Project Information Document (Pid) s23

PROGRAM INFORMATION DOCUMENT (PID) CONCEPT STAGE

Report No.: AB4935 Project Name Pension and Health Finance Reform Program Region Africa Sector Finance and Private Sector Development (AFTFP) Project ID P117531 Borrower(s) The United Republic of Tanzania Implementing Agency Bank of Tanzania Date PID Prepared July 17, 2009. Revised on September 9, 2009 Estimated Date of August 30, 2010 Appraisal Authorization Estimated Date of Board January 27, 2011 Approval

1. Key development issues and rationale for Bank involvement

As part of the policy dialogue on financial sector development being pursued in the context of the Financial Sector Support Program (FSSP), the Bank of Tanzania (BOT) has expressed concerns about the sustainability of current pension and health finance arrangements and has requested support from the Bank to help design and implement a comprehensive reform of the existing pension and health finance system.

Pension Issues

The Tanzanian population is estimated at approximately 41 million persons and is relatively young. Population growth in 2009 is expected to be 2.04% and, taking into account the effects of HIV/AIDS, malaria and other diseases, life expectancy is currently 52 years. The size of the labor force is 20 million, of which 6.5% work in the formal sector. Employees in the formal sector have access to five pension funds, all of which are contributory schemes with defined benefit which is guaranteed by the state. Each of these funds targets a particular group and is incorporated under its own discrete legislation.

The pension objective of providing protection against old-age income poverty is highly questionable in Tanzania for a number of issues. First, system covers a very small but relatively better-off portion of the population and, therefore, it fails to serve social policy objectives. Second, Tanzania’s socialist experience makes the principle of defined benefit pensions appealing to policy-makers, but the sensitivity of such schemes to economic uncertainties and political interference makes them a suboptimal instrument of achieving social objectives. Finally, scheme rules allow early cashing out in case of unemployment making the system financially unsustainable.

The government already has a material exposure due to the quantum of unfunded liabilities in the schemes and the implicit government guarantees of those schemes. Both the ILO and the Cadogan Reports expect the government’s liability to continue to grow under the current structure. Even then, early estimates of the future liability of the government appear to be built on very generous assumptions (steady earning rates of 10% per annum on investments and the ability to reduce costs significantly) and are qualified to the extent that it is not possible to estimate from an actuarial perspective the impact of the early cashing out facility offered by most schemes.

The lack of domestic securities in Tanzania and the reluctance to invest internationally has resulted in the investment portfolios of most funds being heavily weighted in real property, mainly commercial property. The average allocation to this asset class is between 25% and 30% of the investment portfolios. Crude measures of the return to this asset class indicate that it is a poorly performing class. Some of the property investments undertaken are on the basis of the fund being the project manager and assuming the project risks.

Health Finance Issues

The Third Health Sector Strategic Plan (HSSP III) (mainland) has been finalized and formally launched. It focuses on primary health care, meeting the health MDG’s, improving health human resources, addressing the underperformance in the area of maternity and newborn care, improving referral services, implementing PPP, and addressing health financing. Health outcomes have seen remarkable progress since reforms commenced, including a 24% reduction in child mortality and 32% reduction in infant mortality. However, sustaining the gains and making further reductions will be a challenge, as will improving maternal and reproductive health which has not made similar gains. Reforms to date have included a focus on building capacity to better plan, budget, manage and monitor particularly at local level. The sector’s greatest unmet need is for qualified human resources. Low production, poor deployment, lack of incentives to perform and high attrition undermine service delivery.

In terms of health financing, a number of issues remain. Although per capita allocations have increased, the unit costs of service delivery continue to rise, and very little of the increase has come from the Government’s own revenue. Further, the increased dependence on large earmarked external funds crowds out critical discretionary financing and has implications for sustainability. Some progress has been made in protecting households from impoverishment due to illness, but planned expansion of the National Health Insurance Fund (NHIF) and of Community Health Funds (CHF) has stalled. To address these issues, HSSP III plans to develop a comprehensive health financing strategy and action plan, which includes stakeholder involvement and buy-in, to help move things forward in this area. A key consideration of this strategy is the appropriate role of the NHIF, NSSF and CHFs within the overall health financing framework.

