A model for humanitarian investment: can it work?

Pierre Heisten is a One Young World Ambassador from South Africa who is passionate about finding ways to identify and unite that which drives every individual.

This week, the focus of the inaugural UN World Humanitarian Summit (WHS), held in Istanbul, was about finding ways the private sector can play a role in humanitarian relief. But as Alexander de Croo, Deputy Prime Minister of Belgium, succinctly said, “It is not giving that is the strength of the private sector; it is managing resources and risk.”

Typically, in humanitarian projects, the private sector plays a role in logistics, communications, consulting or construction. Companies are simply service providers rather than invested partners.

Another area that is underutilized is the financial expertise of the private sector and its innovative models to manage debt, revenue and spending.

An example of such a model was launched at the WHS. Speaking on the panel, Deputy Prime Minister de Croo contributed his support for a new Humanitarian Impact Bond implemented by the International Committee of the Red Cross (ICRC). The bond would allow private capital to support health programs of the ICRC in fragile and conflict-affected countries.

The mechanics of the bond are relatively simple. Whether it will work or not remains to be seen, and when asked whether this could be scaled up to assist other development funding, the Deputy Prime Minister said that the concept needs to be proven before it is rolled out any further.

The bond involves three parties: the social investors (private sector), the ICRC and outcome funders (typically charity foundations and government institutions).

The ICRC proposes a project that has easily quantifiable outcomes, such as providing prosthetic devices to victims of violence in Sudan. A time-scale for completion is set (for example, 3 or 5 years), and the parties agree on what a realistic outcome is for that time — let’s say 5,000 prosthetics fitted.

The outcome funder is the party that will eventually pay for these prosthetics, but only once the project is complete. They will only pay for the actual outcome of the project.

To implement the project, the ICRC raises the entire funding for the 5,000 prosthetics from the social investor.

At the end of the set time period, if the ICRC does not reach their goal and fit less than 5,000 prosthetics, then the social investor loses. This is because they paid for all 5,000 devices while the outcome funder ends up paying an amount for less than 5,000 devices — this is the potential risk. If the ICRC exceeds its target, then the outcome funder is liable to pay for more than 5,000 devices, and the difference is earned by the social investor — this is the potential premium.

With this model, the ICRC is able to receive the entire budget for the project upfront instead of relying on annual donations, thus making planning easier and implementation more efficient.

The outcome funders carry no risk of project failure — they only donate funding for work that is completed and where impact is already achieved.

Assuming that the incentive for the social investor is purely financial, the return relative to risk of the Humanitarian Impact Bond has to be higher than standard government bonds. Given the current market, the ICRC would need to offer a return between 1 and 3 percent — depending on the investor’s perception of the ICRC’s ability to complete projects.

The fragility of the arrangement lies in how expectations are set and how they change over time. To attract investors, in this example, the ICRC needs to repetitively exceed their targets by 1 to 3 percent. But constantly exceeding targets means that achievable targets will be more accurately calculated, and the bond will lean towards a zero-return investment.

It may be enough for altruistic investors to accept a zero-return on average knowing that, without losing money, they have supported a humanitarian cause. But relying on altruism limits scope.

For the bond to sustainably attract private investors on financial grounds, the outcome funders will have to allow the ICRC to constantly set the arranged outcome of the project artificially lower than the expected outcome. This may work — the outcome funders are ultimately interested in impact and may be willing to accept the arranged premium as financing costs for the project.

Mixing incentives is like a conversation in two different languages — it can work, but only if the goals of the humanitarian sector can be translated into goals of the private sector.

Originally published at www.oneyoungworld.com on June 6, 2016. Follow us on Twitter @oneyoungworld