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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY I~TE~ATIONAL ~ E ~ L O P ASSOCIATION ~ N T PROPOSED ADDITIONAL FINANCING OF SDR 1.40 MILLION (USS2.0 MILLION EQUIVAL,ENT) TO BOSNIA AND HERZEGOVINA FOR THE SOCIAL INSURANCE TECHNICAL ASSISTANCE PROJECT Human Development Sector Unit South East Europe Country Unit Europe and Central Asia Region PROJECT PAPER June 1,2005 Report NO: BA This document has a restricted distribution and may be used by recipients only in the performance of their official duties, Its contents may not otherwise be disclosed without World Bank authorization,

2 CURRF"Y EQUIVALENTS (Exchange Rate Effective May 23,2005) Currency Unit = Konvertible Marks (KMJ KM1.OO = U5$ US$l,00 =KM XDR= US% FISCAL YEAR January 1 - December 3 1 AggR~~ATI~NS AND ACRONYMS BiH CAS CEE CFAA DFID E3F ECA EDSs FBH FHIF PI0 FMS FMOH HSEP HIF IDA MCA MHSW 3osnia and Herzegovina Country Assistance Strategy Central and Eastem Europe Country Financial Accountability Assessment Department for International Development Extra Budgetary Fund Europe and Central Asia Economic Development Strategy Federation of Bosnia and Herzegovina Federation Health Insurance Fund Pension and Invalid Institute Financial Management System Federation Ministry of Health Health Sector Enhancement Project Health Insurance Fund International Development Association Ministry of Civil Affairs Ministry of Health and Social Welfare (RS) MSP MOF MS OHR PAYG PCU PFSACII PIU QAG ff RS SC SDR SFRY SITAP SOSAC SOTAC UK USAID Ministry of Labor and Social Policy (FBH) Ministry of Finance Marginally Satisfactory Office of the High Representative Pay- As-You-Go Project Coordination Unit Public Fhance Sector Adjustment Credit I1 Project Implementation Unit Quality Assurance Group Project Paper Republika Srpska Steering Committee Special Drawing Rights Socialist Federal Republic of Yugoslavia Social. hsurance Technical Assistance Project Social Sector Adjustment Credit Social Sector Technical Assistance Credit United Kingdom United States Agency for International Devel. Vice President: I Shigeo Katzu Country Director: j Orsalia Kalantzopoulos Sector Manager: Arnin H. Fidler Task Team Leader: 1 Betty Hanan

3 BOSNIA AND HERZEGOVINA SOCIAL INSifRANCE TECH'NICAL ASSISTANCE PROJECT Date: June 1,2005 Country Director: Orsalia Kalantzopoulos Sector ~ anager~~rector~ h i n Fidler Project XI): PO95596 Lending Instrument: Technical Assistance Credit (TAC) Team Leader: Betty Hanan Sectors: Health ((;S%/b>, Compulsory pension and unemployment insurance (35%) Themes: Social risk mitigation (P), Health system Performance (PI Environmental screening category: Not Safeguard screening category: No impact Responsible Agencies: State: Ministry of Civil Affairs Federation of Bosnia and Herzegovina (FBI ): Ministry of Health; Ministry of Labor and Social Policy; Ministry for Issues of Veterans and Disabled Veterans of the D~fensiye-Lib~rati~n War; Health Insurance and Reinsurance Institute; Pension and Disability Insurance Institute; and Tax Administration. Republika Srpska (TIS): Ministry of Health and Social Welfare; Ministry of Labor and Veterans-Invalids' Protection; Health Insurance Fund; Pensions and Disability Insurance Fund; and Tax ~ dm~s~at~on. Implementing agencies: Federation Ministry of Health Project Implementation Unit Trg heroja Sarajevo Bosnia and Herzegovina Tel: Fax: EIfrp@,Bifi.Net. 3a Ministry of Health and Social Welfare of RS Project Coordination Unit Kralj a Petra I Karadjordj evica m.a Luka Bosnia and Herzegovina Tel: SI Fax: c)-l68 moh.~cu~,~lic.net FY nnual 0.4 Cumulative This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.

