An impact bond is an innovative, results-based, financial contract between an investor, an outcome funder and a service provider to deliver social or environmental services. Within a well-defined, measurable program, the investor (typically a private sector actor or NGO) provides upfront capital to a service provider to deliver high quality services to the population in need. Upon achievement of results, the outcome funder (typically a public-sector agency) repays the investor at a premium. By doing so, the investor is able to generate a return on its investment and the public sector only pays for successful results that achieved the targeted impact. In a Development Impact Bond (DIBs) the role of the outcome funder is played by external development agencies as opposed to Social Impact Bonds (SIBs) where the role is played by the government.
The impact bond encompasses seven key components which are illustrated below:
1. Government selects a specific social or environmental outcome that is of great importance. It assesses the value proposition for its citizens (and tax payers), determining that the program/intervention will provide fiscal and non-fiscal benefits that warrant the investment.
2. Government contracts with a qualified private sector service provider, sets pre-agreed outcomes. This is often referred to as Pay-For-Success contracting.
3. Private capital fully funds the initiative. Post completion of rigorous due diligence, third party funders agree to provide the funds to ensure sufficient financial resources to achieve the targeted outcomes. Often this will include funds to strengthen the capacity of the service provider, enhanced data collection and real-time evaluation capacity. The counterparties to the financing agreement are the private funders, government and the lead service provider.
4.Service provision by high-quality provider. A lead organization engages with the targeted population. Often to achieve the targeted outcomes, the services require an integrated approach, leveraging the skills and capabilities of several sub-contractors under the direction of the lead service provider.
5. Data management. The provider uses data tools to continuously monitor and evaluate effectiveness of the program, course-correcting as necessary. Important to note that the contract with the government provides the flexibility for the lead implementer to manage and adapt the program in order to achieve the targeted outcomes.
6. Independent evaluators assess the performance and outcomes of the services provided.
7. Government pays for “what works”. Should the targeted outcomes be achieved, government repays the private funders principal and an agreed upon interest rate.
Why Impact bonds?
Impact bonds show the potential to improve results and overcome barriers to social innovation. They do this by ensuring that public funding goes only to those interventions that are clearly demonstrating their impact through rigorous outcome-based performance measures, transferring the risk of program implementation to the investor, and providing an effective way for state and local governments to maintain and scale up interventions that show success.
For Outcome Funders
1. Management: Impact bonds encourage improved fiscal management, as governments reallocate scarce resources to programs and service providers that achieve the targeted outcomes. The characteristics of impact bonds allow for a robust “feedback loop” to ensure that the targeted outcomes are achieved and “course correct” as necessary
2. Accountability: Outcome funders only pay for the achieved outcomes
3. Transparency: Impact bonds establish a high degree of transparency, allowing for close verification of the quality of service provision, related costs and the delivery of outcomes
4. Capital: Impact bonds use blended investor capital to assure full upfront capitalization of programs, thus avoiding deferred payments to providers
5. High Priority: Impact bonds can be applied to high priority government interventions to support the implementation of high quality, measurable intervention programs.