The Next Phase of Innovative Financing

When Alberto Cairo, head of the International Committee of the Red Cross (ICRC) orthopedic program in Afghanistan received the Henri Dunant medal in 2013 for his work in Afghanistan, he expressed one wish: to dramatically expand access to physical rehabilitation services for those in need. The ICRC reports that on average only 10 percent of the 90 million people with physical disabilities who need a mobility device worldwide have access to one today.

As one remedy, the ICRC introduced an innovative form of public-private partnership in September 2017 to finance the construction and operation of three new physical rehabilitation centers in the Democratic Republic of Congo, Mali, and Nigeria.

The governments of Belgium, Italy, Switzerland, the United Kingdom, as well as Spain’s la Caixa Banking Foundation—the group of so-called outcome funders—committed a collective $27 million for payout to a group of private investors who provided the necessary up-front capital for the program. The twist is this: The private investors lend under the agreement that their financial return depends on the positive social and health outcomes achieved over five years. If the centers meet their performance targets, they make money, otherwise they don’t.

Access to physiotherapy and mobility devices like wheelchairs and artificial limbs will change the lives of the more than 6,000 disabled victims of conflict the centers expect to help each year. But the program also represents an innovation opportunity for the ICRC’s physical rehabilitation program, which currently operates in 139 locations in 34 countries and reached nearly 330,000 people in 2016.

Abdul Latif, at left, is a patient at the ICRC's orthopedic center in Lashkar Gah, Afghanistan. (Photo courtesy of Thomas Glass for ICRC)

Formally called the Program for Humanitarian Impact Investment, the investment is placed as a private loan by Lombard Odier, a Swiss bank and co-sponsor of the transaction that also invested through its philanthropic foundation, alongside other investors such as New Re, a subsidiary of the German reinsurance giant Munich Re. Contingent on ambitious social impact targets, the private debt offers a financial return of up to 7 percent per year, while also putting 40 percent of capital at risk should the effort fail to meet its targets.

Since the advent of the first social impact bond pilot in the United Kingdom in 2010, such contingent-return financing has captured policymakers’ and impact investors’ attention. Some 70 social impact bonds have been launched around the world since, using so-called “pay-for-success” models to address intractable social problems like recidivism and homelessness. The ICRC program mobilizes long-term innovation capital for an organization that is the world’s leading physical rehabilitation services provider, financing the future development of one of its core programs.

Evolving Finance Solutions

The mechanisms that came out of the Paris Declaration on Aid Effectiveness in 2005 and the Accra Agenda for Action in 2008 moved much larger volumes of capital than the ICRC investment.

For example, the International Finance Facility for Immunization, which makes funds rapidly available when donor government pledges are monetized as bonds in capital markets, provided $2.5 billion to GAVI, the Vaccine Alliance over the last decade. The 2009 pneumococcal Advance Market Commitment, supported by the Bill & Melinda Gates Foundation and several governments with a $1.5 billion joint investment, pledges to prevent an estimated seven million childhood deaths by 2030.

These innovative financing solutions often relied on a kind of impact arbitrage. Higher impact was rendered possible by what is referred to in finance as “time value of money:” A dollar today is worth more than a dollar in the future. If a future funding commitment can be borrowed against and turned into cash today to finance vaccines that have a high health impact, then the resulting health outcome is greater than what would be achieved by buying vaccines at a later point in time, even if there is a borrowing cost. Similarly, providing sizeable advance purchase commitments creates scale and certainty about what is purchased, and this can lower the price point for beneficiary communities.

A decade later, the world of development finance has evolved. Market-based instruments and public-private partnerships are gradually becoming the norm rather than the exception.

The key questions are: How can they reach a comparable scale? How can we move from a series of pilots to a steady flow of solutions? Established organizations like the ICRC, with large budgets, an excellent reputation, and widely-recognized legacy programs, can lead the way forward.

Harnessing Digital Tools

Digitization is key to advancing innovative finance solutions. Digital tools enable humanitarian and other social-purpose groups to be more sophisticated about collecting data and tracking their program results. And where results and improvements can be tracked, they can be priced. In the case of the Program for Humanitarian Impact Investment productivity is measured with a “staff efficiency ratio.”

