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How to be a successful outcomes payer

By Rebecca Rosser

It is indisputable that public funds will not fulfil the UN’s Sustainable Development Goals (SDGs). Consequently, eyes are on the private sector. Yet, asking the private sector to undertake the seventeen SDGs and immediately fund the perfect world is fanciful at best, and irrational at worst, since the private sector needs to generate profit in order to survive and continue developing innovation, employment and economic growth (SDGs 8 and 9).

Growing following
Collaborations between the private and the public sector through Social Impact Bonds (SIBs) have gathered an increasing number of supporters over the last ten years. Indeed, since the first impact bond was launched in 2010 in the UK, 26 countries have joined the impact revolution developing 136 impact bonds. In The Netherlands, there are eleven SIBs and Social Finance NL and her partners have been part of the development of an Outcomes Fund with four additional impact bonds next month.

Seeking solutions
Maroana Mazzucato, an Italian-American economist, would argue that the success of SIBs and impact investment is not exclusively due to innovative finance or the private sector’s semi-organic drive towards sustainability, peace and justice. Mazzucato has researched the role of the state in the development of the Big Four (Facebook, Amazon, Apple and Google) and concluded that financial, technological and scientific innovation occurs thanks to public authorities’ support. She argues that when public authorities have a problem that they cannot resolve, they become the largest investors in innovation, hoping to get a more effective and efficient solution to their problems.

It is therefore understandable that ten out of the eleven SIBs in The Netherlands count on a ministry or municipality as an outcome payer. Although Dutch insurance and international philanthropic organisations have contracted outcome payments, public authorities, whether local, national or intergovernmental, continue to be the largest bidders.

For these reasons, this article is dedicated to public authorities, key players in impact bonds. We explain the role of public authorities as outcome payers and draw from Social Finance’s experience and expertise to discuss our observations and make some useful recommendations.

What do the Ministry of Justice & Security and the Municipalities of Rotterdam, Utrecht, Eindhoven, The Hague, Veldhoven and Venlo, have in common?

They are all outcome payers.
From 2013 onwards, they all engaged in a SIB.

What’s a SIB?
For the newcomers in the world of results-based-financing, Social Impact Bonds are outcomes-based contracts whereby investors provide upfront capital to a service provider (frequently, a social enterprise or NGO). If the social enterprise accomplishes the previously defined expected outcomes, a public stakeholder pays out the investment to investors. Often, the relevant parties can agree on an additional interest rate that the outcome payer will also pay to investors if results are met.

It sounds like these stakeholders, or problem owners as we refer to them, just pay. So, is this really a financially beneficial solution to their problems?

Not cheap
As a matter of fact, we would be lying if we said that SIBs are a cheap financial solution to a social problem. Setting up a SIB, an outcomes-based contract, requires recruiting investors and a suitable service provider, writing a legally complex contract, and elaborating a cost-benefit analysis with a high quantity of different quantitative and qualitative data. Furthermore, as SIBs are a multiparty contract, there are tough negotiations between investors and outcome payers to be moderated. Consequently, there is a real need to hire an intermediary, such as Social Finance, and possibly, a project manager to act as the responsible person.

Additionally, outcome payments are often accompanied by an additional interest or risk premium which public authorities have to pay in order to compensate investors for the risk they undertook when providing the upfront capital for the intervention. Altogether, these costs can escalate significantly; Brookings Institute, an American think-tank, has pointed out that this can cause disappointment amongst outcome payers and almost put at stake the monetary efficiency of SIBs.

Having said that, let’s look at the rest of the financial picture.

The intervention is previously shaped according to an accurate cost-benefit analysis, which is built with extensive historical and comparative data and market assessments to make it both efficient and effective. We do this by first examining the target group – identifying all its needs, expenses and sources incomes – as well the public authority’s liability to this group. We ask: how much does the state authority pay to the target group, with what aim and what is the real impact of this compensation?

The essence
This research leads to abundant qualitative and quantitative data that enables us to define the intervention that would be most effective and efficient at resolving the social issue – or in other words, cheaper and faster. We can indicate the exact output and outcomes that the service provider needs to obtain in order to guarantee meaningful impact. As a matter of fact, this forms the essence of the SIB – an outcomes-based contract signed by an outcome payer, a service provider and investors by which all parties agree on the specific outcomes intended to achieve. Investors then provide the service provider with upfront money to deliver the impact goals – a combination of business output and outcomes – and the outcome payer repays investors if the service provider succeeds in securing fulfilling the agreed expectations.

This transparency in the definition of impact, the goals and the money that is put in leads to a detailed plan of action, ensuring a high degree of efficacy. But what is more interesting is that it doesn’t end here, so you don’t have to take our word for it. SIBs are underpinned by consistent monitoring, carried out by an independent evaluator. It is the independent evaluator who assesses if the service provider has met the output and outcomes objectives set at the beginning of the intervention.

