Editor’s Note: This blog post is one in a series of posts in which guest bloggers respond to the Brookings paper, “The potential and limitations of impact bonds: Lessons from the first five years of experience worldwide.”

Social impact bonds (SIBs) are one of a number of new “Payment by Results” financing mechanisms available for social services. In a SIB, private investors provide upfront capital for a social service, and government pays investors based on the outcomes of the service. If the intervention does not achieve outcomes, the government does not pay investors at all. The provision of upfront capital differentiates SIBs from other Payment by Results contracts.

Development Impact Bonds (DIBs) are a variation of SIBs, where the outcome funder is a third party, such as a foundation or development assistance agency, rather than the government. To date, 47 SIBs and one DIB have been implemented in the sectors of social welfare (21), employment (17), criminal recidivism (4), education (4), and health (2).

In a recent Brookings study, drawing from interviews with stakeholders in each of the 38 SIBs contracted as of March 1, 2015, we evaluate 10 common claims of the impact bond literature to date, so far made up of published thought-pieces and interview-based reports.

Figure 1. Common claims about Social Impact Bonds

Source:  The Potential and Limitations of Impact Bonds: Lessons Learned from the First Five Years of Experience Worldwide, Brookings Institution, 2015.

Of the 10 common claims about impact bonds, we found five areas where the SIB mechanism had a demonstrable positive effect on service provision:

1. Focus on outcomes. We found a significant shift in the focus of both government and service providers when it came to contracting and providing social services. Outcomes became the primary consideration in these contracts in which the repayment of the investment depended on achievement of those outcomes. Given that outcomes are the pivotal and defining piece of a SIB contract, it is unsurprising that many of those interviewed in the course of our research emphasized their importance, though we did find that this represented a more significant transformation in culture than expected.
2. Build a culture of monitoring and evaluation. The outcome-based contract necessitates the collection of data on outcomes, which helps build a culture of monitoring and evaluation in provider organizations and government. We found that the SIB is beginning to help solve longstanding problems in systemic data collection in multiple instances. In turn, government evaluation of outcomes and obligation to pay only for successful outcomes provides transparency and value for taxpayers. However, it is too soon to tell whether the monitoring and evaluation systems will remain in place after the SIB contracts conclude.
3. Drive performance management. The involvement of the investors and intermediaries in management of the service performance is a key component of SIBs. These private sector organizations often have stronger background in performance management and bring a valuable perspective to the social service sector. However, on average we find limited evidence that the service providers in SIBs to date have been able to significantly adjust their programs mid-contract in the case of poor outcomes, despite SIB proponents claiming this is one of the mechanism’s greatest merits.
4. Foster collaboration. In addition to collaboration between the for-profit, nonprofit, and government sectors, we also find evidence of gridlock-breaking collaboration across government agencies, levels of government, and political parties due to SIB contracts. This was noted to be one of the most important aspects of SIBs but also one of the most challenging.
5. Invest in prevention. External, upfront capital for services allows government to invest in preventive programs that greatly reduce spending in the future, such as early childhood development programs that reduce remedial education, crime, and unemployment. We found that all but one of the 38 SIBs were issued for preventive programs. Going forward, SIBs will not necessarily need to be tied to cash savings for government, but could simply be used as a method to finance programs that achieve desired social outcomes. 

Where do SIBs currently fall short?

For the five remaining claims about SIBs, we found less evidence of impact.

