Social Impact Bond - What Is It, Examples, Pros. Cons, Types

A Social Impact Bond (SIB) is a financing method for the public sector or governments to fund certain social development projects. And in exchange, the investors receive returns from the savings created during the project’s tenure. The prime purpose of SIB is to fund social programs and provide returns to investors.

It tries to bring a nearby solution for social problems. It allows investors to make profits on successful social programs. In addition, it also fosters growth in the nation. However, the social impact bond model does not act like a usual bond.

Key Takeaways

Social Impact Bonds (SIB) are financial instruments that allow investors to invest in social programs and projects initiated by the government.
There are two types of SIBs, namely individual SIBs and SIB funds. Further, the former is categorized into direct, managed, and intermediary SIBs.
The concept has its origin in the year 2010. Social Finance Ltd was the sole firm to issue SIBs to investors.
The only difference between SIBs, development impact bonds, and green bonds is that the former focuses on social programs. While the other two aim to fund development and environmental projects.

Social Impact Bond is a financial vehicle that allows investors to provide funds to the government or public sector. In other words, the former provides capital to the latter for social development projects. But it does not act like other bonds. Instead, it is a future contract based on the social outcome. It enables the government to release gains only when achieving the desired goals. Therefore, the investor’s hope for constant returns does not exist.

Following are the steps for releasing the social impact bond. Let us look at them:

#1 – First Stage – Identification of social problems

At the initial stage, the government must list all the problems and possible solutions. For example, public safety may be a serious agenda for the government.

#2 – Second Stage – Approaching the Investors

Once the problem is identified, the government should approach the social impact bond investors for capital fulfillment. They can raise funds from private partnerships and non-profit organizations. However, the bond raiser must highlight the potential successive factors for attracting investment.

#3 – Third Stage – Implementation of the Project

As capital inflow has occurred, the government can execute the program with the help of project managers. The total funds received will be distributed among the service providers to recover operating costs.

#4 – Fourth Stage – Declaration of the Savings

Once the project has reached mid-way, the public sector can assess the program and find deviations, if any. But, if there are none, the government can release savings for the social impact bond investors.

History

The first social impact bond model was introduced by the United Kingdom (UK) in 2010. Social Finance Ltd developed the first social impact bond in the UK. However, implementation of this model occurred in Peterborough to reduce reoffending rates. Later, other nations also started implementing it. The social impact bond structure differs from the other bonds issued.

Since its origin in 2010, various names have been given in different nations. In Europe, it is called Social Impact Partnerships. Similarly, in the United States, it is called Success Schemes. And lastly, the Australian population refers to it as Social Benefit Bonds. Despite their different synonyms, they work the same. They intend to accelerate the desired outcomes through proper investment guides. However, the process for the same may differ.

Types

Based on the function, two types of social impact bond structures exist. It includes individual SIBs and SIBs funds. While the former can issue only a single contract, the latter has access to multiple contracts. However, the individual SIBs are further divided into three subcategories. Let us look at them:

#1 – Direct SIBs

In a direct SIB, the contract between the government (outcome payer) and the service provider is signed. Here, the latter is responsible for the execution of the social project and performance evaluation. In short, the service provider has a major role in social impact bonds.

#2 – Intermediary SIBs

The intermediary SIBs enable a third-party contract between the outcome payer, the intermediary, and the investor. Here, a mediator tries to control, assess, and monitor social development projects. In some cases, an intermediary can also invest in SIBs.

#3 – Managed SIBs

This SIB is signed between the bond-raiser (or outcome-payer) and the intermediary (prime contractor). Here, the intermediary is usually responsible for major activities. However, the only difference between the intermediaries SIBs and Managed SIBs is the investment type.

Examples

Let us look at the examples of social impact bonds to comprehend the concept better:

Example #1

Suppose Hellingston is a country situated among the Western countries. It has changed from an underdeveloped to a developing economy in the past few years. Further, it wishes to accelerate the social and economic development of the nation. Among the major issues, the Hellingston government wishes to improve the transportation infrastructure. Therefore, they issue SIBs to the investors. They successfully raised $300 million for the project for seven years. By the end of the tenure, the savings made by the government were transferred to the respective investors.

Example #2

A recent article dated January 2023 stated that Japanese local governments are boosting the spread of social impact bonds. Many local governments are turning into SIBs since they improve the overall efficiency of administrative services while reducing expenses. The companies who take up projects on behalf of the governmental bodies can implement creative changes on top of making a profit for themselves.

In addition, there are various awareness programs issued for the public interest. The success of SIBs has led to the increase of their popularities on a large scale securing these programs more support and funds.

Pros And Cons

Pros

It encourages development and innovation in public sector services.
SIBs allow collaboration of public sector and private partnerships.
It considers the benefits of the stakeholders and investors and tries to outperform their expectations.
SIBs provide returns in the form of savings to investors.
The financial burden is transmitted from the government to different investors.
Additional funds are generated for social development programs apart from the budget allocated.

Cons

SIBs contain enough complexity from development to execution.
There are various fees and high transactions involved in this process.
The officials might find it difficult to evaluate the funding program for the project.
A sudden or slight drift in the project’s objectives can hamper the relationship between investors and service providers.

Although development impact bonds (DIBs) have similar functions, they differ in their characteristics. So, let us look at their potential differences:

Since social impact and green bonds focus on different sectors, their characteristics also vary. Thus, let us look at the differences between them:

Frequently Asked Questions (FAQs)

Why invest in social impact bonds?

Of all, the prime reason to invest in social impact bonds is the pace of the project’s growth. If a government considers a valuable project with the right tools, it will bring advanced growth to the nation. As a result, the money invested in this project will also yield higher returns.

Who created social impact bonds?

Justice Secretary Jack Straw of the UK Parliament proposed this idea of SIBs on March 18, 2010. The only intention was to fund the prisoner’s rehabilitation program. Later, in 2011, under the presidency of Barack Obama, even the US government raised funds to capitalize on social impact pilot bonds.

What are the special features of a social impact bond?

The major feature of SIBs is that they are not affected by interest or market risks. It only depends on the performance of the projects. However, inflation can also affect the social impact of bonds.

How many social impact bonds are there in the world?

According to a report by the Brookings Institution Global Impact Bond Database, as of June 2023, 229 SIBs contracted globally. In total, there are 247 impact bonds.