Investing in Social Outcomes: Development Impact Bonds


1.      Are Development Impact Bonds really bonds?

Development Impact Bonds (DIBs), like Social Impact Bonds (SIBs), are results-based contracts in which private investors provide pre-financing for social programmes and public sector agencies pay back investors their principal plus a return if, and only if, these programmes succeed in delivering social outcomes. Unlike SIBs, DIBs involve donor agencies, either as full or joint funders of outcomes. Because repayment to investors is contingent upon the achievement of specified social outcomes, DIBs are not “bonds” in the conventional sense.

This type of approach to financing and delivering social services has been given many names in different countries, including “Social Impact Bonds” in the U.K. and Ireland; “Pay for Success” in the U.S.; and “Social Benefit Bonds” in Australia. The principle of all of these approaches is the same: investor returns are linked to results, driving results-focused social programmes. 

Although the risk-return profile will vary with each DIB, in many cases, a DIB may be more similar to an equity investment than a debt investment. With a debt investment, the business borrowing the money has to repay the original amount invested, plus an interest charge, within an agreed timeframe, regardless of how well or badly the business is performing. By contrast, when an equity investment is made, money is invested in a business in the form of shares and there is no requirement for the business to repay the cash – instead, the investor makes a return through dividends on their shares (payable when the business performs well) and by selling the shares in the longer term.  

2.      Who might invest in Development Impact Bonds?

Among private investors, there is a spectrum of investors with different objectives and risk appetites. At one end of the spectrum are investors who expect a social return but no financial return (e.g. charities making grants); at the other end are investors who expect double-digit financial returns, without necessarily any social return (e.g. private equity investors).

Because DIBs have yet to be tested, initial investors are likely to consist of socially motivated individuals and organisations with an appetite for risk – i.e. willing to sacrifice some (if not all) financial returns in exchange for potential social returns. These might include trusts and foundations, development finance institutions and high net worth individuals with a significant interest in the target geography and/or social issue. Private institutional investors, on the other hand, may have less appetite for the high risks entailed in development programmes, and may not come on board until the DIB model develops a track record of success.

3.      Why do investors receive a positive financial return in the event of success? Aren’t they making money from the poor?

The transfer of risk from public agencies to private actors is an essential feature of Development Impact Bonds. High levels of risk, among other factors, can prevent public agencies – typically donors working with national governments – from investing adequately in prevention, or in innovative approaches where there may be some uncertainty as to expected results; when they do invest in social programmes, public agencies are often forced to micro-manage inputs (i.e. how funds are spent) to minimise risks of failure, thus inhibiting a results focus and flexibility in programme implementation. By bringing in private investors who provide upfront funding, DIBs allow public agencies to transfer the kinds of risk that are keeping them from investing in socially desirable interventions.

However, risk transfer is not free. Investors must be compensated for the risk of losing money. As a general rule, the greater the risk investors believe they are taking, the higher the financial return they will require for their investment.  The perceived level of risk transfer, and the required level of financial returns, will also be greater the more a risk is believed by investors to be outside of their control. If donors were to fund the programmes themselves, they would be the ones taking on the risk of failure, as they would have to pay for services regardless of whether or not they were successful in delivering outcomes. 

There are additional benefits to private sector involvement beyond risk transfer. The alignment of financial and social returns creates incentives for the private sector to work more efficiently (see FAQ 6), such that: new approaches are tested; performance is rigorously monitored; and service delivery is enabled to respond to new data as this is collected and analysed. The private sector may also be less susceptible to political pressures to misallocate resources. However, purely private sector solutions can suffer from problems of equity and access. DIBs can harness the strengths of private sector management, while ensuring that the programme is designed to enable access to services for those who would otherwise not have received them.

4.      What kinds of financial returns can investors expect to make?

Investors must be compensated appropriately for the risks they undertake. The greater the risk investors believe they are taking, the higher the financial return they will require for their investment. Given the dual interest of DIB investors in both social and financial returns, with most investors likely to be impact-first (rather than finance-first) investors, especially in early DIBs, there will be a limit to the level of returns that DIB investors can expect. Key DIB parties will need to develop DIBs collaboratively so contracts offer good value for money to outcomes funders (i.e. donors), whilst remaining an investible proposition for investors. 