4 Revised project development obj e~tives/outco~es~ Consistent with the original project, the development objectives remain unchanged: to strengthen the effectiveness and efficiency of health and pension insurance systems by provision of high quality technical assistance and training to help implement existing reforms and to help design options for future social insurance reforms. For Loan~/Credits/Grants : Total Bank financing (US$m>:

5 SOSNLA AND HFXZEGOVXNA PROJECT PAfER FOR THE SOCIAL FNSUCE TECHNICAL ASSISTANCE PROjECT 1. Introduction 1. This Project Paper seeks the approval of the Executive Directors to provide an additional credit in the mount of SDR 1,40 million (US$:! million equivalent) to the Bosnia and Herzegovina Social Insurance Technical Assistance Project (PO7 1004), Credit OS. 2. The additional credit would finance scaled-up activities that would enhance the impact of the project. The additional activities would contribute to efforts to contain growing expenditures for the social insurance systems while helping to strengthen govemance and institutional capacity to design and implement institutional, policy, and financing reforms in the social insurance systems. In particular, the additional financing will enable the provision of technical assistance needed to: (i) perfbrm external audits of cantonal level health insurance funds, large hospitals and other health providers in both Entities, (ii) develop the legal and institutional framework for the establishment of a unified system of disability assessment for all categories of beneficiaries, and (iii) support the joint inter-entity pension reform working group. These activities would contribute to M e r strengthening the effectiveness and efficiency of the health and pension insurance systems. 3, The Project is being cofinanced by the UK Department for International Development (DFID), which is contributing US$ 1-73 million equivalent towards the financing of technical assistance and training or 18% of the original total project costs. The project complements activities supporting the modernization of the Treasury financed by USAID. 2. Background and Rationale or Additional Financing 4. U r i ~ project i ~ ~ design. ~ The original credit was for SDR 5.2 million (ijs$7 million equivalent). The project was approved on June 10, 2003 and the credit became effective on October 3, The objective of the project, which will remain unchanged with the additional activities, is to strengthen the effectiveness and efficiency of health and pension insurance systems by the provision of high quality technical assistance and training to help implement existing reforms and to help design options for future social insurance reforms. The project is providing technical assistance that is, inter alia, facilitating the learning process of the institutions through problem solving. It addresses three areas: (i) effective implementation of health and pension-related reforms supported under the Public Finance Sector Adjustment Credit (PFSAC 11); (ii) an in depth analysis of key policy issues which affect health and pension insurance systems to develop well-founded recommendations for future reforms; and (iii) technical assistance and limited investment support to strengthen those aspects of External 3udgetary Funds (EBF) operations that are likely to be part of their core mandate, in whichever policy framework they operate. The project is also: (i) supporting the overhaul of the PAYG pension system in the medium- term and assessing the 1