1.  Achieve scale. Of the 38 impact bonds contracted as of March 1, 2015, 25 served less than 1,000 beneficiaries. The largest impact bond, the SIB to reduce criminal recidivism at Rikers Island Prison in New York City, aimed to reach up to 10,000 individuals, but was terminated a year early this July because it did not meet target outcomes. The smallest SIB supports 22 homeless children and their mothers in the city of Saskatoon in Canada. These numbers are nowhere near the scale of the toughest problems facing the globe, where, for example, 59 million children are out of school. However, since March of 2015, two larger SIBs have been contracted, which may be an indication of increasing confidence in the mechanism. The Ways to Wellness SIB in the U.K. aims to improve long-term health conditions of over 11,000 beneficiaries and the first DIB launched plans to improve enrollment and learning outcomes of nearly 20,000 schoolchildren in Rajasthan, India. Further, the impact bond fund model used in the U.K. for 21 SIBs—where teams of service providers, intermediaries, and investors bid for SIB contracts based on a rate card of maximum payments per outcome government is willing to make—could be used to reach greater scale by contracting multiple SIBs at once. The largest of the impact bond funds, the Innovation Fund, reaches over 16,000 beneficiaries across 10 SIBs.
2. Foster innovation in delivery, and 
3. Reduce risk for government. SIBs vary in the degree of innovation and risk to investors—SIBs based on more innovative programs pose a greater risk to investors and may have higher investment protection or greater potential returns to balance the risk. In our study we found that very few of the programs financed by SIBs were truly innovative in that they had never been tested before, but that many were innovative in that they applied interventions in new settings or in new combinations. The literature claims that SIBs reduce the risk to government of funding an innovative service (government pays nothing if outcomes aren’t achieved), but as of March of this year it did not seem that the programs were particularly risky. The SIB in Rikers Island Prison was one of the most innovative and risky, and the early termination of the deal was an important demonstration of the reduction in risk for government. The New York City Department of Correction did not pay anything in this case; instead the investor and foundation backing the investment paid for the program.
4. Crowd-in private funding. Our research also shows mixed evidence on the power of impact bonds to crowd-in private funding, the fourth claim with unclear results. The literature up until now has claimed that impact bonds crowd-in private funding for social services by increasing the amount of money from traditional funding sources and bringing in new money from nontraditional sources. There is some evidence that traditional service funders, such as foundations, are increasing their contributions because of the opportunity to earn back what would otherwise have been a donation. Many of the current investors in impact bonds, Goldman Sachs for example, are indeed new actors in the space and their increased awareness of social service provision may be a benefit in and of itself. However, if a program is successful, government ultimately pays for the program. In this case, investors are solving a liquidity problem for government by providing upfront capital and not actually providing new money. Nonetheless, there is some evidence that paying only for proven outcomes has motivated the public sector to spend more on social services and that the external upfront capital has allowed government to shift spending from curative to preventive programs. Further, most programs thus far have been designed such that savings to the public sector are greater than payments to investors, resulting in a net increase in available public sector funds.
5. Sustain impact. Finally, five years since the first impact bond, we have yet to see whether impact bonds will lead to sustained impact on the lives of beneficiaries beyond the impact bond contract duration. The existing literature states that impact bonds could lead to sustained impact by demonstrating to government that a sector or intervention type is worth funding or by improving the quality of programs by instilling a culture of outcome achievement, monitoring, and evaluation. However, the success of impact bonds depends on whether new efforts to streamline the contract development stage come to fruition and whether incentives for all parties are closely scrutinized.

The optimal financing mechanism for a social service will differ across issue area and local context, and we look forward to conducting more research in the field on the suitable characteristics for each tool.

Downloads

• Download the policy recommendations
• The potential and limitations of impact bonds: Lessons from the first five years of experience worldwide (PDF)

Editor’s Note: This blog post is one in a series of posts in which guest bloggers respond to the Brookings paper, “The potential and limitations of impact bonds: Lessons from the first five years of experience worldwide."

In 2014, clause 5 (1) of the County Early Childhood Education Bill 2014 declared free and compulsory early childhood education a right for all children in Kenya. Early childhood education (ECE) in Kenya has historically been located outside of the realm of government and placed under the purview of the community, religious institutions, and the private sector. The disparate and unstructured nature of ECE in the country has led to a proliferation of unregistered informal schools particularly in underprivileged communities. Most of these schools still charge relatively high fees and ancillary costs yet largely offer poor quality of education. Children from these preschools have poor cognitive development and inadequate school readiness upon entry into primary school.

The Kenyan constitution places the responsibility and mandate of providing free, compulsory, and quality ECE on the county governments. It is an onerous challenge for these sub-national governments in taking on a large-scale critical function that has until now principally existed outside of government.

