Setting up social impact bonds

Essex County Council has been at the forefront of the development of social impact bonds. Richard Curl explains what was involved.

Social Impact Bonds are a form of outcomes-based contract in which public sector commissioners commit to pay for significant improvement in social outcomes (such as a reduction in offending rates, or in the number of people being admitted to hospital or taken into care) for a defined population.

Social Impact Bonds are an innovative way of attracting new investment around such outcomes-based contracts that benefit individuals and communities. Through a Social Impact Bond, private investment is used to pay for interventions, which are delivered by service providers with a proven track record. Financial returns to investors are made by the public sector on the basis of improved social outcomes. If outcomes do not improve, then investors do not recover their investment.

Social Impact Bonds provide up front funding for prevention and early intervention services, and remove the risk that interventions do not deliver outcomes from the public sector. The public sector pays if (and only if) the intervention is successful. In this way, Social Impact Bonds enable a re-allocation of risk between the two sectors. In addition to providing investors with the opportunity to earn a financial return on their at risk investment there is an acknowledged feel good factor – the chance to contribute directly to socially important schemes delivering real improvements in the lives of individuals and communities.

Essex County Council is the first local authority in the UK to use Social Impact Bonds to finance a project – to provide multi systemic therapy (MST) to young people designed to keep children who might otherwise end up in local authority care out of care. Given the high cost to the authority of accommodating children in council care, the savings generated by a successful MST rollout are then used to (a) pay for successful outcomes and (b) provide a suitable return to investors on funds injected into the scheme to deliver the service in the first place.

Working with ECC’s in house lawyers, Essex Legal Services’ specialist Projects Team, the authority ran a fast tracked competitive dialogue procurement to select a partner to deliver a socially financed solution. The successful bidder, Social Finance, established a special purpose vehicle (a) to contract with ECC to achieve the required outcomes, (b) to receive investment from investors and distribute returns, subject to performance and (c) to engage the MST service provider as contractor to the SPV to actually deliver the service.

In practice, some features of the financing structure are akin to those used in mainstream project finance where investors finance projects often with a combination of debt and equity funding (whether through up front provision of capital costs or as with MST by paying for the service in the period before outcomes are achieved). Because investment is at project level rather than through a corporate line to the delivery party’s parents/sponsors but without parental guarantee of investment return or performance, repayment of capital debt and return on interest is dependent on the income stream generated by the project once commissioned and running. In other words, investors are being expected to take the risk that the project “works” and outcomes are achieved.

A particular challenge addressed by Essex Legal Services was the development of a payment mechanism which directly linked payment to results. Traditional contracts with service providers link payment to inputs but for SIBs to work as intended, this structure needs significant modification. First, the SIB model must ensure that at service delivery level the service providers (e.g. therapists, social service contractors etc) are paid to deliver the service. This is achieved by utilising the funders’ upfront investment and reflects the fact that service providers in the sector may be small or low-capitalised operators unable or unwilling to work “at risk” or with a significantly rear-ended payment profile.  

The second principal driver is to ensure that at investor level the payment mechanism operates so that the public sector only pays as and when results are achieved. This in turn requires that “success” is defined as part of the contract with the development of a suitable “control” mechanism. By incorporating a control the authority can ensure that the returns to investors are not inflated by “success” that might have been achieved in any event, even without the service.

For example on the ECC MST project, a successful outcome triggering payment was defined in terms of the number of days which a young person who had received MST spent out of care in excess of the number of days that statistically they might have been expected to spend out of care in any event. The latter statistic was calculated using an analysis of historical data of days spent in and out of care by young people who would been suitable for MST had the service been available at the time. This in turn reflects the fact that depending on the nature of the service and profile of service users not all would have been “eligible” and the need to ensure that historical care patterns for “ineligible” service users did not distort the control.

In strict finance parlance, Social Impact Bonds are not bonds in the traditional sense e.g. they are not tradable instruments. That said, as the sector develops, investors may see the development of a secondary market in SIBs and the growth of specialist funds to invest in schemes e.g. on a portfolio basis to balance risks across a basket of projects.

Finance for the ECC scheme was arranged by Social Finance and came from a consortium of seven investors including Big Society Capital and charitable foundations active in the care sector. Further interest from social investors and public sector partners in future projects across the UK is expected. Internationally, the potential for adapting the model to deliver aid programmes effectively in the developing world is significant as well as in developed countries including the US where the Obama administration has expressed interest in the scheme for use in a number of US cities.

Following the successful procurement of the ECC scheme, it is expected that other local authorities in the UK will look at utilising the model to deliver a range of social projects. The Projects Team at ELS have been working with colleagues in ECC and at the Cabinet Office to provide guidance on templates and solutions and would be pleased to share knowledge and expertise with colleagues in other authorities as required.

Richard Curl is Head of Projects at Essex Legal Services. He can be contacted on 01245 506824 or by email.