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June 21, 2012
Why Nonprofits Should Embrace Social Impact Financing

by George McDonald

Social entrepreneurs in Britain have come up with a creative new way to finance efforts to mend our social contract, to address problems like unemployment, homelessness, recidivism and drug addiction at a time when government resources are severely constrained.

The concept, called a social impact bond, is deceptively simple: private investors put up money to finance preventive social services. The investors, service providers, and government agree on a set of objective statistical measures to assess how well the providers perform. If the organizations achieve the agreed-upon goals, like reducing the number of former inmates who end up back in prison, government pays back the investors out of the cost savings created by the social services. And if the goals are not achieved, the investors do not get repaid and taxpayers are held harmless.

This is an idea that deserves our attention.

It could provide much-needed new money for social services when governments at all levels are cutting back. It could also introduce market discipline and competition into the delivery of services to people in need. It could save governments substantial amounts in the long run and it could improve many lives.

Contracts would be awarded to organizations that have demonstrated an ability to produce verifiable results, and their efforts would be judged by performance-based measures, through transparent data and tangible outcomes.

For too long, social service providers have been compensated primarily on the volume of services they deliver, rather than by the outcomes they produce. Social impact bonds could hold investors and providers more accountable and make them more efficient.

The first experiment of this innovative arrangement involves a program to reduce recidivism in a prison in Peterborough, England, about 90 miles north of London. Philanthropic organizations, including the Rockefeller Foundation, invested $8 million to pay several nonprofit agencies to work with the inmates. Over six years, the agencies will assist 3,000 short-term prisoners to help them find work and housing after they are released, so they can avoid returning to crime and, eventually, back to jail.

If the nonprofit agencies can lower the rate of recidivism by more than 7.5 percent, the government will repay the investors. Currently, about 60 percent of prisoners serving short-term sentences in the United Kingdom return to prison within a year of their release.

The government would repay the investors from its reduced prison costs if the number of repeat offenders declines. The investors’ return could range from 7.5 percent to as much as 13 percent, depending on how substantially recidivism is reduced.

The British entity that serves as an intermediary between the investors and the service providers – Social Finance, a kind of investment bank for social entrepreneurs – has opened an office in Boston to stimulate interest in social impact bonds in the United States.

The states of Massachusetts, New York and Connecticut are considering whether and how to experiment with the format, as is New York City. The Obama administration introduced a similar concept into the current federal budget, calling it “pay for success” contracts.

Although some nonprofit groups may be put off by the rigorous demands of these arrangements, organizations like The Doe Fund would welcome them. For more than 20 years, our Ready, Willing and Able program has been helping homeless men and former offenders to stabilize their lives, find work and become productive citizens. As with like-minded groups, we are not afraid of having our work measured and being judged by the results. We have long taken statistical account of what we do, believing that if you cannot measure something, you cannot be held accountable and probably should not be doing it.

Social impact bonds would provide new opportunities for nonprofits that can stand out from the pack, because they would enable governments and investors to distinguish much more clearly providers that use successful strategies and produce positive outcomes from those that do not.

Some in the world of social services are concerned that social impact bonds would lure in for-profit providers and investors, driving out the nonprofit organizations that have long served the most vulnerable among us.

For now, though, investors in the bonds are likely to be foundations and other philanthropic groups. But if the bonds demonstrate over time that they do promote positive results, that they can make service providers more productive, deliver better services to people in need and trim back costs for the government, then perhaps they could -- and should -- attract private investors interested in a financial return and a more equitable society.

And if for-profit service providers should decide they want to participate in programs financed by social impact bonds, let them compete. Nonprofits with strong track records should be able to hold their own.

Social impact bonds could also stimulate innovation, which our current system does insufficiently. They could improve people’s lives, helping them to find jobs, stay out of jail, avoid falling into homelessness or free themselves from drug or alcohol dependency.

For decades, we have been paying for failure. It’s time to pay for success.

George T. McDonald is the Founder and President of The Doe Fund.

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