The potential benefits are great, but one problem is measuring success. David Ainsworth reports
For an idea that is still only a few months into its first pilot project, the social impact bond has generated a huge amount of interest.
Social Finance, an organisation founded in 2007 to build a UK social investment market, came up with the concept in 2009 as a way of financing schemes that tackle social problems.
It is based on a payment-by-results contract. Public bodies agree to pay third sector organisations for measurable results, such as reducing drug use or re-offending rates. The amount paid depends on the results.
Once the terms are agreed, voluntary organisations use that contract to attract project funding from investors. If the project succeeds, the investors profit; if it fails, they lose.
Toby Eccles, development director at Social Finance, says: "Traditionally, a lot of public money has been thrown at problems once they're at the crisis stage. It's more effective to spend the money preventing the problem arising. But government often hasn't funded prevention schemes because it's difficult to identify whether they work."
The bond required the agreement of many arms of government, particularly the Treasury. And the first pilot project was set up last year in HM Prison Peterborough to reduce re-offending among 3,000 short-term prisoners (see panel below).
The concept is gaining momentum. The government's criminal justice green paper, published in December, said it was interested in establishing another six schemes; two local authorities, Liverpool City Council and Essex County Council, want to develop bonds for improving children's services; and other public bodies are interested in rehabilitating drug addicts.
Social Finance is also investigating whether social impact bonds could fund charities in other payment-by-results schemes, such as the government's Work Programme.
Peter Wanless, chief executive of the Big Lottery Fund, which is backing the Peterborough project and providing £5m for three other pilots, thinks bonds have the potential to help disadvantaged people in a "game-changing way".
He says: "If it works, it will allow our money to go a lot further. It would re-engineer the way that public services were funded."
The first pilot, with funding of £5m, has attracted about 15 investors, including the Esmee Fairbairn Foundation, the Monument Trust, the Tudor Trust and several philanthropists. Social Finance expects it to be over-subscribed.
So far, however, there are no commercial investors. Eccles says it was a deliberate decision to seek only charity investors in the Peterborough scheme and to find commercial investors once the bonds show a return on investment.
"Bringing new capital to bear is about building a track record," he says. "We expect the early investors to be focused on the social returns. Gradually, we expect to appeal more to commercial investors because it has been shown to be a successful way to make money."
Martin Brookes, chief executive of the think tank New Philanthropy Capital, says that attracting commercial capital will be the acid test and expectations must be managed. "Sooner or later, someone will use bonds for a project that won't work," he says. "When that happens, we must be careful not to throw the baby out with the bathwater."
Another will be deciding how much to pay investors. One problem will be the same one that has deterred governments from investing in prevention - identifying whether projects work. Re-offending is relatively easier to measure than improving children's services. Some sceptics believe that measurement will be an insurmountable problem.
Laurence Demarco, founder of Senscot, the Scottish network for social enterprises, says: "It would be wonderful if the social impact bond could work. But I just don't believe it. I think it's impossible to measure the impact of early intervention with children, and I can see a litigation nightmare between investors and government over whether it has worked. The government should just trust that charities know what they're doing and invest in them."
Nicola Steuer, a project director at the think tank the New Economics Foundation, agrees that metrics will be a challenge. "How do you prove that your intervention produced an outcome?" she asks. But the potential benefits, she says, are huge. "We did work with Action for Children that estimated early intervention in children's services could save £486bn over 20 years."
THE PILOT PRISON BONDS
In the six-year social investment bond pilot project at HM Prison Peterborough, investors are providing £5m for charities to run programmes aimed at reducing re-offending among 3,000 prisoners serving sentences of less than one year.
The Big Lottery Fund is pledging £5m and the Ministry of Justice £3m to pay back investors from 2014 onwards. If re-offending does not fall, there will be no payout. If re-offending rates fall by 7.5 per cent, investors will receive a payment, yet to be decided, representing a proportion of the cost of re-offending. The more re-offending rates fall, the greater the payment - up to a maximum of the £8m.
The role of Social Finance has been to create an organisation called the Social Impact Partnership to receive funding from investors and employ charities on the project. The first indications of whether the project has been a success are expected this summer. Janette Powell, the programme's director, says the initial signs are encouraging.
Rob Owen, chief executive of the offender rehabilitation charity St Giles Trust, one of the main service providers, says: "This project gives us more freedom with the interventions we use."