5.      Isn’t this just an expensive way for the government to fund programmes?

Development Impact Bonds represent a way for donor agencies and partner governments to be more innovative and transfer risks associated with delivering successful outcomes to investors; outcomes funders pay if and only if pre-agreed outputs and outcomes are successfully achieved. There is therefore particular value to outcomes funders in transferring risk if there is uncertainty or complexity around what works in a particular social issue area or context.  For example, private sector rigour and accountability mechanisms may make investors better placed to manage risk around delivery and implementation (see FAQ 6). The financial incentive associated with this risk transfer provides investors with an incentive to monitor and react quickly to poor performance to ensure that outcomes are successfully delivered.

When assessing whether a DIB proposition represents good value for money compared with other approaches, it is important to take into account different success scenarios. Where similar programmes have been funded historically via traditional aid contracts, the average cost of delivering outcomes across both successful and unsuccessful programmes in the social issue area needs to be taken into account when assessing the average cost of delivering outcomes. If funders only considered the maximum possible cost of a DIB (i.e. when the highest possible level of success is achieved) this would not be a true reflection of DIB costs.

DIBs won’t be suitable for every problem in development, but in many cases it will be worth considering whether the approach can lead to better results, produced more efficiently than with alternative approaches.

6.      Are DIBs really worth the added costs?

Due to the nature of the DIB structure and emphasis on achievement of outcomes, the added costs of setting up an investment vehicle and systems to support data collection, monitoring and evaluation – critical to measuring and assessing outcomes – mean that DIBs may initially appear more expensive than other, non-results based, aid programmes. However, the additional expenditures have significant benefits. 

For example, early implementation of Social Impact Bonds in the UK has shown commissioners and service providers the value of investing in data systems to enable routine monitoring of performance. Specific day-to-day management and data analysis performed by Social Finance on behalf of investors in the Peterborough SIB (focused on reducing the reoffending rates of short term prisoners) includes: collecting data around client needs and services; tracking performance along key agreed indicators; and discussing monthly performance data and potential changes to services with the service providers involved.

Data and analysis performed can have a direct effect on the way services are shaped and delivered. For example, in the Peterborough SIB, it was identified that unresolved mental health issues had a statistically significant and substantive impact on the cohort’s reoffending behaviour; this information led to the commissioning of an additional and complementary low-level mental health intervention.

In addition to investing in improved data and monitoring systems throughout the course of a programme, there is significant value to rigorous, independently verified outcomes data. This includes being able to assess what public money has been spent on and what has been achieved using that money, and increasing accountability and transparency to both target beneficiaries and taxpayers in donor countries.  Many argue that such systems should be an important part of designing and implementing all types of aid programmes, but linking investor returns to verified results creates the incentives to put high quality data systems in place. Even if outcome payments aren’t triggered and investors lose all or part of their investment, commissioners and service providers have gained a way to assess the performance of the services they are paying for, leading to more efficient and effective management of public money in the longer term.

The other aspect of DIBs that can make them appear costlier than alternative funding approaches is that, if programmes are successful, investors get paid a return. However, this must be considered within the context of the risks that a DIB holds. The lower the risks investors are taking and the greater control they have over the risks they hold, the lower the financial return they will require for their investment. Outcome funders only pay if there is clear evidence that the programme has succeeded in achieving outcomes (see FAQ 3 and 5).

7.      Are Development Impact Bonds a mechanism for privatisation by the back door?

Because of the involvement of private investors and the latitude afforded to them to choose interventions and service providers, critics may accuse DIBs of representing a new form of government privatisation. This criticism belies a misunderstanding of the DIB model and how it works.

First, DIBs take programmes that have a poor record of attracting funding – by both private and public sectors – and turn them into investment opportunities. DIBs are not intended to take programmes adequately funded by government and outsource them to private sector actors; instead, they are intended to create incentives to invest in socially desirable programmes that would otherwise be neglected due to, for example, risks associated with their delivery, their lack of political salience, inefficiencies in public spending, or short-term election cycles.

Second, the involvement of private investors is intended to better align incentives – of all stakeholders, not just private investors – with the achievement of social outcomes. The first step to implementing a DIB is to identify a robust, independently viable outcome, or combination of outcomes, that captures accurately the intent of the project for both public and private sector actors. This is different from privatisation, where a public agency simply contracts out services to a private entity, whose financial interests and incentives may be at odds with that of the public agency.

Moreover, Governments have a critical role in DIBs – they need to be fully supportive of the programmes, and confident they meet their national goals and priorities.  The precise role of the host country government in implementation will vary, including but not limited to service provider and co-monitor of contracts. Moreover, should DIBs prove successful in scaling a specific intervention, governments may then choose to fund the intervention directly, obviating the need for a DIB structure.