In Nairobi City County, out of over 250,000 ECE eligible children, only about 12,000 attend public preschools. Except for one or two notable public preschools, most have a poor reputation with parents. Due to limited access and demand for quality, the majority of Nairobi’s preschool eligible children are enrolled in private and informal schools. A recent study of the Mukuru slum of Nairobi shows that over 80 percent of 4- and 5-year-olds in this large slum area are enrolled in preschool, with 94 percent of them attending informal private schools.

In early 2015, the Governor of Nairobi City County, Dr. Evans Kidero, commissioned a taskforce to look into factors affecting access, equity, and quality of education in the county. The taskforce identified significant constraints including human capital and capacity gaps, material and infrastructure deficiencies, management and systemic inefficiencies that have led to a steady deterioration of education in the city to a point where the county consistently underperforms relative to other less resourced counties. 

Nairobi City County now faces the challenge of designing and implementing a scalable model that will ensure access to quality early childhood education for all eligible children in the city by 2030. The sub-national government’s resources and implementation capacity are woefully inadequate to attain universal access in the near term, nor by the Sustainable Development Goal (SDG) deadline of 2030. However, there are potential opportunities to leverage emerging mechanisms for development financing to provide requisite resource additionality, private sector rigor, and performance management that will enable Nairobi to significantly advance the objective of ensuring ECE is available to all children in the county.

Social impact bonds (SIBs) are one form of innovative financing mechanism that have been used in developed countries to tap external resources to facilitate early childhood initiatives. This mechanism seeks to harness private finance to enable and support the implementation of social services. Government repays the investor contingent on the attainment of targeted outcomes. Where a donor agency is the outcomes funder instead of government, the mechanism is referred to as a development impact bond (DIB).

The recent Brookings study highlights some of the potential and limitations of impact bonds by researching in-depth the 38 impact bonds that had been contracted globally as of March, 2015. On the upside, the study shows that impact bonds have been successful in achieving a shift of government and service providers to outcomes. In addition, impact bonds have been able to foster collaboration among stakeholders including across levels of government, government agencies, and between the public and private sector. Another strength of impact bonds is their ability to build systems of monitoring and evaluation and establish processes of adaptive learning, both critical to achieving desirable ECD outcomes. On the downside, the report highlights some particular challenges and limitations of the impact bonds to date. These include the cost and complexity of putting the deals together, the need for appropriate legal and political environments and impact bonds’ inability thus far to demonstrate a large dent in the ever present challenge of achieving scale.

In the Kenyan context, especially at the sub-national level, there are two key challenges in implementing impact bonds.

To begin with, in the Kenyan context, the use of a SIB would invoke public-private partnership legislation, which prescribes highly stringent measures and extensive pre-qualification processes that are administered by the National Treasury and not at the county level. The complexity arises from the fact that SIBs constitute an inherent contingent liability to government as they expose it to fiscal risk resulting from a potential future public payment obligation to the private party in the project.

Another key challenge in a SIB is the fact that Government must pay for outcomes achieved and for often significant transaction costs, yet the SIB does not explicitly encompass financial additionality. Since government pays for outcomes in the end, the transaction costs and obligation to pay for outcomes could reduce interest from key decision-makers in government.

The above challenges notwithstanding, a combined approach of results-based financing and impact investing has high potential to mobilize both requisite resources and efficient capacity to deliver quality ECE in Nairobi City County. To establish an enabling foundation for the future inclusion of impact investing whilst beginning to address the immediate ECE challenge, Nairobi City County has designed and is in the process of rolling out a modified DIB. In this model, a pool of donor funds for education will be leveraged through the new Nairobi City County Education Trust (NCCET).