6 Project preconditions for further institutional, parametric and systemic changes and (ii) promoting the harmonization of health and pension policy frameworks between the two entities. There have been no changes in the design of the project or the project development objectives. 5 ~ ~ ~ ~ to date. ~ Progress u r with implementation ~ # ~ of most ~ sub-components ~ is satisfactory. Eight major contracts are under full implementation and three others are at the contractual signing stage. Of the eight, three have been fully implemented or are about to be completed. The last supervision mission (March 2005) downgraded the project performance to Marginally Satisfactory (MS) to reflect problems developed with the implementation of one sub-component. These problems are being addressed, Troubles in this sub-component are not expected to affect the success of proposed scaled-up activities. The additional activities would contribute to efforts to contain growing expenditures for the social insurance systems while helping to strengthen govemance and institutional capacity. In terms of development objectives and related outcomes, the project is performing well, Efforts are being displayed by both implementing agencies and contractors to work together to ensure institutional building under the project. Training under each of the sub-components is taking place through a number of w~rkshops/courses and through formal courses and study tours. The in-country training as well as foreign training is helping improve the efficiency of health and insurance systems. As of May 19, 2005, USg1.52 million has been disbursed from the IDA Credit and US$0.50 million from the DFID grant. Disbursements are expected to accelerate in the coming weeks with payments under ongoing and new contracts. (For more information on project performance and institutional arrangements, please refer to paras 18-19). 6. ~ ~ ~ the # u d ~ i ~ t ~ ~ o ~ othe ~ additional ~ r ~ ~ ~ financing ~ ~ i request ~ g is. a result of an intensive and productive dialogue in the social sectors where the Bank enjoys a strong relationship with the governments. The Bank has financed over 10 operations in the social sectors since the conflict, Implementation performance of these operations has been consistently satisfactory. SITAP was among nine projects (out of 130) rated highly satisfactory by the Quality Assessment Group (QAG) in its evaluation of September The QAG evaluation rated the project highly satisfactory for focus on development eeectiveness and supervision inputs and processes. The activities proposed under the additional financing have been under active discussion with the governments during the past several months. Recent audit reports indicate problems in financial management and accountability in the social insurance system. The request comes from the highest levels of government, i.e. Entity Prime Ministers and Ministers of Health. The additional activities would contribute to efforts to contain growing expenditures for the social insurance systems while helping to strengthen govemance and institutional capacity to design and implement institutional, policy, and financing reforms in the social insurance system. In addition, in addressing financial management issues, they will build sustainable financial management capacity and improve transparency. At the request of the Govement, the Bank has approached several. donors to explore options or financing of these activities, However, these efforts have not been successful. 7. Consistent with the Government and the Bank s sector policy and strategies, the objective of the additional financing is to scale-up activities through the provision of 2

7 technical assistance to: (i) perform extemal audits of cantonal level health insurance funds, large hospitals and other health providers in both Entities, (ii) develop the legal and institutional framework for the establishment of a unified system of disability assessment, and (iii) support the joint inter-entity pension reform working group. These activities would contribute to ibrther strengthening the effectiveness and efficiency of the health and social insurance systems, A description of the additional activities to be undertaken follows: Audit of Cantonal HIFs, Large Hospitals and health providers 8. As other countries in Central and Eastern Europe (CEE), Bosnia and Herzegovina (BiH) follows the health insurance model whereby employers and employees contribute to publicly-managed funds that finance the bulk of health care provision. Health financing relies heavily on payroll taxation and the collection capacity of tax authorities. In both Entities, the main source of health care financing is the Health Insurance Funds (HIFs), which derive the majority (75-80 percent) of their resources from wage taxes. Public sector expenditures on health amount to 7.6 percent of GDP, which is significantly above CEE average and the second highest figures in the ECA region after Croatia. In addition, it is estimated that out of pocket expenditures amount to another 4.7 percent of GDP, though private expenditures are not captured effectively, as much of these expenditures are done in the form of informal payments, rather than eo-payments. 9, The current contribution rate for formal employees is one of the highest in the ECA region - 18 percent of gross salary in the Federation and 15 percent of net salary in RS, Compliance rates are relatively low, leading to a situation where the public sector is the main contributor to health insurance. The system has a rather non-transparent flow of funds among various extra-budgetary funds, which are supposed to make contributions on behalf of their beneficiaries (pensioners, registered unemployed) and limited Govement contributions on behalf of some of those who are exempt from making contributions. A Country Financial Accountability Assessment (CFAA) for BiH was carried out in The CFAA identified systemic and structural weaknesses in public sector budgeting, accounting, reporting, and auditing. Although there have been several positive developments in the past years, most notably, implementation of a fully automated treasury system across all the Cantons in the Federation and all the regions in RS, recent audit reports indicate numerous problems in financial management and accountability in the health sector in general and HIFs in particular. All this contributes to growth in expenditures, inequities, constitute a limiting factor for the competitiveness of formal sector enterprises, encourage the proliferation of the informal sector, and undermine the sustainability of the social insurance system. Overall, the burden of the health sector on the economy is substantial and from a macro-economic perspective, containing the growth of health expenditures is essential. 10. To help tackle these issues and to build sustainable financial management capacity in the health sector, the Bank-financed Health Sector Enhancement Project (HSEP) includes funding to strengthen auditing and financial management and to conduct audits of Entity level health insurance funds and two large hospitals in each Entity. During the processing of HSEP, the Entity Ministries of Health requested Bank assistance to mobilize additional resources to undertake similar work at the level ofthe cantonal health insurance funds and 3