8.      How can Development Impact Bonds support the capacity development of host country governments?

Donors should avoid projects that create parallel systems and thus undermine the capacity of host country governments. The aim of DIBs is to create incentives to invest in socially desirable programmes that would otherwise be neglected under prevailing funding models, and their focus should be to strengthen the host government’s capacity to collect and measure data, commission services, and co-manage contracts rather than create unnecessary, duplicative parallel systems.

Moreover, DIBs are focused on scaling innovative, evidence-based interventions that tackle the root causes of poverty. It is understandable – perhaps even desirable – for such interventions to come from and be tested outside of government, as governments – both in developed and developing countries – are generally more constrained in what they can and cannot spend public resources on.

9.      Can DIBs create a better mechanism for service user feedback?

By tying investor returns to achievement of social outcomes, DIBs create incentives for investors to put in place the necessary feedback loops, data collection and performance management systems necessary to achieve desired outcomes. The collection of up-to-date information from customers enable service provision to quickly respond to new needs and circumstances as these emerge, resulting in a more bottom-up, client-centred approach.

10.  Could Development Impact Bonds work in a context where there is limited data?

Results-based approaches depend on access to good data, which may be limited: statistical codes of practice may not exist or may be poorly implemented; resources may not be sufficient to ensure robust data; fraud may occur; and government administrative sources may be slow, inhibiting results-based approaches which need timely access to information.

Because DIBs are not yet a tested instrument, initial pilots will probably focus on countries and/or sectors where either reliable data already exists, or cost effective ways to collect data can be found, even if it means starting small. Once DIBs get off the ground and are proven to deliver results, they can expand into areas that could benefit from a DIB but that currently lack sufficient data systems to measure and track outcomes. In such contexts, outcome funders and/or investors could provide additional resources (not necessarily on an outcomes-basis) to help build local governments’ capacity to collect and measure its own data.

11. Don’t DIBs put too much focus on quantitative social indicators and can’t these indicators be gamed?

As with other results-based approaches, funding under DIBs is linked to results which must be quantitatively measured. Independent verification of outcomes is therefore a critical part of DIB design to ensure that the outcome funder (donor or government) is paying for something that actually happened. Outcome metrics, and how they will be verified, must be carefully defined at the onset of the project to minimise chances of perverse incentives or gaming. 

The alternative to paying for results – paying for project inputs – is more problematic because it often leaves funders unsure of the outcomes of their programmes. DIBs put in place the incentives to get good quality measures of development outcomes and evidence of what strategies lead to those outcomes.

12. What is the difference between DIBs and existing results-based mechanisms?

Results-based funding approaches to aid programmes have emerged as an alternative to traditional input-based funding and attempt to increase the effectiveness of aid. DIBs build upon the positive work that has already gone into the development of results-based funding programmes and share many of the advantages of other results-based approaches, for example increasing accountability around the impact of aid funding. Many development challenges will be better suited to approaches that pay governments or service providers directly for results rather than via a DIB investment-backed mechanism.  However, in some cases, DIBs could help to address the limitations of existing results-based mechanisms, thereby bringing additional benefits. First, existing results-based approaches require that service providers and/or the partner government provide pre-financing. This is not always possible, particularly for smaller organisations and/or developing countries with limited access to capital markets. By bringing in private investors to provide project financing, DIBs enable service providers and/or partner governments to access the finance they need to roll out interventions, but without compromising the results focus. This shifts risk from service providers or governments to private investors.

Second, by tying investors’ financial returns to the achievement of social outcomes, DIBs create a distinct stakeholder group with a strong incentive to ensure effective and efficient delivery of outcomes. Private sector actors whose financial returns are tied to achieving social outcomes can make the process of monitoring and ultimately achieving outcomes more rigorous. 

13. What is the difference between Development Impact Bonds and the IFFIm (International Finance Facility for Immunization) bonds?

The IFFIm bonds were designed to raise funds for issues where frontloading of funds is essential; capital market investors provided funding for immunisation programmes, which require long-term budget and planning decisions, and donors made long-term pledges to pay investors their principal and a return. Returns to investors are not based on the success of the programmes; in contrast, a key feature of DIBs is that independently verified results are the trigger for payments back to investors.

Unlike the IFFIm bonds, DIBs are not meant to be only a financing instrument for social programmes, but rather a new model for how services are delivered. DIBs create partnerships that give private sector actors incentives to improve the efficiency and effectiveness of service delivery, and the financing mechanism allows this to happen.

