Financing Urban Innovation and the Rise of Social Impact Bonds

By Frank Teng

Frank Teng is a current MBA in Sustainable Management student at Presidio Graduate School in San Francisco and is on the board of Sustainable Silicon Valley. He works with Jones Lang LaSalle, a global real estate services firm, to manage global energy and sustainability programs for corporate clients in the technology and financial services sectors. Please note: Frank's views are his own and do not necessarily reflect the views of his employer.

Sep 11, 2013 | Economy, Society | 0 comments

As local governments struggle to meet their budgets, they have been forced to cut social programs often because of reduced federal support. This bears several questions:

  • Where will cities get the money to get smarter?
  • How can a smart city also be good for its people?


A tool in the toolbox that is gaining a lot of attention is the social impact bond (SIB), also known as pay for success or social innovation financing. The idea is based on a commitment from government to use a proportion of the savings that result from improved social outcomes to reward non-government investors that fund the early intervention activities. Initially developed in the UK to finance a prisoner rehabilitation program, which yielded savings to the government, it has also gained traction in Australia and increasingly in the U.S., with both support from the Obama administration and leading public officials and philanthropists. Thise animated 2-minute video above, by McKinsey & Co, does an excellent job in introducing SIBs.

The particular characteristics of projects funded by social impact bonds are particularly aligned with the goals of a smart city: successful performance can be measured through available data, efforts should be scaleable and replicable, and total benefits to society should be greater than the programs they replace.

Furthermore, only those programs that deliver the promised results are paid, otherwise the risk is borne by the third party investor. Therefore, government only funds programs “that work”. And we should all agree that smart city initiatives must work.

In fact, the Social Capital Markets Conference occurring in San Francisco this week features a session on SIBs, where they are discussing a range of existing SIB deals targeting recidivism in New York City, at-risk youth in Boston, early-childhood in Salt Lake City, supportive housing in Massachusetts, workforce development in California, and family health care in South Carolina. Goldman Sachs has invested more than $9 million in the program at Rikers Island in New York.

Funding to improve health outcomes

Some SIBS have the potential to affect health outcomes, one of the fastest rising costs in the U.S. and high on the public radar. Medical evidence shows that more than 50 percent of health outcomes are driven by “upstream” factors: where we live, work, learn, and play.

For example, Social Finance US is hoping an asthma reduction project will turn into the first major healthcare social impact bond in the nation. The project is based in Fresno, Calif., which has one of the highest rates of asthma among children in the U.S., and has nearly 20 people treated every day in the emergency room for asthma complications, at a cost of approximately $35 million annually. The group is working with 200 low-income families to provide education, home care and help in reducing environmental triggers that can aggravate asthma, like dust mites, mold and cigarette smoke. The California Endowment has provided $660,000 in funding for the project. The goal is to reduce emergency room visits by 30 percent and hospitalizations by 50 percent over the year, which is estimated to save $5,000 per child annually. Insurance claims data will be used to measure cost savings.

Could a smart city conceivably be able to support and deliver a program like this?

Couldn’t smart transit projects and walkable communities also reduce asthma rates and improve fitness? Urban agriculture and vertical farms could improve access to fresh produce and reduce heart disease and high blood pressure. Smart parking systems could reduce the future need for additional street expansions or expensive congestion mitigation. Since smart city solutions often lead to more efficient utilization of resources, quantifiable improvements would be fitting for SIB funding.

Smart cities are excellent candidates for financing

In fact, the conditions are ripe for this to occur. Earlier this year the Mayor’s Challenge innovation prize funded by Bloomberg Philanthropies announced five winning cities that leverage ideas to solve major challenges and improving city life. Providence, Chicago, Houston, and Philadelphia were winners, along with Santa Monica which is proposing to measure wellbeing and formally embed it into policy-making, “via a sophisticated index focused on economic vitality, social relationships, health, education/care, and local environment.” That sounds like a smart city challenge.

Though these cities were fortunate to receive million-dollar awards, one of the goals of the Mayor’s Challenge is to ensure replicability. If the five winning projects prove successful by meeting performance metrics and yield potential savings to taxpayers, social impact bonds could serve as an excellent vehicle to expand and proliferate similar programs across the nation.

Part of the elegance of SIBs is that they can focus on preventative and early-stage interventions to social challenges, since their success hinges on performance outcomes, not activity. Emergency response, education, even energy usage and carbon reduction could be areas ripe for systemic change that have consistently been frustrated by siloed approaches lacking a systems view. There are interesting parallels between the concept of carbon offsets and social impact bonds, where we are valuing the reduction from a baseline.

Two resources on social impact bonds

Though SIBs have their own challenges, such as cities establishing relationships with multiple third-parties and complex contracts as well as added costs, it will be exciting to watch how this tool performs in the marketplace of ideas. The Pay for Success Learning Hub developed by the Nonprofit Finance Fund is an excellent central source of information on SIBs. One resource it highlights is a 12-month research project performed by McKinsey & Co which conducted a full assessment of the potential SIB sector through interviews with stakeholders and review of existing projects.

Another resource is the Harvard Social Impact Bond Technical Assistance Lab, as mentioned in this Harvard Magazine article, which is conducting research and providing pro bono assistance to six winning state and local governments from a national competition held in June 2013  (Colorado/Denver, Connecticut, Illinois, New York, Ohio, South Carolina).

Ultimately social impact bonds can provide options to cities who are looking to create major change and maybe even test the limits of their ideas, but lack the funding or mechanisms to do so. Putting the risk of this on third-party investors helps leverage public-private partnerships, and successful projects will yield benefits accruing in the form of savings to taxpayers, not to mention measurable social improvement. This surely seems like a win-win. Of course, the implementation will be complex and take time, but hopefully these are solvable in the smart cities of tomorrow.

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