I joined Social Finance just over two months ago from Bain & Company. While I thought the consulting world was flush with acronyms, I quickly realized that was nothing compared to the world of Social Impact Bonds (or SIBs, our first acronym). As I worked to decode and digest all of this terminology, I came to realize that despite some redundancy, each of these terms has its own nuance. To help others who may be new to this field, I offer this brief guide to market acronyms and terminology.
The broadest, and perhaps most common, term used in the space is PFS or Pay-for-Success, which in this context refers to programs in which payments are based on explicitly defined, measurable social impact. PFS requires a formal agreement between a government agency and a service provider or intermediary aimed at producing pre-agreed outcomes, such as higher employment rates among ex-offenders or reduced pre-term births among low-income mothers.
Social Impact Bonds
This brings us to what we call a SIB or Social Impact Bond, one possible financing mechanism for a PFS contract. SIBs mobilize investment capital from private and philanthropic investors to provide upfront financing for service providers delivering programs under a PFS contract. In a SIB, the public sector will only pay for improved social outcomes and public savings that result from a nonprofit’s work, as initially funded by private investors and determined by independent evaluators. Despite their name, Social Impact Bonds are not traditional “bonds,” but do share some features of both debt and equity: they have a fixed term but offer variable returns based on performance.
Other terms are used more or less interchangeably for SIBs. Some prefer the term SIF or Social Impact Financing. In Australia, these types of contracts have been called SBBs or Social Benefit Bonds. Back in the US, the Center for American Progress also uses the term PFS Bonds.
The structuring process of a SIB often begins when a government launches a procurement process. I’ve broken down the steps involved in a typical state procurement process below; however, the process varies somewhat state to state.
1) First, the state releases an RFI or Request for Information to gain a better understanding of the service providers and intermediaries in its jurisdiction interested in this type of social innovation financing. At this early stage in the market, RFIs serve an important market education function, but may ultimately prove unnecessary as governments become more familiar with PFS.
2) Next, the state issues an RFP or Request for Proposals (analogous to a Request for Qualifications for a municipal bond offering) to which service providers and intermediaries respond with more formalized proposed SIB structures. Some RFPs specifically require both a service provider and an intermediary to respond together with a joint proposal, while others run separate, but parallel, processes for intermediaries and service providers (as Massachusetts did, though these were called RFRs – Requests for Responses).
3) Finally, through its evaluation of the RFP submissions, the state selects one or multiple providers to launch the process of developing a SIB partnership. The state then begins contract negotiations for PFS project(s) with these providers. Learn more about how a SIB works here.
Note: On the legislative side, the CRA or Community Reinvestment Act may provide an impetus for banks to get involved in SIBs, when it is time for SIB partners to begin fundraising. The CRA requires banks to help meet the needs of LMI (low- and moderate- income) neighborhoods in their regions. CRA portfolios have the capacity to allocate financing to PFS projects—in 2012 alone, US banks provided almost $219 billion in CRA loans.
Other financing mechanisms for Pay-for-Success
Additional financing mechanisms exist for PFS contracts that share some characteristics of SIBs. A HUCAP or Human Capital Performance Bond also brings capital to high-performing service providers that create economic value from social outcomes, but HUCAP bonds are actually structured as market-rate bonds. Thus, they have a lower cost of capital and are backed by the full faith and credit of the state itself. Minnesota has pioneered HUCAP legislation in the US. Another type of PFS financing mechanism is the TIF or tax increment financing tool, which captures the future value of an improved property to pay for the costs of those improvements. These tools are used by cities of all sizes to create public value by aligning the incentives of public and private partners, and are fairly commonplace in government financing.
Looking more broadly, PbR or Payments by Results are public policy instruments in which payments are contingent on the independent verification of results. Unlike SIBs, investors are not directly involved in a PbR transaction, leaving the service provider to take on more risk. A government, for example, may pay a provider for each participant in a work program that gets off welfare, but not for those who remain on it. Another concept, used by both service providers and governments, is RBA or Results-Based Accountability, a way to serve communities that begins with explicit goal setting. After end-goals are determined, providers work backwards to plan how to achieve them. Like SIBs, RBA identifies target populations and outcomes at the onset of the intervention, but is more likely to be used to directly shape or change the specifics of the intervention itself.
Resources to learn more
Across the span of nomenclature, the core idea of paying for the success of efficient social impact remains consistent. With all of these acronyms, it is easy to get confused; for more information on the above terms, I suggest starting with the links below.
Entry by Alissa Bonneau, Associate Extern