The model seeks to apply the basic principles of results-based financing, but in a structure adjusted to address aforementioned constraints. Whereas in the classical SIB and DIB mechanisms investors provide upfront capital and government and donors respectively repay the investment with a return for attained outcomes, the modified structure will incorporate only grant funding with no possibility for return of principal. Private service providers will be engaged to operate ECE centers, financed by the donor-funded NCCET. The operators will receive pre-set funding from the NCCET, but the county government will progressively absorb their costs as they achieve targeted outcomes, including salaries for top-performing teachers. As a result, high-performing providers will be able to make a small profit. The system is designed to incentivize teachers and progressively provide greater income for effective school operators, while enabling an ordered handover of funding responsibilities to government, thus providing for program sustainability.

Nairobi City County plans to build 97 new ECE centers, all of which are to be located in the slum areas. NCCET will complement this undertaking by structuring and implementing the new funding model to operationalize the schools. The structure aims to coordinate the actors involved in the program—donors, service providers, evaluators—whilst sensitizing and preparing government to engage the private sector in the provision of social services and the payment of outcomes thereof.

The confluence of the agreement on 17 Sustainable Development Goals (SDGs, or Global Goals) in 2015, and the increased attention being paid to the role of non-traditional actors in contributing to shared prosperity, provide a unique opportunity to focus attention on attempts to identify promising new solutions to the barriers that impede the full development of the world’s youngest citizens. Current estimates indicate that 200 million children globally under the age of 5 are at risk of not reaching their development potential. With these goals, the global community has a tremendous opportunity to change the course of history. There is evidence that certain early childhood development (ECD) interventions—spanning the nutrition, health, water and sanitation, education, social protection, and governance sectors from conception to age 5—have high potential to help to achieve the SDGs related to child development. Furthermore, early childhood interventions have been found to improve adult health and education levels, reduce crime, and raise employment rates, which will be paramount to achieving global economic, climate, and physical security.

Impact bonds have the potential to address some of the main financing and delivery constraints faced in ECD. By providing upfront private capital, impact bonds could help to address service provider liquidity constraints and leverage public capital by allowing the government to connect preventive programs with future benefits to individuals, society, and the economy. Impact bonds also have the potential to drive performance management, support monitoring and evaluation, and create accountability, which all help to address quality and capacity constraints. By fostering innovation, experimentation and adaptive learning in service delivery, cost-effective solutions could be identified through impact bonds. By producing evidence of outcome achievement, impact bonds could shift the focus toward effective ECD programs. Finally, collaboration across stakeholders—a necessary component of impact bonds—has the potential to allow for alignment of interests and a win-win situation for investors, outcome funders, and program beneficiaries alike.

The high participation of non-state actors and potentially significant returns in ECD make it a promising sector for impact bonds. Unlike other services that may have entrenched interests, the multitude of agencies and non-state entities financing and providing ECD services potentially allows for more experimentation. The preventive nature of ECD programs also fits well with the core feature of SIBs, which is that preventive investments will result in valuable short- and potentially long-term outcomes. There is evidence that ECD interventions can have immense effects on later-life outcomes. For example, a longitudinal study of a program in Jamaica, in which participants received weekly visits from community health workers over a 2-year period, was found to increase the earnings of participants by 25 percent, 20 years later.

There may, however, be some particular challenges associated with applying impact bonds in the ECD sector. Impact bonds (and other Payment by Results mechanisms tied to outcomes) require meaningful outcomes that are measureable within a timeframe that is reasonable to the outcome funder (and investors in the case of an impact bond). Meaningful outcomes are outcomes that are intrinsically or extrinsically valuable. Intrinsically valuable outcomes that are measureable within a reasonable timeframe could be extrinsically valuable if they are proxies for long-term benefits to individuals, society, or the economy. The delay between ECD interventions and later-life results may prove an impediment in some cases. By identifying appropriate interim measures such as language development, socioemotional development, and schooling outcomes that may proxy for desirable longer-term outcomes, the issue of delay could be mitigated. For example, there is evidence that early stimulation and health programs can have statistically significant effects on schooling outcomes in the short-run. An increase in focus on the intrinsic value of short-term outcomes that result from ECD interventions, such as child survival, is also important.

