Social Finance: A Primer

In recent years, a growing number of philanthropic foundations, policymakers, social service providers, and researchers have come to recognize that the social sector is changing. Shrinking public-sector budgets have limited traditional government grant programs. An increasing number of private funders have created financial models that pay for performance and emphasize the importance of and need for evidence. And complex social challenges such as criminal recidivism, poor school performance, homelessness, and chronic health conditions, with their panoply of causes and effects, seem to resist nearly every attempt to solve them. These issues have given rise to the creation of new models of partnership between the public, nonprofit, and private sectors that focus on achieving results.

The status quo in the social sector simply cannot hold. One in five American children lives in poverty. More than 600,000 people were homeless on one night in January 2012 when the Department of Housing and Urban Development last conducted its census for the Annual Homeless Assessment Report. Nearly 100,000 of those people were chronically homeless, meaning they had been continuously homeless for at least a year or had been homeless at least four times in the past three years. Many long-term homeless individuals are single adults, but homelessness among families is a growing problem in some localities or municipalities. For instance, 1 in 100 children in New York City today does not have a permanent home. There are approximately 133 million Americans suffering from a chronic illness, including 7.1 million children with asthma. Up to 73 percent of low-income children with asthma do not receive proper treatment.

These numbers demonstrate the scale of challenges facing those who want to improve their socioeconomic conditions or receive better treatment for what ails them. They also represent enormous cost to the public. In response, a new suite of tools has been developed in an attempt to affect positive change in the social sector. These new mechanisms fall under a broad umbrella of what is referred to as “social finance,” where evidence, evaluation, and scale capital are brought to bear on intractable social issues. While these tools are still fairly new and far from mainstream, we can nevertheless take valuable lessons from how—and why—they were developed.

There are essentially three avenues for social finance today: new methods of grant making, such as the Social Innovation Fund; innovative public-private partnerships, such as social impact bonds and Pay for Success contracts; and new strategies and behaviors in the capital markets, such as impact investing.

This brief offers a primer on each of these tools, explaining what they are, how they are being used, and where policy changes can help them reach their full potential. It is important to understand innovation funds, social impact bonds, and impact investing as “tools” or “mechanisms.” They are the means by which we can hope to reach a range of very important ends—improved educational attainment, economic security, and stable, healthy lives for some of our poorest and most vulnerable citizens—and build on the impact of ambitious, large-scale public and philanthropic efforts. When all is said and done, impact—real, measurable, verifiable impact—is the bottom line.

Just as not every program is a good candidate for being scaled through an innovation fund, there are considerable limitations to when social impact bonds should be used.

First, social impact bonds can only be used in instances where a specific, measurable outcome can be set. That means sufficient historical data must exist to set a realistic outcome. Given that everything in a social impact bond hinges on the outcome—from the plans of the service providers to the investors’ decision to put money into the deal to the eventual payment from the government—it is essential that all parties know the baseline from which they must work.

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