Pinning benefit bonds down

Social benefit bonds are already proving popular among Australian investors.

Summary: Social benefit bonds (SBBs) are providing Australian investors with a mechanism to fund solutions to pressing social problems and receive a financial return in the process. Returns on the investment are reasonable – if the social outcomes are met. But in some programs investors risk losing all of their investment.
Key take-out: As SBBs require measurable outcomes, they are best suited to programs that already have strong evidence of their ability to achieve better social outcomes.
Key beneficiaries: General investors. Category: Fixed interest.

The introduction of Australia’s first social benefit bond has brought the spotlight onto this innovative funding mechanism, which allows investors to blend business with social change.

Cash-strapped governments in Australia and other developed countries are beginning to trial a new financing mechanism which allows non-government and private investors to fund solutions to pressing social problems and receive a financial return on this investment.

Known as a social benefit bonds (SBB) – social impact bonds or pay-for-success bonds elsewhere – charitable and philanthropic trusts as well as ethical and institutional investors replace government in its role providing funding for prevention and early-prevention social programs.

In return for the funding, service providers agree to deliver specific social outcomes through nominated programs. As these programs ward off future social ills and associated costs, governments can make significant long-term savings.

Kylie Charlton, co-founder of Unitus Capital and a lecturer at the Centre for Social Impact, says SBBs would initially appeal to philanthropists, charitable foundations or high net worth individuals looking for ‘a blended value return’.

“Philanthropists typically do good with one pocket of money and they do financially well with another pocket of money. So the beauty of social benefit bonds is that they can combine the two.”

Some of these philanthropists may have funded the social program without there being a financial return. However, SBBs may also be attractive to traditional investors such as superannuation funds and corporate investors who value the social impact of the program as well as getting the financial return they require.

How the SBB works

Social benefit bonds are not “bonds” in the conventional sense (i.e. they don’t have a fixed interest rate and may also not be required to be paid out in full). Instead, the return and repayment arrangements are often dependent on the success of social outcomes being met. And while the bonds are for a fixed term, there is unlikely to be a secondary market for them.

Usually investors carry significant risk regarding the success of the underlying program. This results in an increased focus on measurement and performance evaluation of the service provider’s program.

How the SBBs work:

  1. The bond issuing organisation in liaison with the government and service provider structure a tripartite arrangement balancing the interests of the stakeholders. This focuses on the government payments, target returns to investors and the cost structure of the service provider.
  2. Private investors, superannuation funds, philanthropists and charitable foundations invest in the bond.
  3. The issuing organisation directs the capital raised to the service provider to fund the agreed program.
  4. If the specific pre-agreed targets are met, the government makes payments to the bond issuing organisation.
  5. The bond issuer uses those payments to provide investors with a return on their initial investment and to continue on-going funding of the program.
  6. Upon maturity of the bond term investors receive the balance of their capital, subject to performance targets.

Different countries, legal systems and social programs necessitate variations on this structure.

Outcome focused

As SBBs require measurable outcomes, they are best suited to programs that already have strong evidence of their ability to achieve better social outcomes.

SBBs therefore focus on social metrics that reflect an improvement in program participants’ lives (e.g. a reduction in the reoffending rate or fewer children in out-of-home care).

In terms of priorities, the programs most likely to be supported by governments are those that promise significant and identifiable cost savings into the future. For example, the savings in prisoner incarceration costs.

One way of measuring the outcomes is through Social Return on Investment (SROI). This methodology is well aligned to SBBs because it values outcomes and also considers how those values are attributed.

While some might argue that social programs should be funded directly by government, it seems that introducing external investors with returns tied to the social outcomes increases the rigour with which the programs are managed and hence their efficacy.

Governments are clearly attracted to these schemes as they are able to defer their own investment, make significant savings in the long-term and encourage more effectively managed programs. It means they can fund programs they want to support but are unable to due to budget constraints.

Incentive for success

The SBBs provide service providers with the flexibility to design and run projects with a focus on delivering results instead of expending resources trying to meet all the requirements that might be laid out in a government grant.

Typically, government payments attach to service delivery rather than the outcome the government is seeking to achieve. In contrast, SBBs provide a direct financial incentive to focus on and improve the relevant outcome. This emphasis on performance targets gives everyone involved in the project more incentive for success.