8 the largest health care providers in both Entities. The proposed additional financing will provide technical assistance to cany out accounting and internal control reviews of cantonal health insurance funds and the largest hospitals and other health providers in both Entities. This will result in clear steps to improve transparency and accountability in the management of resources. The outcome of this review will, inter alia, include as a first step the development of an Action Plan. A second step will be to overhaul and strengthen the financial management systems (FMS) of the HIFs by beginning the implementation of the agreed Plan. The third stage in this process would be to evaluate the effectiveness of the implementation of the Plan on the operations of WIFs and major hospitals and then take appropriate measures to address the gaps. Development of the legal and institutional framework or the establishment of a unified system of disability assessment 11. Disability programs in BiH include cash and in-kind benefits, as well as services. The program mix comprises: (i) social insurance benefits under pension and invalid insurance; (ii) programs and benefits for disabled war veterans; (iii) benefits for civil victims of war; and (iv) benefits for children and adults with disabilities, As a result of the war, the total proportion of persons with disabilities is higher in BiH than in any other country in Europe. Overall, about one out of every 10 potential workers has a disability. Despite this, the system for assessing disability is outdated and implemented in an. inconsistent manner across programs and across areas of each Entity. There is also considerable anecdotal evidence of abuses in the system, with informal payments made to doctors that conduct the assessment, considered to be a common practice. The result is a series of disability programs which consume significant resources, but continue to include unjustified beneficiaries and may exclude deserving claimants, 12. Initial technical assistance on disability assessment reforms was provided under the Social Sector Technical Assistance Credit (SOTAC) as well as part of SOSAC 11preparation. The analysis of disability policy and programs supported under SOTAC showed that the current system of disability assessment is ill-suited to deal with the disability challenges that Bosnia and Herzegovina faces today. The technical assistance recommended the development of new disability assessment rulebooks as well as the consolidation of disability assessment for adults in one institution. The development of new disability rulebooks are part of the core reform program supported by SOSAC II. 13. The support in this area would focus on the development of the institutional and legal framework for a unified system of disability assessment, This would include support for: (i) the establishment of a central institution responsible for the assessment of disability for all beneficiaries irrespective of their status &e. civilians, civilian victims of war, war veterans), (ii) the development of business processes, (iii) the definition of the organizational structure of the new institution, (iv) the preparation of new disability rulebooks that would be applicable to all categories of beneficiaries. Since they are at an advanced stage, the audits currently being performed under the Veterans Law shall be completed in accordance with the current rulebooks. However, upon the development of the new system, and enactment ofthe new rulebooks, the legal framework will be amended to allow another audit of all individual 4

9 decisions on the level of disability to be undertaken by the newly established institution. In addition, technical assistance under this activity would support the development of a Disability Policy Strategy Note to promote the development of a modem system of protection of disabled people. Support to the Inter-Entity Pension Reform Working Group 14. While many countries in Europe and Central Asia (ECA) experienced significant deterioration in their contributor base during the 199Os, in only a few cases was the decline as dramatic as in BiH, Even in the absence of the conflict, BiH's pension contribution base would most probably have deteriorated significantly, resulting in a financial crisis. However, this process was accelerated by the war, which prematurely ended the financial viability of the pre-war scheme. Overall, the ratio of pensioners to contributors had reached 1 : 1..3 by the end of the conflict, with only a marginal improvement to 1 : 1.4 in the FBH since then. In RS the situation is worse, with each contributing worker supporting more than one pensioner (1.08: 1). As a result, even high payroll taxes and budget transfers in RS produce an average pension that is less than 30 percent of income per capita. In contrast, a somewhat better ratio of pensioners to contributors in the FBH allows for much higher absolute and relative pension levels, even though the pension spending to GDP ratio is lower, 15. In response to the ongoing financial imbalances in the pension systems of both Entities, more dramatic action was taken in The Office of the High Representative (OHR) imposed a strict cash rationing system on both Entity pension funds, whereby pension benefits in any month are only fmanced from contribution revenues in the previous month, plus legally mandated budgetary transfers for specific groups of privileged pensioners. Pension levels are controlled by use of a coefficient that, if necessary, lowers paid pension levels to a percentage of legal entitlement, with the coefficient a function of prior month pension contribution revenues. As intended, the policy of introduction of cash rationing has precluded the accumulation of firther systemic arrears. By late 2002, the system appeared to have stabilized, with monthly pensions paid with a full coefficient, and the stock of arrears have declined. 16, The combination of the Socialist Federal Republic of Yugoslavia (SFRY) inheritance and post-war developments has resulted in a range of institutional issues in the BiH pensions systems that are in need of attention, These relate to the operation of existing Entity systems, relations between Entity systems, and the evolving role of the State level in the hture system. With respect to the operations of the current Entity pension systems, the attempts of both Pension Funds to control expenditure management in the face of fluctuating revenues have meant that their institutional focus has been very short-term, with little or no strategic planning. This is not simply a product of the conflict, Pension funds throughout SFRY countries typically exhibit outmoded managerial structures and practices, weak and nontransparent business processes and internal controls, including uncertain data security. In addition to intra-entity institutional issues, there remain serious coordination problems between the two Pension Funds, These contribute to ongoing problems with recognition and payment of pensions for people moving between Entities, either during their working life or once they are receiving pensions, Even in cases where the payment liability is undisputed, 5

