What have we learned about development impact bonds 10 years on?

Ten years ago, Social Finance, a U.K.-based nonprofit consultancy, started work on a new way of funding development projects: the development impact bond.

An impact bond is a particular type of outcomes-based finance in which a third party — a finance provider — backs the deal. This is often a charitable foundation or a philanthropist, although it can sometimes be a commercial investor. It provides the upfront capital to allow the delivery agent to provide the necessary services.

In this arrangement, the finance provider will take on a proportion of the risk in the arrangement. If the delivery agent hits the targets, the finance provider makes a profit. If the project doesn’t work, the finance provider loses out.

The development impact bond was the successor to a domestic British initiative, the social impact bond. Initial work on a DIB in 2012 was followed by a consultation in 2013 and the launch of the first pilot project in 2014.

Since that point, the model has grown in popularity and is being used around the world; 24 DIBs have launched in low- and middle-income countries, principally in the fields of health, education, and livelihoods. Last week, for example, a DIB focused on anti-poverty practices in Kenya reported that it would generate lifetime impacts of more than $21 million — roughly four times the overall cost of the project — despite the disruption of the COVID-19 pandemic.

Though they have attracted a lot of attention, DIBs remain a relatively small part of the development landscape, with the largest only in the range of $10 million to $20 million.

Devex caught up with Louise Savell, a co-founder of Social Finance and a joint lead of its international development team, to find out more about how the field has grown and changed in the past decade. This conversation has been edited for length and clarity.

What are the benefits of impact bonds and outcomes-based finance?

Outcomes-based finance shifts the focus away from what the service provider has done, to the difference that they have made. This is why [DIBs] are well suited to complex populations and changeable context, because it shifts the focus away from a fixed idea of what needs to be provided.

In early discussions [about DIBs] everyone focuses on the investor intervention. For me, that’s secondary. The shift is away from payments being target-based to outcomes-based.

Outcomes-based contracts are resource-intensive. You should be using them for complex situations, complex populations, complex needs.

These are never going to be massive, but does that matter? Is that what they are for? I’m increasingly of the view that they can be effective tools to support local implementation.

These are really helpful tools where we don’t know what interventions work or where we know something works in one place and we want to try it in another. In South America, they’ve used it with populations that they’ve struggled to reach. Impact bonds aren’t tools to reach 80% of the population; they’re for the 20% you’ve been struggling with.

In LMICs, where government resources are quite constrained, it’s quite hard for them to justify spending money on things that might not work. That’s where outcomes-based contracts can be really helpful. They can say, “Look, we’re trying a new approach, but if it doesn’t work, we don’t pay.”

You talk about the importance of getting governments involved. Why does that matter?

What’s exciting to me is when we see a government saying, “Hey, isn’t this how we should be thinking altogether?” Using data systems, tracking results, focusing on impact, having governance and accountability over how you use data and the results you get. Then using those tools to identify particular parts of the population where standard interventions aren’t working. And then having agility and experimenting. There’s a mindset shift among politicians and civil servants that stops seeing a change in your plans as failure.

We’re increasingly thinking about how we support that change in mindset among governments, donors, and the big agencies. Changing services because they aren’t working isn’t failure; it’s success.

We’re seeing a range of types of deals. Some of the quicker ones to get off the ground don’t involve national governments as a contractual counterparty. It takes longer to launch with government around the table, but it’s probably time well spent.

Who is backing these deals as finance providers? Is it commercial entities or NGOs?

Sometimes you start off with philanthropists paying for outcomes. But as it transitions, governments commit their own money.

In some cases, philanthropists back social finance as an exit strategy. Where they previously committed grants to support a population, they then fund impact bonds as a way to show that a program will generate positive results that increase incomes or reduce demand on government services and are therefore effective for governments to fund themselves.

We know from higher-income countries that if you want to get fully commercial capital involved as a finance provider, it has to be massively underwritten. It’s helpful to have more professional investment capital involved. Those people can do proper due diligence and bring in other investors who haven’t assessed these deals before.

What do you need to make a DIB work?

There have to be a lot of moving parts [that] come together before you say, “Let’s do an impact bond.” If they don’t all come together, you might want to use another approach with some elements of a DIB. We bear the scars, and we’ve learned when it’s all likely to come together and when it might be better to use an easier way.

The first question we tend to ask is whether there’s a clear definition of the target population. And alongside that, is there a definition of what success would look like for that population? And are all the major stakeholders on board with that?

You need to understand whether someone is willing to pay. Is that success something a government or another counterparty will pay for? Is it in the window between “we’ll fund it” and “we won’t fund it,” which is “we’ll fund it, but only if it works”?

Then there’s a second piece around whether it makes sense to use an outcomes-based approach. Will it strengthen incentives? Will it enable adaptation? Will it provide value for money?

If you know what works, just pay for the intervention. We know that if we vaccinate people, for example, they are less likely to get ill. It works.

For an impact bond to be the right answer, there has to be uncertainty in the causal link. You have to not be sure it’s going to work. There’s a level of complexity or uncertainty.

What are the next steps in the DIB market?

One is developing a toolkit to help governments assess how ready they are. That will help if they want to use outcomes funding. There’s this broader set of skills around supporting governments towards outcomes-based mindsets — data-driven, governance-focused, flexible in how you deliver, willing to see change as success. That can be really game-changing.

Then there’s a broader question around how you reduce the transaction costs and how you get bonds launched more quickly and effectively.

Bigger is better because your relative costs are lower. One way to achieve that is to commission through an outcomes fund that can commission multiple deals simultaneously or at least in successive rounds.

There is real value to governments and donor agencies making significantly more funding available for both outcomes funds and, by extension, outcomes contracts as a mechanism to test and learn which models are most effective. While outcomes approaches work well for complex social issues or delivery contexts, this is not as niche as it sounds. Many social challenges in LMICs have these characteristics.

Government policy is like an oil tanker, and we’re in the business of turning an oil tanker around. DIBs are tugboats: We’re nimble and can change direction easily. It’s a labor-intensive process to shift the direction of an oil tanker, but it’s worth it. Once you’ve shifted the oil tanker, that’s a lot of power moving in a different direction.

This coverage exploring innovative finance solutions and how they enable a more sustainable future, is presented by the European Investment Bank.