As the global community moves beyond the Millennium Development Goals to a set of Global Goals and associated targets linked to measurable outcomes, there is an opportunity to demonstrate a commitment to invest in future generations. Leveraging upfront funding, focusing on outcomes through adaptive learning and testing new ways to deliver early childhood interventions more effectively are all means of achieving the ECD-related goals. Despite the hype around all of the new financing mechanisms, the keys to creating high-quality, locally appropriate programs remains simple—real-time collection of outcome data, the freedom to fail, and the flexibility to course-adjust. In some circumstances social service provision based on outcomes and adaptive learning may require mechanisms like impact bonds or other Payment by Results mechanisms. In other circumstances it may not. As this very nascent field continues to grow, more research will be needed to capture lessons learned, contextualize them within the larger landscape of ECD financing and service provision, and apply them to real-world social challenges with the world’s youngest and most disadvantaged populations at the forefront of the conversation. 

Read the previous report on the landscape of impact bonds across sectors and geography »

Downloads

• Download the full report
• Download the policy brief

Event Information

Webcast archive:

View speaker presentations here:
1. Impact Bonds Worldwide
2. Impact Bonds for ECD

Impact bonds, also known as Pay for Success contracts in the United States, have leveraged over $200 million in upfront private capital for social services worldwide over the last six years, and by 2020 the market is expected to triple. Brookings experts have published two reports analyzing the market, the first of which is a comprehensive review of the global impact bond market and the second of which examines applications to Early Childhood Development programs.

On February 29, the Global Economy and Development program at Brookings hosted a discussion on the scope for social and development impact bonds to address social challenges globally. Sessions reflected on the types of challenges for which these new financing modalities are best suited, and the factors critical for their success. Sir Ronald Cohen, chairman of the Global Social Impact Investment Steering Group, provided keynote remarks, followed by presentations from Emily Gustafsson-Wright, fellow at the Center for Universal Education at Brookings and lead author of both reports on impact bonds.  The event included two panel discussions and a networking lunch.  

 Join the conversation on Twitter using hashtag #ImpactBonds.

Audio

• The global potential and limitations of impact bonds

Transcript

• Transcript (.pdf)

Event Materials

• 20160229_social_impact_bonds_transcript

“For a not-for-profit it’s the equivalent of venture capital,” said Sir Ronald Cohen, chairman of the Global Social Impact Investing Steering Group, about impact bonds in his keynote address at a recent event at the Brookings Institution. Impact bonds combine results-based financing and impact investing, where investors provide upfront capital for a social service and government agencies, or donors, agree to pay investors back based on the outcomes of the service. At their best, they could allow for innovation, encourage performance management and adaptability, promote learning through evaluation, and create a clear case for investing in what works. However, impact bonds thus far have had immense transaction costs and there are risks that poor execution of the impact bond mechanism could have negative consequences for beneficiaries.

It has been six years since the first impact bond was implemented in March of 2010, and the field is beginning to move from an exploratory stage to looking at systemic change, as Tracy Palandjian, CEO and co-founder of Social Finance U.S. described. The event, “The Global Potential and Limitation of Impact Bonds,” served as a point of reflection for stakeholders at this pivotal stage of the field, bringing together over 500 individuals in the room and on the webcast, including practitioners developing impact bonds around the world. While context matters, there were notable similarities in the motivations and challenges across regions.