14. Can donors make multi-year commitments to pay for outcomes?

In most cases, DIBs will require governments and/or donors to: 1) obligate the full amount of funds for a successful outcome upfront, although there would be uncertainty as to the exact level of outcomes that would be achieved (and thus the amount of outcome payments due), and/or 2) make a binding multiyear commitment when laws require that budgets be set annually.

Governments and/or donor agencies will vary in their legal capacity to make such binding, long-term financial commitments. Laws may require that funds allocated for any given year be spent that year, whereas DIBs require funds to be committed flexibly, based on the level of  success that programmes achieve and without a guarantee that any particular amount will be used to make an outcome payment.  To maintain the integrity of the outcomes-based approach, outcome funders should make this funding flexible when possible (allowing, for example, funds that are committed but not disbursed in the first or second year of a pilot be carried over) and avoid setting rigid expectations for results that will be reached. 

Public sector agencies will have to consider their own legislative or budgetary systems to determine how outcomes-based programmes could be structured. They can explore options such as: funding initial DIB pilots with ‘challenge funds’ that are set up under alternative, more flexible budgeting rules, or setting up funds to absorb any payments that are committed but not disbursed because the expected level of outcomes was not achieved. These funds could be used in a number of ways: for example, they could contribute to the payments of other outcomes-based programmes funded by the same donor, where achieved results are greater than expected. They could also be used to pay for new programmes (not necessarily outcomes-based) designed to address issues that prevented the government or service providers from achieving expected results under the DIB.

15. Do outcome funders relinquish all control over how contract outcomes are delivered?

Outcome funders constitute a key stakeholder within the DIB structure; they help define outcomes and ultimately pay for them if they are achieved. However, in principle, they should avoid dictating the means by which outcomes are to be achieved; prescribing solutions will not only compromise the results focus and flexibility in delivery to react to implementation challenges and client needs that are so fundamental to DIBs, but also make DIBs a less attractive  business proposition to investors.

This can be a challenge given the need for donor agencies to be accountable for how public funds are used. Although they only pay for success, outcome funders must still ensure that outcomes have not been achieved at a broader cost, i.e. through corruption or violating social and environmental safeguards. 

Therefore, although outcome funders should avoid prescribing how outcomes are reached, appropriate safeguards will also need to be carefully considered to ensure that outcomes funders are comfortable that interventions will be aligned with their ethical principles and social objectives. Outcomes funders should stipulate in the DIB contract broad parameters, or best practice principles (such as adherence to agreed standards of professional conduct, etc.), to ensure that interventions are in line with prevailing norms, laws and regulations, while giving service providers the flexibility they need to deliver outcomes.

16.  What kind of safeguards would be put in place to protect both investors and outcomes funders from risks out of their control, e.g. political risk?

When structuring a DIB, it is important to identify the key risks of the programme and to be clear about who holds these risks within the DIB contract. The value of the model lies in the transfer of key delivery and implementation risks to investors who are better placed to manage them than the outcomes funder. However, the contract should also clearly lay out how payments will be settled in the event of an Act of God or force majeure occurrence which neither party has control over.  For example, it may be the case that both the outcomes funder and the investors agree within the contract that further capital drawdowns/investment flows will be stopped under circumstances such as force majeure and agree some kind of political risk mitigation clause. From an investor’s point of view, it is important that responsibility for certain risks, such as political risk, are clearly laid out in the contract so that they are able to price, monitor and manage their investment effectively.

17. Is it possible to offer a guarantee to investors?

Some examples of SIBs across the world have been structured with a guarantee of principal to certain investor classes. The idea of offering some form of guarantee to investors is possible if outcomes funders (or other stakeholders) are willing to provide it. Offering a guarantee which could, for example, take the form of full or partial protection of principal (or guarantee of outcome payments in the event that payments are not honoured by an outcomes funder), reduces the risk to investors and has the potential to widen the investor base, making it easier to raise capital. However, when considering structuring any form of guarantee, it is important to analyse what kind of effect this would have on the risk transfer proposition. One of the key benefits of the DIB model is that risks associated with delivering successful outcomes are transferred to investors, who then have a stake in those social outcomes; therefore, those structuring the DIB must be careful to ensure that incentives remain aligned with the achievement of outcomes at all times.

It may be the case that some of the risks being transferred to investors are ones which no stakeholder has full control over, for example political risk if operating in fragile states. For investors to hold these risks, they would either have to be compensated sufficiently, which may make the return higher than outcomes funders would want to pay, or be offered some kind of political risk guarantee to lower the risk profile of the investment.