10 there is no linking or compatibility of IT systems to allow basic data exchange between the Funds. 17. There are also outstanding policy issues in the pensions system on the entitlements side. Pensions policy and a~inistration officials and pensioners themselves view the current cash rationing system as very much an interim arrangement, and see a strong need for systemic refom, In recognition of the importance of coordinated policies, which ensure the harmonious operation of the Entities pension systems to create preconditions for a future pension reform. that may eventually lead to the establishment of a unified, State-level pension provision, the three Prime Ministers have agreed to form an Inter-Entity Pension Policy Working Group, The responsibility of the Working Group is to: (a) provide policy advice to the Entity Prime Ministers regarding the legal and technical requirements to harmonize pension policies and pension legislation across the Entities, institutional cooperation in the fields of pension provisions and pension contribution collection, and international social security agreements and (b) formulate a Joint Pension Policy explaining the agreed social policy goals and operating principles of a future pension system, the method of assessing benefits based on past and future contribution histories and the methods and timeframe of harmonizing pension contribution and pension assessment des, which are core SOSAC I1 second tranche measures. The Working Group is to meet every two weeks with the meeting place alternating between Sarajevo and Banja Luka. The Bank was requested to assist the Working Group through the provision of technical advice on pension system related matters. 3. Proposed Changes 18, The proposed activities will not change the overall project development objectives (DO); the DO will remain unchanged. The proposed activities will complement those already underway and will further strengthen the efficiency and effectiveness of the health and social insurance systems. The institutional arrangements, which are working well under the original project, will be the same (see paras 22-23). Each implementing agency has Focal, Points responsible for overall coordination of implementation in their respective minis~/agency. The project is supported by a Project Steering Committee (SC) comprising high level officials from each of the implementing agencies and the Entity level Ministries of Finance. The objective of the SC is to oversee project implementation and to help address complex issues that arise during project implementation that cmot be resolved at the individual institution level, Tfie SC also acts as an important policy discussion forum so that the views and concerns of the implementing agencies are reflected in policy development. 19. Additional activities will commence immediately after hnding becomes available. There will be no changes in the closing date and implementation schedule. 4. Consistency with the CAS 20, The proposed additional activities are fully consistent with the CAS discussed at the Board in September Under the third pillar of the CAS - investing in key social and economic infrastructure, one of the key objectives and expected outcomes is improved social sector management. An additional objective of the CAS is to continue to strengthen

