Social impact bonds primer

Those who have been following the impact investing sector have probably heard of Social Impact Bonds (SIBs)—otherwise referred to as Pay for Success (PFS) contracts.

PFS is a financing mechanism that brings together funders, payers, and providers to finance and execute on an intervention targeting a specific social outcome. The first SIB/PFS deal was in 2011 in the UK for recidivism reduction—and since then, more have surfaced around the world (e.g. US and Australia) exploring a variety of issue areas (e.g. health, child welfare, education, homelessness).

PFS Stakeholders — Funder, Provider, Payer. Source: PFS Investor Primer

From a funder perspective, PFS contracts present a new set of investable risks—whereby the interpretation and appetite for these risks vary depending on the nature of the investor and the capital base they work with (e.g. philanthropic, blended, investment).

For PFS, much of the experimentation with the first few deals have been seeded using highly risk-tolerant capital, and has mostly served the purposes of demonstrating:
  1. operational (and political) capability, and,
  2. demand-side willingnesses from payers (like government, who see PFS as a risk transfer tool) and providers (non-profits, who see PFS as a scaling tool)
I think that getting PFS to the next stage will require more deliberate attention on the supply-side picture (e.g. funders).

With many of the first PFS deals seeded philanthropically (which has cost of capital of ~0), much of the discussion around risk has been side-stepped. However, better segmentation of risks, and understanding of how these risks link to returns, will need to be the underpinning of any attempt to access/catalyze larger pools of capital needed for the sector to continue to grow/develop/experiment.

To kickstart this discussion, I've put together a high-level document detailing what I see as the key PFS risk factors ("model variables"), and how these link to financial return outcomes relevant for a broader set of funders. This is conceptualized using a basic cashflow valuation model, summarized in this a short primer.

Download here
Pay for Success - Social Impact Bond - Valuation Model / Framework Exerpt. Source: PFS Investor Primer

Thanks to Yale M for technical advice on the topic.