The thinking is, regardless of how effectively an organization can deliver a good or service, significant productivity gains are almost always possible when lean manufacturing principles are systematically applied. This means clarifying what adds value and reducing all other activities that don’t. This requires investment and innovation capital that extends beyond the typical duration of government funding cycles constrained by the electoral calendar. Investors are the risk takers investing in innovation and efficiency improvement. They are rewarded for financing the work that enabled these improvements in the first place—provided they work.

Evidence-based information about what interventions work especially well can form a solid foundation for raising funds for pay-for-success initiatives. The pace of progress has been vertiginous. Fifteen years ago, when the Kenyan Agricultural Commodity Exchange linked up with cell phone provider Safaricom, the partnership’s Short Messaging Service to provide farmers with up-to-date commodity market prices over their phones broke new ground. Today, Big Data enables sustainable investors to access ever more relevant information about which firms have a good sustainability performance. And continuously providing up-to-date evidence on an intervention’s effectiveness can lead to better operational decision-making.

Leveraging data to unleash the next phase of innovative financing is not only promising, but necessary.

Addressing Our Generation’s Defining Problems

Today we are confronted with a number of social problems that require radically new solutions. In addition to finding ways to substantially improve existing solutions, building a better pipeline of new ones—and bringing those solutions to market faster—is critical.

Social problems, such as those addressed by the ICRC, continue to plague our world. One person out of 113 is displaced from their home by conflict and persecution—an all-time high since the United Nations High Commissioner for Refugees began keeping records in 1951. Innovative finance solutions could make it possible to serve 100 times more people who need a mobility device than are currently being served by all social impact bonds launched on a variety of causes between 2010 and 2016.

Take the ongoing conflict in Syria as another example. When the civil war eventually ends, the task of rebuilding will require skills.

The conflict has displaced over 11 million people to date. Twenty-five percent of Syrians aged 18-24 were enrolled in higher education before the civil war. That number now stands at less than ten percent. The Institute of International Education estimates that there are over 100,000 qualified Syrian students currently being left out of higher education.

Whether the 100,000 former students will be Syria’s lost or greatest generation depends in part on whether effective innovative financing solutions are put in place. At the 2016 Supporting Syria and the Region conference, international donors pledged $12 billion to help those whose lives have been torn apart by the war. Consider the impact of providing massive access to online education via tuition scholarships and testing that model using a contingent financing pilot. A donor government outcome funding commitment of half a billion dollars could get 100,000 students the education needed to have them form the core of Syria’s long-term rebuilding effort—an effort that could be financed without having to go through the Syrian government, a country designated by the U.S. as a State Sponsor of Terrorism since December 1979.

Beyond One-Off Investments

A decade ago, innovative financing solutions were considered with enthusiasm but were typically one-offs. Today, both the financial industry and nonprofits are much better equipped to jointly engineer impact investment solutions on a broader scale.

People and institutions’ propensity to align their investments with their values has increased dramatically since the term “impact investing” was coined in 2007. Today more than one-fifth of all professionally managed financial assets globally follow some sustainability or impact guidelines. Asset transformation through impact investing is quickly becoming investors’ guiding principle. They demand investment opportunities in multiple asset classes, public and private debt, and equity. And some are open to contingent return products such as social impact bonds.

Instruments such as the ICRC Program for Humanitarian Impact Investment could be catalytic in bringing contingent financing solutions into the mainstream in ways comparable to the development of the climate bond market, which issued $55.8 billion in the first half of 2017, just a decade after it launched.

If your organization is considering using contingent return financing to increase its efficiency, here are six tips:

• Identify a program of strategic importance to your organization that has potential to be taken to the next level.
• Launch an ambitious internal brainstorming and readiness assessment effort to consider how alternative funding mechanisms could provide the capital needed for a future iteration of that core program.
• Develop a set of metrics that can track the program’s results at a reasonable cost and establish a base of empirical evidence.
• Make sure senior leaders are willing and able to devote the attention this effort requires to succeed.
• Enlist funders close to the organization and make them part of a joint “moonshot” innovation effort.
• Recognize that innovative financing efforts may take time—and give yourself the time needed.

There is certainly much work to do as we enter the next phase of innovative financing. Nonetheless, the prospects for growing the pool of smart capital with innovative financing solutions have never been better.

Read more stories by Maximilian Martin.