In our presentations of our research and subsequent panels, we focused on the potential value and challenges of combining results-based financing and impact investing through an impact bond. Shri Naveen Jain, mission director of the National Health Mission of Rajasthan, India, who is working to develop an impact bond for maternal and child health services across his entire state, pointed out that the value of a results-based financing contract to him was in the added transparency it provides—the government is able to see what they are paying for, keep service providers accountable, and incentivize providers to achieve better outcomes. Louise Savell, a director at Social Finance U.K., the entity that first put impact bonds on the map, explained that results-based financing contracts are often arranged such that only one portion of the contract is based on results. This, she explained prescribes a model and does not allow for flexibility; furthermore, it forces service providers to bear a significant risk. Impact bonds allow for the entirety of payments to be based on results, which gives the provider full flexibility (at least in theory), but puts the risk of service performance on the investor. The shift of risk to investors could be particularly useful for service delivery in conflict affected areas, where donors are often highly concerned about how money will be used, mentioned Francois de Borchgrave, co-founder and managing director of Kois Invest, who is working on an impact bond with the International Rescue Committee of the Red Cross. The panelists also emphasized that impact bonds are more powerful than results-based financing contracts alone because, if successful, they pay real financial returns to investors. This draws a great deal of attention from policymakers and the public, and the added scrutiny helps in making the investment case for preventive interventions highly explicit. Mayor Ben McAdams of Salt Lake County, Utah said that “data and evidence is bridging a partisan divide” in his state—when the case for investment is clear, policymakers from both sides of the aisle are willing to invest. Impact bonds do not necessarily add value by increasing the total amount of funding available for social services, because investors are repaid if outcomes are achieved. Rather, impact bonds could help increase the outcomes achieved with given funding.

Overall there was agreement that impact bonds have enormous potential to lead to more outcome-focused financing that focuses on preventive interventions and incentivizes collaboration. However two critical considerations for the use of impact bonds arose throughout the day.

The first consideration discussed was whether or not impact bonds can support innovation or scale. As found in our first report, impact bonds have been relatively small in scale in terms of capital and beneficiaries. The average upfront investment in impact bonds to date is $3.7 million, reaching an average of 1,900 beneficiaries. They also have not, on average, focused on particularly innovative interventions—in fact they have almost all had a relatively strong base of evidence behind them. Views on the panel differed on whether the uses of impact bonds could be expanded—if they could be used for highly innovative pilot programs or proven large scale programs. One perspective was that impact bonds could indeed provide seed capital to test new ideas for service delivery. This would require investors who are willing to test not only the innovation but also this relatively new financing mechanism. Given the high transaction costs that impact bonds entail, however, this may not be the most efficient use of resources. Impact bonds could also reach more beneficiaries per transaction (greater scale) with changes in public procurement and the creation of markets for tradeable impact bond assets. Government can play a role in facilitating larger impact bonds by creating central government outcome payment funds, providing tax breaks for investment in impact bonds, and enabling the development of investment vehicles, all of which are being implemented in the U.K. Impact bonds could also help effective social services reach scale by encouraging government to fund programs at scale after the impact bond is over or by improving data use and performance management in government-funded services broadly.

A second, and related, discussion happened around evaluation methodology—which may differ depending on whether the impact bond is intended to test an innovative intervention or scale an intervention already backed by significant evidence. The “gold standard” randomized controlled trial (RCT) is the only methodology that eliminates the possibility that impact could be attributed to something other than the intervention, though the majority of impact bonds thus far use evaluation methodologies that are less rigorous. The panelists explained that it is important, however, to consider the status quo—currently, less than 1 percent of U.S. federal spending on social services has been shown to be effective. The same is true in low- and middle-income countries, where there are relatively few impact evaluations given the number of interventions. At the end of the day, the government agency acting as the outcome funder must decide on the importance of attribution to trigger payment through the impact bond in view of the already available evidence of program effectiveness and weigh the criticism that might ensue in the absence of a valid counterfactual.

Though impact bonds are a potentially useful tool in the toolbox of many financing mechanisms, there are some significant constraints to their implementation. The biggest barrier to impact bonds and other results-based contracts is the administrative hurdle of contracting for outcomes. Peter Vanderwal, innovative financing lead at the Palladium Group, and Caroline Whistler, co-president and co-founder of Third Sector Capital Partners, both stated that governments often are unable or do not know how to contract for outcomes, and there is a need to invest in their capacity to do so. Appropriation schedules are part of this challenge, governments are often not allowed to appropriate for future years. When an audience member asked how we go about changing the culture in government to one of contracting for outcomes, Mayor McAdams answered that impact bonds may have a contagious effect—contracting for outcomes will be the expectation in the future. Additionally, the transaction costs of establishing the partnership are large relative to other mechanisms, though they may be worthwhile. Jim Sorenson, of the Sorenson Impact Center, pointed out that service provider capacity and data collection systems could be barriers to the development of future impact bonds. There is also still a long way to go in developing outcome measures and in particular in calibrating those outcome measures to low- and middle-income countries.

