Why Development Impact Bonds?

Development Impact Bonds come at a price: private investors provide upfront funding for social interventions and expect a return, including some compensation for the risk they are taking, if outcomes are delivered.  Is that price worth paying?  The second meeting of the CGD and Social Finance Development Impact Bonds Working Group recently considered this question in some detail.

While a market is starting to emerge for Social Impact Bonds in the UK, US and other developed countries – for instance, UK Prime Minister David Cameron announced yesterday that payment-by-results models in the criminal justice sector should be expanded, building on thePeterborough prison pilot engineered by Social Finance –  the Development Impact Bonds Working Group is exploring opportunities for applying SIBs to development, and delving into questions that are sure to come up as governments and aid agencies consider whether they should be shifting more funds to this type of approach.

A Social Impact Bond (explained further here and here) is an outcomes-based contract whereby private investors provide upfront funding for social interventions and are remunerated by public sector agencies if evidence shows that the intended outcomes were achieved. In the case of development, host country governments may be able to provide all or part of this outcome payment, although in many cases outcome funding will come from donor agencies. In that sense, a Development Impact Bond could be a more efficient and effective way of channeling aid, by targeting resources toward a specific social outcome.

A Development Impact Bond could be more expensive than traditional ways of funding development because of the costs of investors’ returns and a coordinating organization that manages contracts with investors and service providers.  However, a key advantage for donors or outcome funders is that they wouldn’t have to put up funds until there is evidence that outcomes have been achieved. Outcome funders, typically public sector agencies, are transferring the risk of failure to the private sector, likely justifying potential added costs. But outcome funders will have to ask themselves how a DIB could solve a particular problem better than existing or alternative approaches can. (See Owen Barder’s blog postor this presentation for our early thinking on the kinds of problems DIBs are well-suited to solve.)

The Working Group is discussing several possible advantages of Development Impact Bonds over other approaches to funding for development, outlined in our background materials to the group’s meetings. These include:

  1. Providing upfront funding while using a results-based contract: Development Impact Bonds are similar to other results-based approaches, including Cash on Delivery Aid proposed by CGD, because they link payments to development outcomes, shifting the focus of programs to achieving and measuring those outcomes and allowing for locally tailored approaches to solving social problems. One of the first questions typically asked about results-based funding approaches is, how can governments or service providers achieve results without upfront-funding to implement programs? DIBs solve this problem by bringing in investors who finance a series of interventions upfront that are expected to lead to improved social outcomes. The structure can be used to deliver outcomes where effective interventions are not well understood, or to expand programs that have been effective on a small scale but around which there is uncertainty around using direct funding for scaling up.
  2. Coordination: Within a Social Impact Bond structure, a coordinating organization may contract with investors (who provide funds for implementing interventions), service providers (who carry out the interventions) and outcome funders (who provide funds after results have been achieved). All of these stakeholders are focused on a pre-agreed outcome, and outcomes are independently verified before investors are remunerated.  Public sector agencies therefore do not have to enter into individual contracts with service providers but also do not have to take the risk that service providers or the coordinating organization do not deliver.  Reflecting a problem likely seen by all governments, a recent paper by the Institute for Government examines the UK government’s commissioning skills and reports that there has been a perception of too great a focus on “securing a good price for individual contracts as opposed to developing a diverse market of suppliers that can effectively meet the needs of users in the long term.” In the UK, Social Impact Bonds are aiming to bring in new actors, shift to longer term contracts, and improve coordination with traditional public sector actors, to better solve social problems.  The same kind of new approaches and improved commissioning capacity are likely to be needed in developing countries too.
  3. More targeted interventions:  Because a DIB approach allows for a more flexible intervention approach, service providers can adapt their interventions (or even be replaced in cases where they are underperforming) to keep up with changing situations and maintain a focus on achieving outcomes. Coordinating organizations, reporting to private sector investors, can implement effective performance management systems which can give service providers real time feedback on the effectiveness of their interventions. Development Impact Bonds can also create incentives to focus on preventative services (as in the Peterborough Prison Social Impact Bond example) or on hard-to-reach populations or areas.  As they transfer to private investors the risks associated with delivering outcomes, Development Impact Bonds could be a tool for delivering more efficient and more effective approaches to solving complicated social problems.

Development Impact Bonds could lead to huge efficiency and effectiveness gains, with benefits for all stakeholders – public sector commissioners, taxpayers, investors who are socially motivated, and most importantly individuals and communities in target populations. The Working Group will convene one more time this winter to discuss defining characteristics and the potential value added of Development Impact Bonds as well as to assess specific ideas for implementing DIBs (some of which are discussed in this Wonkcast). It will then generate a report of its conclusions. As CGD and Social Finance further explore this financing mechanism, we’ll be looking out for ways that it could change the landscape of development finance – stay tuned.

By Rita Perakis from the Center for Global Development

This post originally appeared here

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