of Denver has developed a social impact bond that seeks to provide additional support services for the homeless population in that area. This program provides housing, transportation assistance, therapy and psychiatric services, access to health services, food assistance, and other means of support for some of Denver’s most vulnerable citizens.

This program, like most social impact bonds, focuses on preventative services. The goal of the Denver Social Impact Bond program is to provide housing and supportive case management services to at least 250 homeless individuals who most frequently use Denver’s emergency services.

The idea is that this impact bond will provide support to help better serve this population and will help to reduce the need for this group to utilize emergency services and reduce interactions with the criminal justice system. This would reduce the costs to the city of Denver associated with the use of these emergency services. Social impact bonds are designed to create win-win scenarios.

The next bond I briefly wanted to talk about focuses more on the environment than on social outcomes but I still wanted to cover it because it is structured in the same way as a social impact bond and I think it illustrates the diversity of these types of bonds. DC Water recently completed an environmental impact bond project that was designed to support green infrastructure development in Washington DC. This project was called “Rock Creek Project A” (A catchy title if I don’t say so myself).

Rock Creek had issues with stormwater runoff that led to sewer overflows to the rivers and waterways in the area. This obviously had a negative effect on the water quality and this was becoming a significant environmental challenge for the area. The DC Water Environmental Impact Bond financed the installation of about 20 acres of green infrastructure. This project was ultimately successful, leading to a 20% reduction in stormwater runoff and helping to improve the water quality in the area.

A List of Social Impact Bonds

Over 200 social impact bonds have already been developed around the world, across a total of 37 different countries. These social impact bonds cover an incredible number of social issues.

These issues include early childhood development, access to safe drinking water, elderly care, workforce development, adoption, and gender violence. And that only just scratches the surface of the types of social issues addressed by these bonds. There is no way for me to cover every social impact bond in this article but check the references below if you’re interested in learning more about social impact bonds.

Impact Bond Funds (A Warning!)

I just wanted to provide a quick warning about social impact bond funds. This isn’t necessarily a warning but just something I thought was important to mention and something I wanted you to be aware of. Social impact bonds are a very specific type of investment. Remember that they are performance-based contracts; not bonds.

A lot of ESG bond funds will use the terms “impact” or “social impact” in the language in the fund prospectuses. That’s because these funds are looking to make investments that will create some type of environmental, social, or governance impact along with generating a financial return. Since these funds are trying to create some type of positive impact they will often use the term “impact” to communicate these goals. But these ESG bond funds don’t specifically invest in or hold social impact bonds.

I actually couldn’t find any examples of ESG bond funds that hold social impact bonds. I believe that’s because of the way social impact bonds are structured and because they’re not publicly traded. But if you know of any bond funds that do hold SIBs please let me know in the comments below. I’d be interested in taking a look at them.

Now, just because ESG bond funds don’t hold social impact bonds doesn’t mean that these funds aren’t creating impact. There are even some ESG bond funds that specifically seek to invest in causes that improve social outcomes.

I think the Domini Impact Bond Fund (DSBFX) is a good example of this. This mutual fund seeks investments that support affordable housing, accessible healthcare, economic development, and the transition to a low-carbon future. There are plenty of bond funds that support ESG investing and want to make a positive impact. But I did want to point out that those funds don’t utilize social impact bonds to meet those goals.

How to Invest in Social Impact Bonds

So how can you invest in social impact bonds? Well, unfortunately, social impact bonds are not publicly traded and aren’t available to everyone. As of right now, these impact bonds are only available to institutional investors or accredited investors.

And to be considered an accredited investor you need to have a personal net worth of over one million dollars or you need to be able to show that you have an annual earned income of over $200,000 in each of the last two years. Social impact bonds are still a relatively new type of investment so I’m hoping that access to these bonds will improve over time.

Social impact bonds aren’t something you hear a lot about so I wanted to try to use my voice to bring a little more attention to them.

But what are your thoughts about social impact bonds? Are these something that you’d ever consider investing in? Share your thoughts in the comments below!

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