The influence that impact bonds have on the provision of quality services globally depends on the quality of implementation. With a rapidly growing market, there will inevitably be “bad” impact bonds in the future. To ensure that impact bonds are used as effectively as possible, governments and the research community have a pivotal role to play in asking the right questions: Will a results-based contract help improve outcomes in this particular case? What should the outcomes be to avoid perverse incentives or potentially negative externalities? And would an impact bond structure add value? 

March 18 was an historic day for early childhood development (ECD) financing—the Departments of Social Development and Health of the Western Cape province of South Africa committed 25 million rand ($1.62 million) in outcome funding for three social impact bonds (SIBs) for maternal and early childhood outcomes. This is the first ever funding committed by a middle-income government for a SIB—to date no low-income country governments have participated in a SIB either—making South Africa’s choice to pioneer this new path especially exciting.

A SIB is a financing mechanism for social outcomes where investors provide upfront capital for services and a government agency repays investors contingent on outcome achievement. There are currently two active development impact bonds or DIBs (where a donor provides outcome funding rather than a government agency) in middle-income countries, one for coffee production in Peru and one for girls’ education in India. The South African SIBs, whose implementation was facilitated by the Bertha Centre for Social Innovation and Entrepreneurship at the University of Cape Town and Social Finance U.K. as well as other organizations, will be the first impact bonds in Africa.

We have been following closely the development of these SIBs over the last two years through our research on the potential applications of impact bonds for ECD outcomes, and recently hosted a discussion on the topic at Brookings. There are currently nine other impact bonds worldwide that include outcomes for children ages 0 to 5, including two recently announced impact bonds in the U.S. for nurse home-visiting in South Carolina and support for families struggling with substance abuse in Connecticut.

Impact bonds are well suited to fund interventions that have high potential returns to society; that require learning, adaptability, and combinations of services to achieve those returns; and that are not core government-funded services (often resulting in a relative proliferation of non-state providers). In our recent report, we find that a majority of evaluations show ECD can have unparalleled returns, but there are also a number of evaluations that show no significant impact or where impact fades out. Overall however, there are few evaluations relative to the number of service providers and interventions, an indication of how little we know about the effectiveness of the majority of service providers. For example, there are only 15 studies examining the effects of ECD interventions in low- and middle-income countries on later-life socioemotional development, which has been shown to be a critical determinant of success in school and life.

The case for government investment is strong, but continuous learning and adaptation is needed to ensure the high potential impacts are achieved. Tying payments to outcomes could help the ECD sector in three ways: it could encourage new government investment in ECD, it could encourage performance management and adaptability, and, crucially, it could help develop the knowledge base of what works in ECD. Unlike some other sectors where providers are able to finance their own operations to participate in a results-based (performance-based) contract through fees or other cash flows, ECD providers will almost always require upfront capital in order to reach the most vulnerable. Consequently, we find that, despite some significant challenges, ECD interventions are particularly well suited to impact bonds.

For this reason, there are three things we find particularly exciting about these new SIBs for early childhood development in South Africa:

1. Collaboration of two departments to ensure a continuity of outcome measurement and, hopefully, achievement. Given their different mandates, the Department of Health will fund outcomes for pregnant mothers and children in their first 1,000 days and the Department of Social Development will fund outcomes for children ages 2 to 5. The Bertha Centre writes that “the funding will be made available to three community based organizations working with pregnant women and children up to five years of age with outcomes including improved antenatal care, prevention of mother to child transmission of HIV, exclusive breastfeeding, a reduction in growth stunting, and improved cognitive, language and motor development.” 

The continuity of quality services is essential to sustaining the impacts of early childhood services, and this is the first set of impact bonds to address outcomes across the development spectrum from age 0 to 5. Selecting outcomes however, particularly for more complex learning outcomes for children ages 3 to 5, can be one of the greatest challenges for impact bonds in the ECD sector.

