Social-impact bonds, which are also called “pay-for-success contracts,” are not really bonds or fixed income securities in the traditional sense. Instead, they are a new way to pay for and run social services. Private impact investors pay up front for a social intervention that is preventative in nature and is delivered by a third party (usually a non-profit) to a vulnerable population.
The local or state government then promises to pay back the private investors with the money saved from not having to pay those costs. However, this will only happen if the intervention is successful, which means that certain predetermined, measurable goals have been met. Social impact bonds allow governments to pay only for certain results (hence the name “pay for success”) and bring in private investors, who have a financial reason to track progress and are better able to hold the service provider accountable for getting results.
For example, private investors pay for a preschool program for kids who have been tested and found to be at risk of needing special education services. The local government will pay back investors if, and only if, the preschool program helps these at-risk children enough and saves the government money by keeping them out of the special education program. Investors get a certain rate of return based on how well the preschool program works at keeping these kids from needing special education help.
Other SIBs have paid for programs to keep people from going back to jail or being homeless. In the developing world, similar structures are used where the outcome payor is a charity or aid agency (see “Development Impact Bonds”).