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In tackling vexing social problems like homelessness, chronic unemployment, and juvenile delin­quency, on which progress may take years to achieve, one encounters common difficulties: Many state and local governments lack the funds needed to invest in innovative new programs — especially at times when existing programs are being cut. And when it comes to prevention efforts in public health and other areas, the costs must be borne in advance, whereas the benefits may not come until much later.

A new approach to financing preventive investments, called “social impact bonds,” can potentially overcome these and other barriers, offering the prospect of swifter progress in ameliorating social ills. The Kennedy School is at the forefront of the effort to bring social impact bonds into greater use, with Professor Jeffrey Liebman and a team of current and former students affiliated with his Social Impact Bond Technical Assistance Lab (SIB Lab) leading the way.

The SIB model, Liebman explains, overturns the normal formula for funding social programs in two ways. First, government pays for results achieved rather than for services provided. Second, because private investors, rather than the government, “provide the up-front capital and absorb most of the risk,” he says, it becomes possible for cash-strapped governments to make investments in preventive services.

Here’s how the idea works: A government enters into a contract with a private sector intermediary that specifies a schedule of payments the government will make if outcome targets — such as reduced recidivism or higher third-grade reading scores — are achieved. The intermediary recruits service providers to achieve the out­comes and raises funds from a combination of commercial and philanthropic investors to finance the service providers’ operating costs. If the outcomes are achieved, investors get repaid their capital plus a return.

This arrangement could be advantageous in several ways. First, there’s the prospect of improved performance, because all partners in the project will be focused on achieving the target outcomes. The model can also spur the adoption of novel solutions, says Liebman, “because the risk of wasting taxpayer dollars if the new strategy fails is transferred to the private sector.” Financing through social impact bonds can encourage greater investment in preventive services, an area that’s often underfunded owing to constraints on government budgets. Although funding through individual government agencies has often led to the compartmentalization of problems, the SIB model — with its focus on results — can promote greater cooperation among disparate agencies and organizations, all working toward a common goal. Finally, notes Liebman, “the model will lead to more rapid learning about what works,” because thorough, ongoing program evaluations are automatically built into the process.

While it’s easy to understand the government’s interest in arrangements that shield it from risk, it’s harder to see the upside for investors. In the short run, says Liebman, “there seems to be suffici­ent enthusiasm about this model from philanthropic foundations and socially minded investors” — organizations and individuals who are not necessarily seeking the maximum financial return but are instead willing to put their money to work to advance a cause. “People accustomed to making grants without having rigorous assessments of their investments find the perform­ance-­based focus of this approach appealing,” he adds. “And they like being in a partnership with government that can allow successful interventions to scale rapidly.” Commercial investors are also starting to show interest, in part because they see a potential market in providing growth capital to successful nonprofits.

Despite its many potential benefits, it is unclear how well the idea will work in practice. But some early indications may be available soon: The first social impact bond programs are now under way in the United Kingdom and New York City. The UK project was launched in 2010, when Social Finance UK raised $7.9 million from investors — both individuals and charities — for a program designed to reduce reoffending by providing intervention services for 3,000 male prisoners exiting Peterborough Prison in England during a six-year period. If the recidivism rate drops by at least 7.5 percent compared with rates at similar prisons, the government will in turn pay the contracted sum to Social Finance, which will pay its investors. In New York City, the Bloomberg administration has created the first U.S. SIB — an initiative that is providing services to 16-to-18-year-olds who are jailed at Rikers Island with the aim of reducing recidivism and related budgetary and social costs.

Despite Liebman’s current enthusiasm about social impact bonds, he was skeptical of the idea when he first heard about it in 2010. But after some reflection and digging, he realized that it was interesting enough to be worth further analysis. He spent six months studying the model and writing a paper, published in 2011, that discussed the promise and limitations of this approach while spelling out the practical details that would have to be addressed before it could be implemented. One of his concerns was that state governments wouldn’t be able to take on projects of this sort because of the complex performance-based contracts that would need to be worked out and because their staffing was too thin to dedicate time to something so experimental. “I felt that if we couldn’t find a way to solve the government capacity problem, it wouldn’t happen,” Liebman says. “So I decided to provide pro bono help to any state that wanted it and got lucky because Massachusetts was the first state that was interested.”

In 2011, he met with the Massachusetts secretary of administration and finance, Jay Gonzalez, to discuss how the state could take advantage of this innovative funding mechan­ism. As he walked out of Secretary Gonzalez’s office, Liebman bumped into a former student, Greg Mennis MC/MPA 2007, who serves as one of Gonzalez’s top deputies. Together, Mennis and Liebman arranged for Danielle Cerny, a Rappaport Fellow and MPP student, to spend the summer in Gonzalez’s department, helping to move “social innovation financing” (Massachusetts’s term for SIBs) closer to reality.