A full list of recommended outcome metrics for ECD impact bonds is available in our report.

2. Outcome fund structure. The SIBs in South Africa have been designed as impact bond funds, where the outcome funder issues a rate card of prices it is willing to pay for certain outcomes and multiple service providers are awarded contracts to provide those outcomes. This structure, which has been implemented in four instances in the U.K., could help facilitate impact bonds at greater scale than what we have seen thus far.

At the Brookings event on impact bonds, Louise Savell of Social Finance U.K., explained that scale was critical in the South African case because there are few providers that work across the entire province. While the discussion around pricing outcomes in the U.K. was more focused on future value to the economy, the discussion in South Africa had to be more attuned to the price of providing services. These delivery prices differ greatly by township, which may result in different outcome payment prices by township. The impact bond designers also had to ensure the outcome price allowed for providers to serve the hardest to reach.

3. Matching of private-sector outcome funds. This is the first impact bond to date where private-sector actors will augment outcome funds, in addition to serving as investors. Impact bonds take a great deal of work for a government agency to establish—though it will likely drop over time—and additional or matching of outcome funds will be critical to making this effort worthwhile for low- and middle-income country governments.

Looking forward, it will be interesting to compare and contrast the structure and design of these SIBs with the impact bonds for ECD outcomes in Cameroon, India, and potentially other countries as they launch in the coming years. Each impact bond must be designed taking into consideration the particular issues and challenges in a given context. However, sharing learnings from one impact bond to the next will likely improve both efficiency and quality of the impact bond implementation. 

Impact bonds, and other RBF mechanisms, require the measurement of outcomes and create an incentive for the service provider to deliver results. Both aspects encourage the service provider to improve performance management and, ultimately, the quality of the service. Because governments or donors only pay if results are achieved, funding is not wasted on unsuccessful programs. Furthermore, the guarantee of value can encourage governments or donors to explore new, potentially high-impact interventions, instead of continuing to fund low-impact programs.

Impact bonds may also have other positive spillover effects on development. For example, the involvement of private intermediaries and investors may also help grease the wheels of new government contracting systems or provide a way for the business sector to engage in a social issue.

However, despite the enormous potential of impact bonds, there are also some considerable limitations and challenges associated with their implementation. Three criteria are necessary to even consider the use of an impact bond:

1. The ability of the funder to pay for outcomes rather than inputs
2. Sufficient evidence that a given intervention and service provider will be able to deliver a stated outcome for an investor to take the risk of engaging
3. Meaningful outcomes (i.e., related to the SDG indicators) that can be measured within a time frame suitable to both investors and outcome funders

In addition to these three critical criteria, the ability for the key stakeholders to collaborate with one another has enormous implications for getting an impact bond off the ground. These factors contribute to the complexity and high transaction costs associated with impact bonds (relative to traditional input-based financing). Given these constraints, impact bonds are suited to areas where service providers need flexibility and where risk factors discourage direct funding but are minor enough to attract impact investors.

Thus far, these criteria have limited impact bonds to particular subsectors, regions, and investor types and have restricted their scale (both monetarily and in terms of beneficiary numbers). Impact bonds have been developed in fields with complex service inputs and simple outcomes, and for services that cater to particularly underserved or marginalized populations. The scale of impact bonds has been limited—the majority serve fewer than 2,000 individuals, and the largest reaches less than 16,000. Investors have been limited to philanthropic or impact investors rather than commercial investors. However, all impact bonds thus far have supported interventions that have at least some evidence of effectiveness.

Given trends in the global impact bond market, what role do impact bonds have in fulfilling the financing needs to achieving the SDGs, in particular in developing countries?

Impact bonds are likely to be improve effectiveness of financing rather than increasing volume. They also serve an important role in financing mid-scale interventions with some evidence of effectiveness. While they may not be best suited to large-scale financing of social services, they have the potential to affect large-scale systemic shifts in how governments and service providers think about service provision because they build cultures of monitoring and evaluation, encourage investments in prevention, and incentivize collaboration, all of which are essential to achieving the SDGs.