11 institutions and governance. The additional activities would contribute to efforts to contain growing expenditures for the social insurance systems while helping to strengthen governance and institutional capacity to design and implement institutional, policy, and financing reforms in the health and pensions sectors. This would contribute to improved transparency in management of key public expenditures and programs, Overall support for these objectives should contribute to the overarching CAS goal of poverty alleviation. 5. Appraisal of Scaled-up Project Activities 21. There are limited foreseen institutional risks with the proposed activities, The implementing agencies for the additional activities will be the same as those for the original project: (i> the Entity level Ministries of Health, (ii) Entity level Ministries of Labor, (iii> the Pension Funds, (iv> Entity level Health Insurance Funds, (v> Tax Adminis~ations, and (vi) the Ministry of Civil Affairs. The implementing agencies are the direct beneficiaries of technical assistance, training, and goods supported under the original project and to be supported under the additional financing. 22, As with the original project, the fiduciary tasks of procurement and financial management will be carried out by the existing Project Coordination Unit in the RS Ministry of Health and Social Welfare and the Project Implementation Unit in the Federation Ministry of Health, 30th Units have considerable experience with Bank-financed projects and are integral part of both Ministries of Health. Procurement and Financial Management under the project work well and have consistently been rated Satisfactory. A large number of procurement packages have been processed. The quality and accuracy of doc~en~tion is generally good. Procurement is carried out jointly by the two Entities in terms of preparation of TOR, tendering, evaluation of proposals, negotiations. Joint tendering for all of the packages under SITAP is ensuring consistency of approach and strategic direction, and harmonization of issues being addressed under the project. Project audits have been conducted on a timely manner and the audits have been consistently unqualified. The Coordination Units are also responsible for consolidating quarterly and annual progress management reports and annual work programs and budgets prepared by each implementing agency. Project reporting is also working well. All reports, annual work programs and budgets are submitted in a timely and effective manner. 23. The proposed activities will not alter the environmental category of the project (C> or trigger any new safeguard policies. The scale-up would not involve any exceptions to Bank policies. 6. Expected Outcomes 24. New activities will contribute to meeting development objectives and outcomes. The following includes the additional outcomes to be expected ram the new activities: 7

12 Output Audits of the cantonal HIFs and large hospitals completed and proposal for accounting standards developed with proposed regulation on internal controls New disability assessment system in place Joint pension reform strategy developed Output Indicator Data Collection Strategy Number of cantonal HIFs and 1 Audit reports large hospitals where audit was completed New unified system established and legal framework, including amendments ofthe laws and the preparation and enactment ofthe new rulebooks, completed and assessments conducted WG meeting regularly Draft strategy completed and submittecf the Prime Ministers Reports from institution for disability assessment Regular progress reports and draft j strategy 7. Benefits and Risks 25, There are several anticipated benefits associated with the project, including the additional activities proposed. First, with more professionally trained management staff in the health and social protection institutions, the leadership of those institutions should be better equipped to plan and direct the activities of the institutions to fulfill the social obligations to their clients. Better planning and improved strategic direction in both health and social protection systems would be enhanced thereby improving the systems responsiveness to patients, pensioners and enterprises. Improved financial data, reporting and revenue collections for social contributions would improve solvency for HIFs and the PFs thereby increasing health and pension resources benefiting patients, pensioners and, indirectly, enterprises. 26, The additional activities might encounter the following risks: Risk Resistance to the development ofthe new, unified system for disability assessment by existing institutions participating in the Risk Rating Risk Mitigation Measure Entity Governments commitment to the audits would mitigate the risk. Entity Governments commitment to speed up the activities on the establishment of the new system, - Resistance to the inter-entity cooperation on pension issues undermines the Inter- Entity Pension Reform Working Group s progress in the development of the joint pension reform strategy. Risk Rating -H (High Risk), S (Substantial Risk), M (Modest Ri! The endorsement of the Inter-Entity Pension Reform Working Group (WG) with clear TOR for its work by three Prime Ministers and Bank s techmi support to the work ofthe WG would mitigate the ri Financial Terms and Conditions for the Additional Financing Financial terms and conditions for the additional financing will remain unchanged. 8

13 9. Allocation of Proceeds of Additional Financing Allocation of Proceeds of Additional Financing toy Category (In US$ equivalent *) ( 1 ) Goods 390,000 (2) Consultant Services including audit 1,500,000 (3) Training 0 (4) Incremental Operating Costs 60,000 (5) Unallocated 50,000 TOTAL 2,000,000 * Amounts have been rounded to the nearest thousand. 9

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