McKinsey & Company research consultants describe the potential of social impact bonds (SIBs) as an innovative financing tool for scaling social programs. An SIB is a “bond” in the sense that private investors supply capital to realize financial return. An SIB is “social” in that the investment capital is used to “scale up” social service programs to increase their reach and social impact.

SIBs differ from traditional social sector financing in two ways: First, SIBs are vehicles to grow proven intervention programs. Since governments tend to fund remediation programs (e.g., incarceration) and private philanthropy gravitates toward funding start-ups or capital projects, operating funds for scaling intervention programs remains scarce. SIBs would fill this financing void.

Second, unlike traditional social sector funding, SIBs involve a financier and private investors—which could range from pension funds to mom and pop investors. Traditionally, social sector funding has been one-directional, with a government or philanthropic entity directly financing a nonprofit. Under the SIB framework, additional actors are involved: a financier sells “bonds” to investors who fund the social service provider. If the service provider meets its service performance objectives, a governmental entity reimburses the financier who, in turn, returns the investment plus interest to the investors. The involvement of additional stakeholders increases the flow of funds, but also increases the complexity—and cost—of financing social programs.

The United Kingdom has already pioneered the use of SIBs to scale up services for disadvantaged youth. And last summer, the State of Massachusetts began piloting SIBs to finance homeless and juvenile delinquency intervention programs. Because these programs are new, McKinsey wasn’t able to measure the effectiveness of SIBs in improving social outcomes; however, they do provide evidence from pro forma analyses that indicate, in the long-run, SIBs could provide net benefits to both taxpayers and society.

Could educational institutions benefit from SIBs? As McKinsey portrays it, public schools don’t appear to be eligible candidates for SIB-based financing, for they are governmental institutions with the authority to issue public debt. SIBs, however, may be a useful means of financing nonprofit educational programs—perhaps even charter schools. SIBs could increase private investment to enable the most effective charter school organizations to scale their operations; for example, an organization like KIPP could back SIBs that enable it to open and operate more schools across the country.

Although the Center for American Progress considers SIBs too “risky” for charter school financing, the idea merits further consideration, especially for charter school operators or authorizers who have a proven track-record of success. An SIB backed by an effective charter (triple-A rated, in business terms) benefits the charter operator who seeks greater scale and social impact, while also offering private investors an opportunity for monetary gain in a lower-risk. As a concrete first step, the friends of school choice should follow McKinsey’s analyses and conduct a pro forma cost-benefit analysis of charter school SIBs to establish whether SIBs present a sustainable financial model for proven charter school operators.    

From Potential to Action: Bringing Social Impact Bonds to the US
McKinsey & Company
Laura Callanan, Jonathan Law, and Lenny Mendonca
May 2012

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