Only if the independent evaluator determines that the intervention has been successful, does the outcome payer repay investors. This means that if the service provider does not deliver the expected and agreed results, the outcome payer does not lose any money – the investors do; so, investors carry the risk of the intervention.

All in all, creating a data-driven intervention that is held accountable to an independent evaluator fosters a culture where results are at the epicentre of every action, which primarily benefits the target group (the people suffering from a social issue) and the public authority, whose problem is resolved and no longer has to pay benefits or compensations with unknown effects.

Measuring
However, Social Finance has observed a number of different spin-off effects. Public authorities from all around the world adopt a results-based approach to other projects after engaging in a SIB, illustrating how SIBs shape the working culture. Furthermore, SIBs have successfully placed results monitoring and measuring on the bargaining table. Everyone – social entrepreneurs, NGOs, multinational companies, equity firms, financial institutions, et cetera – recognises the importance of measuring results to improve performance.

Thus, when an outcome payer assesses the financial viability of SIBs, it is worth looking at how the costs of the intervention stand against the multiple gains. SIBs are not just a financial tool to resolve a specific problem, they are champions of a results-based working attitude that increases effectiveness. Only public authorities can make this happen. From Social Finance NL, ‘You don’t just pay! You are a key stakeholder of this transformation.’ We know this – and we want to give outcome payers their deserved merit by outlining below the stake they hold in designing a SIB.

Observations from an intermediary
Outcome payers do much more than paying out to investors. They are at the core of the process from the beginning and their input is crucial to carry out an accurate cost-benefit analysis and to elaborate the contracts.

  • To guarantee an easy and successful design of the SIB, a specific target group must be identified at the beginning of the process. The clearer the characteristics of the target group, the easier and quicker the design process can develop.
  • Once the characteristics of the target cohort are perfectly defined, the outcome payer must consult their archives to supply the intermediary with all relevant (historical) data that enables an accurate assessment of the target individuals’ financial inflows and outflows.
  • When signing a long-term contract that involves a large commitment, it is useful to understand the complexities of it and to acknowledge the unexpected events that may arise in the future. Therefore, the outcome payer usually wants to oversee the process closely and source answers to what may not be clear at first glance.
  • The above tasks are laborious and require working capital. In other words, the outcome payer tends to allocate public officials to ensure that the target group is accurately determined, and that the intermediary has all the necessary data to produce an accurate cost-benefit analysis.
  • Every SIB on hold or abandoned half-way through the process is money wasted. Yet, this happens often. Brookings Institute found that political turmoil and unexpected financial crises, whether at local, national or international level, are often reasons why outcomes-based contracts are halted or discarded altogether. Indeed, if the average duration of a Social Impact Bond is 52 months and each SIB takes around a year to set up, the outcome payer’s commitment must remain strong for at least 5 years. Failure to do so leads to a very expensive cul-de-sac.

Recommendations from an intermediary

  • GoLab, the UK Government’s specialised think-tank in results-based financing, recommends its government to ask itself beforehand, what would I like to do? We agree that this is a very pertinent question to assess the suitability of a SIB. Social Impact Bonds are great financial tools, but there are other results-based financing solutions that could work better and should not therefore be neglected.
  • The seemingly perpetual liberal Anglo-Saxon countries naturally advocate for the benefits of healthy competition amongst outcome payers, service providers, intermediaries, and investors. Indeed, according to the rules of the free market, if we strive to help more people and in more positive ways, we will all be efficiently and effectively accomplishing the SDGs. Yet, to guarantee healthy competition, at Social Finance NL, we strongly recommend more transparency and knowledge-sharing on deals. As discussed in our latest report, ‘Five Years of SIBs in The Netherlands’, more transparency and knowledge-sharing would strengthen the impact investment ecosystem and avoid reciprocations of mistakes, enabling the collective (including taxpayers) to save time and money. GoLab, for example, urges outcome payers to consistently publish plans and evaluations to add accountability to the process. They state that this incentivises other governments to engage in results-based financing – and it must be true because the UK leads the SIBs League Table with 42 SIBs (over a third of the total number of SIBs in the world)!

It’s right, then, that we thank all public stakeholders who support innovation and trust the private sector to develop results-proof solutions to social problems.

At Social Finance NL, we know that every results-based contract is complex, laborious, undoubtedly stressful for those involved, and very much worth it. We have the immense privilege to know that every penny and day spent hard at work leads to meaningful impact or, just as important, very meaningful lessons. If you would like to know more, visit our website, or better: give us a call!

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