“Government is not always good at defining exactly how to solve social issues,” Charlton says. “Governments are recognising that they are purchasing services, but they’re not necessarily getting outcomes. But the social benefit bonds focus on a much higher understanding of what works and what doesn’t work and the measurements associated with that.”

In some SBBs, if the non-profit providing the social service doesn’t meet its goal, the government may not pay a cent, which means investors could lose all of their initial investment.

Experts say this transfer of risk from government to private investors is one of the main reasons big corporate investors and superannuation funds have not leapt on board.

Whereas philanthropists and foundations might look on a lost investment as fulfilling their community service objectives, institutional investors have an obligation to their stakeholders to invest for a financial return – with a certain level of confidence in it being achieved.

“The institutional investors, such as superannuation funds, are very focused on track record. They are attracted to the social outcomes but they can’t always put a value on them. In contrast, SBB programs do deliver long-term savings that can be valued,” says Ian Learmonth, Director of Impact Investing at SVA.

“The bonds will need to develop a track record so that larger pools of money are comfortable that SBBs are a reasonable commercial proposition.”

Pros and cons for investors

The advantages of SBBs from an investor’s point of view include:

  • Philanthropic funders can recoup investments with interest while also supporting social programs.
  • Institutional and/or commercial investors can take heart that their funds are contributing to social good as well as earning a reasonable return.
  • The returns on the investment are reasonable – if the social outcomes are met.

The disadvantages include:

  • High risk. In some programs investors risk losing all of their investment. In others the government or a foundation that would have funded the program may provide the ‘insurance’.
  • As the government savings resulting from preventative programs are large (in multiples of the original investment), investors may become dissatisfied with the rate of return, especially if there is high risk.
  • At this stage, there are no published results from a SBB, so there is limited evidence and experience in the market.

Pros and cons for society

The advantages for society include:

  • Service providers receive up-front, stable and predictable funding to implement programs on a larger scale.
  • Programs that government may not otherwise be able to fund are funded.
  • As a result of its outcome focus, the mechanism encourages more efficiency in the programs than government itself can bring.
  • Governments can improve and expand service delivery with little or no risk.
  • The government makes large savings compared to the costs if the problem had not been addressed – even with the additional cost of financing in this way.
  • Communities and disadvantaged individuals receive more effective, highly-targeted prevention and early prevention programs resulting in less suffering and the many other benefits of early prevention.

The disadvantages include:

  • There’s an extra cost in financing the programs with SBBs compared to direct funding by government. The cost includes the additional: payment of the third party bond issuer/ administrator, and the cost of evaluation and monitoring as well as the interest that investors earn.
  • It is a more complicated and expensive way for government to raise the funds than simply borrowing the money.
  • There’s a risk that if the social outcomes aren’t met, then the program ends. This is less beneficial to the program participants than if the program was funded by government.

Australia’s first SBB

In March 2013, the NSW Government signed a SBB contract with Uniting Care Burnside for its New Parent and Infant Network (Newpin) program, Australia’s first SBB pilot. The Newpin program will allow children in foster care to safely return to their families and will support other vulnerable families to stay together.

Social Ventures Australia (SVA) played a lead role in structuring and marketing the pilot SBB to potential investors and successfully raised $7 million, well ahead of the July 1, 2013 deadline.

Over the seven year duration of the Newpin bond, it is expected that more than 460 children will be supported to return or stay with their families. There are already four Newpin centres in western Sydney and the additional funding will allow another six centres to open across the state.

The SBB is targeting a 10-12% per annum return for investors over the seven year term. This hinges on certain targets being met or exceeded in terms of children being returned to their families.

Some protection features have been written in to the Newpin offer, with investors able to recoup 75% of their principal if the initiative fails in the first four years. That drops to 50% in the final three years.

Governments in Queensland, Victoria, South Australia and Western Australia are all monitoring the NSW pilot and are expected to develop similar SBB offerings.

The making of a new market

There’s no doubt current social bond trials like Newpin are an early test case for governments, service providers and investors alike. But if this new source of capital can deliver greater discipline, more transparency as well as measurable social benefits, then it could be the making of a new and sustainable market for corporate as well as philanthropic investors.


This article was first published in the SVA Consulting Quarterly and is reproduced with permission.