The flawed logic of cashable savings risks undermining Social Impact Bonds

"Cashable savings" to government were part of the economic logic of social impact bonds. But focusing on such savings will lead to perverse incentives. Adrian Brown explains why.

The case for Social Impact Bonds (SIBs) seems irresistible. Government writes a contract with a provider in which payments are linked to the achievement of social outcomes. The provider gets finance from an investor to share the outcome risk and cover working capital costs. Because the outcomes help government to achieve cashable savings, and those savings are greater than the outcome payments, everyone wins. In fact this represents a 'triple win' with government, provider and investor all benefiting.
The logic is familiar, reassuring and flawed, and those who continue to promote it risk undermining the credibility of the social investment revolution they are trying to nurture.
Cashable savings lie at the heart of the argument and are the root of the problem. In short, the focus on cashable savings needlessly imposes the economic logic of the investor onto the government commissioner – with perverse consequences.
Under traditional contracting arrangements, when government chooses to spend money on services such as nursery education or social care it does so because it believes these services are socially valuable and worth paying for. As a society we agree that it is desirable to achieve certain social ends not because we believe they pay for themselves on a discounted cashflow basis but because they are the right thing to do. For example, reducing homelessness is an outcome that society should value regardless of whether it pays for itself.
By focusing on cashable savings we not only risk limiting the scope of SIBs to those policy areas where the narrow economic logic holds but we also restrict the 'pot' of money available. This can be because the cashable savings simply aren't large enough or that they fall across multiple parts of government making them difficult to aggregate. The result is that the 'price' paid per outcome often doesn't reflect the full risk-weighted cost to the provider of achieving that outcome resulting in SIBs that are impossible to scale without ongoing subsidy - effectively a transfer of wealth from philanthropists to investors.
The cashable savings rationale also suggests the primary value of SIBs is to help governments save money. This is debatable. The main benefit of paying for outcomes without specifying activities is that this helps to drive innovation. This innovation, in turn, should help achieve better outcomes than today. In some cases, achieving better outcomes might be more costly for the government in cash terms because they are judged to be worth paying for but were previously unattainable. Also, we know that the complexities of SIBs and risk-transfer involved make them an inherently expensive procurement option. If saving money really is the goal then SIBs are an odd route to choose.
So how should SIBs be funded if not through cashable savings? Commissioners should regularly look across the portfolio of services they buy and ask themselves which are the least effective. Decommissioning these services frees up current spending that can be used to fund SIBs in policy areas where innovation is most urgently needed. (This should also be easier for the Treasury to swallow as they are famously sceptical about the pay today, save tomorrow logic). Over time, as SIBs create innovative new services, these can be commissioned directly and the innovative power of SIBs focused on the next frontier.
For example, the probation reforms currently being proposed by the Ministry of Justice include a payment by results mechanism (the engine inside all SIBs) paid for by reallocating the existing budget rather than tapping future savings. At first this component will cover rehabilitation quite broadly as evidence about what works is generally weak but in the future it could become more focused (e.g. on the hardest cases) as the evidence base is strengthened.
Focusing on cashable savings risks limiting the scope and viability of SIBs as well as misrepresenting their main purpose which is to drive social innovation. I do believe that SIBs have the potential to offer new solutions to stubborn problems – let's not undermine that potential by continuing to push this flawed logic.
Adrian Brown is a Principal at the Boston Consulting Group.