The Commonwealth decided to move forward, and issued a “request for information” to solicit ideas related to social impact bonds. “We received three dozen responses and eventually narrowed them down to two programs — on youth recidivism and homelessness — because those are top priorities for the governor as well as areas where investing in prevention has the potential to produce real budget savings down the road,” Cerny says, who is pursuing a law degree from George­town along with her MPP. “Plus, Massachusetts has some really innovative service providers in these policy areas.”

The youth program will focus on the more than 750 young people who “age out” of the juvenile justice system each year as well as other high-risk youth coming off probation, providing education and employment opportunities to help them make “successful transitions to adulthood.” The homelessness program will attempt to find stable housing for several hundred chronically homeless people throughout the state.

When Cerny headed off to law school, in the fall of 2011, Liebman and Mennis recruited two more students, Michael Belinsky MPP 2012 and Angela Wyse MPP 2012, to keep the process going. Belinsky and Wyse’s work became the basis for their MPP thesis, or “policy analysis exercise.”

With funding from the Rockefeller Foundation, Liebman established the SIB Lab at the Kennedy School to conduct research on how governments can foster social innovation and get better results from their social spending. The thinking behind the lab is that the best way to gain insights into the barriers that governments face and the solutions that can overcome those barriers is through the hands-on involvement that comes from providing pro bono assistance to state and local governments. By engaging current students and recent graduates in this effort, the SIB Lab can provide experiential learning as well.

The lab has recently placed full-time “government inno­vation fellows” in state offices in Massachusetts and New York to help those states staff their SIB policy work. A competition is under way to select four more state or local governments to assist. Ryan Gillette MPP 2012, the government innovation fellow working in the Massachusetts budget office, reports, “The mix of complex analytic modeling and cross-sector team building has made this the ideal first job after the Kennedy School.”

Meanwhile, Massachusetts has selected the non­­profit organization Third Sector Capital Partners to serve as the intermediary for the juvenile recidivism project. Third Sector will be responsible for raising the necessary funds from investors, lining up the organizations that will work with the target populations, and making sure the program yields the intended outcomes. Roca Inc., a Massachusetts-based nonprofit that has worked extensively with young men leaving the juvenile detention system, will be the lead service provider. The Massachusetts Housing and Shelter Alliance (MHSA) has been selected as the intermediary for the homelessness project.

The state is presently engaged in contract negotiations with Third Sector and MHSA, striving to get both programs off the ground in 2013. The process is difficult, Gillette admits, “because contracts of this sort haven’t been done before. But once we write the first one, we’ll have that as a base, so future contracts should go much faster.”

Massachusetts is already considering expanding social innovation financing to other areas. “There’s a lot of interest in doing something in education,” says Gillette. In fact, another Kennedy School student, Katherine Klem MPP 2013, is writing her policy analysis exercise for the state’s Executive Office of Education on this very subject. “We know that investing in education can provide states with significant savings down the road, while offering considerable social value,” she says. “The challenge is that the savings aren’t immediate or direct.”

While Liebman and his SIB Lab team are working on the state government end of things, another Kennedy School graduate, Leo Quigley MPP 1992, is playing a key role in the private sector as a director of Social Finance, Inc., a U.S. nonprofit organization whose mission is to mobilize invest­ment capital to drive social change. Social Finance is the sister organization of Social Finance UK.

Efforts in this area are not confined to the United States or the United Kingdom. Another student, Thomas Dermine MPP 2013, is working to establish SIBs in continental Europe — as his policy analysis exercise.

In contemplating the future of social impact bonds, Katherine Klem believes that the Kennedy School is uniquely positioned to advance this idea. “There’s this incredible network of students and recent graduates who are working right now — in government, social service agencies, and the finance industry — trying to get social impact bonds up and running,” she says. Klem is eager to graduate so that she can start applying social impact bonds in health care, an area in which she sees tremendous opportunities. She’s particularly interested in what these bonds could do for smoking prevention — the field she worked in for six years prior to coming to Harvard. “I think this model is only beginning to take off,” she says.

SIDEBAR
Instiglio

Michael Belinsky MPP 2012, Michael Eddy MPA/ID 2012, and Avnish Gungadurdoss MPA/ID 2012 founded Instiglio, a company whose mission is to take the social impact bond model to developing countries. Instiglio has embarked on a partnership with the Colombian state of Antioquia, conducting feasibility studies of programs to reduce the number of school dropouts and prevent unwanted pregnancies.

In December 2012, the U.S. Agency for International Development (USAID) informed Instiglio of its “intent to award” the company a grant for its Colombian efforts through an agency program that “aims to find and support breakthrough solutions to the world’s most important development challenges.” If the grant is finalized in early 2013, as expected, Instiglio will receive $100,000 from USAID to establish it’s “proof of concept” and could potentially receive millions of dollars to implement the founders’ ideas in Colombia and elsewhere in the world

Steve Nadis is a Cambridge-based journalist.