/ Juvat / by Niklas Ruf

On the success or failure of a Social Impact Bond

A recent announcement has stirred emotions, at least within the Social Impact Bond community. The first Social Impact Bond (SIB) initiated in the United States in 2012 is on the brink of being shut down. The reason for this is as simple as it is logical: The neutral evaluator was unable to demonstrate the effectiveness of the implemented measures, which is so crucial for Social Impact Bonds. As a result, the program will be prematurely terminated in August 2015, and thus well ahead of the original date planned for late 2016.

So far, so good. Or maybe not?

If you look at various online publications about this issue, you’ll soon discover that the matter isn’t so clear-cut after all. In the context of terminating the SIB in New York, a crucial question is posed with regard to Social Impact Bonds: Did the SIB in New York fail? And, if so: What constitutes failure of a SIB?

The Financial Times, for example, argues from the perspective of the upfront financiers (also called investors) and states that the investors have lost their invested capital due to the termination of the NY SIB. This reveals a fundamental flaw in the description of Social Impact Bonds. A SIB should never be described as a bond in the literal sense, i.e., as a traditional loan. Instead, based on current experience, a SIB must be clearly understood as a high-risk investment that is always associated with the risk of failure. No matter how one might spin it, there can never be talk of a positive outcome for the SIB.

Canada’s National Union of Public and General Employees (NUPGE) puts things even more clearly in its statement entitled: First U.S. Social Impact Bond fails. Here the primary argument is that the basic idea behind all success-driven project approaches (pay-for-success models) — successful project work is demonstrated by achieving previously defined targets — is fundamentally flawed. In the opinion of the NUPGE, good work generally cannot be forced into the tight constraints of previously defined targets since there are (too) many (success) factors that have nothing to do with the quantitative set of targets. In addition, it was clear that the upfront financiers were supposed to bear the entire risk of capital loss themselves. That way, public funds — in accordance with the fundamental concept of a SIB — would only be used if it could be proven that the targets had been achieved. Due to a default guarantee from a non-profit (and thus tax-exempt) foundation, this fundamental concept was contradicted in the case of the New York SIB. Despite failure to achieve the defined objectives, tax dollars are now still being used. The NUPGE thus identifies a failure across the board with regard to the issue of Social Impact Bonds (the article can be found here).

Yet there is also another view. An article published in the online newspaper The Huffington Post, represents the position that the termination of the NY SIB is a success since the public sector now does not have to pay for a measure that has proven to be ineffective. Therefore, what is decisive for a SIB is not the achievement of targets at the end of the project term, but rather the clear focus on a desired and measurable impact (the article can be found here).

We at Juvat share this stance. Once it has been initiated, a Social Impact Bond cannot fail. Even if the agreed targets of the project are not met, as has now been proven in the case of the SIB in New York, the overarching goal of “only appropriating public funds in the event of proven project success” is always achieved. This change in the existing funding logic on the part of the public sector — from a sole focus on the process to a focus on the targets or impact — should thus be the decisive factor in assessing a Social Impact Bond.

At the same time, this also does not represent a failure for the upfront financiers, especially if they are non-profit organizations, as was the case with the first German SIB. After all, just like every previous donation, the upfront financing is booked as a one-time payment even if the project targets are not achieved. The advantage here over traditional forms of support is that a neutral third party comprehensively evaluates the effectiveness of the supported measures. The call by the Financial Times for the upfront financing of a SIB to be defined as a high-risk venture is thus completely correct. Moreover, it is precisely why we make the case for not viewing Social Impact Bonds unilaterally as investment products.

Of course the cited criticism about using tax dollars despite failure to achieve the defined targets is justified. In this regard, the SIB in New York had an unfortunate structure. This, however, does not contradict the fact that it should generally be welcomed if non-profit organizations choose to use their funds as part of a public project and for clearly measurable targets instead of supporting projects that can provide no proof whatsoever of their effectiveness (or rather ineffectiveness).

Perhaps when assessing the termination of the New York SIB it really comes down to perspective. Our perspective is that of the taxpayer, meaning the public sector. And there the findings are clear: The spending of public funds on successful measures should always be welcomed. At the same time, it should also always be welcomed when public funds are not spent when defined targets are not met. The conclusion from this is also quite clear: A Social Impact Bond cannot fail.