There is a strong case for improving the existing pension and health finance systems to remove apparent inefficiencies, reduce costs and increase coverage in a manner which is fiscally sustainable in the long- term. The Bank is proposing a Reform Program to enhance the pension and health finance systems and reduce the fiscal impacts of the current systems which appear to be worsening over time.

2. Proposed objectives

The main goal of the Bank’s involvement is to promote the development of an efficient and independent pension and health finance system supported by adequate legal and regulatory structures. With this program, the Bank will also contribute to improving the cost effectiveness of the pension system to free up government expenditure for other poverty reduction programs, and ensuring that the pension system becomes a reliable source of long-term finance available in Tanzania. The proposed Pension and Health Finance Reform (PHFR) will be structured around a multi tranche Development Policy Credit (DPC). Both pension and health finance sectors are going to be tackled as both sectors are interlinked with pension funds which also provide health insurance. The Bank will support policy reforms in the sector through a proposed Development Policy Credit (DPC), and through technical assistance under the existing Financial Sector Support Project (FSSP).

There are a number of alternatives to deal with the pension system. A quantitative analysis of the fiscal impact of each of them will be undertaken after gathering the necessary data (starting in September 2009), but the justification of a DPC for each of the options is explained as follows:

First, any alternative canvassed requires reducing the need for people to cash out benefits. This cashing out has been justified on the basis that there are no unemployment benefits for persons who are unemployed. Putting in place some benefits outside the pension system for these people will reduce the need to cash out but also have a significant and immediate fiscal impact.

Another possible solution is to retain the existing schemes and restructure the benefits from defined benefits to defined contributions. There would be a substantial and immediate fiscal impact as the government funded the existing unfunded liabilities and had to compensate existing members for the future rights that they would surrender. It would be necessary to remove the early cashing out option in the schemes to avoid contributors cashing in a “windfall gain”.

An alternative may be to rationalize the number of schemes. It is interesting to note however, the largest fund has the highest cost ratio, driven in part by the costs of administering early cash outs. Rationalizing the number of schemes would involve harmonizing the benefits in the schemes and would have a fiscal impact through ensuring equivalence of benefits. Contributors with greater benefits would have to be compensated for the loss of benefits or, alternatively, contributors with lesser benefits would have their benefits broadened and increased. Pension funds are an important employer and there is likely to be a loss of employment as a result of any rationalization.

A further alternative may be to remodel the sector based on models used in the Baltic region. Under these models, a central agency acts as the pension fund management company, receiving contributions, keeping records, producing statements and arranging payment of benefits. The company outsources the investment management function to asset management companies. In the case of Tanzania, existing fund manager may choose to seek to be licensed as asset management companies. Current employees would have the option of joining the central management company or staying with the asset management company, thereby eliminating the impact on employment. Again the benefit structures would need to be harmonized with the attendant fiscal impacts to make this alternative workable.

The existing schemes may be closed and members transferred to the pay as you go scheme canvassed above. Again, the government would need to fund the existing unfunded liabilities and compensate current members.

A related issue is the future role of health insurance, either as part of existing pension programs – as is currently the case with the NSSF – or as a parallel program along the lines of the current NHIF/other pension fund model. These options need to be evaluated in terms of their fit with the broader pension policy directions, as well as the potential for using the selected model to extend health insurance coverage to those who are currently not reached by any of the existing schemes. The extension of health insurance coverage is a key element of the Health Sector Strategic Plan (HSSP) III, which was officially launched on June 30, 2009; so the long-term options selected for evolution of health insurance should be consistent with these objectives.

Possible options could include: (i) creating a single national fund, which incorporates the existing NHIF and NSSF health insurance operations, and also includes elements of the CHFs; and (ii) creating a regulatory framework which provides for effective oversight of multiple funds, including both compulsory and voluntary (supplementary) health insurance. Beyond these options, strategies will also need to be developed for extending health insurance coverage to a greater proportion of the population. The DPC would also support technical assistance for the development of options for the further development of the health financing system, including the necessary regulatory and organizational linkages, if any, to the pension and other social protection system. The DPC would also be used to help lay groundwork for the effective implementation of the selected approach, including detailed planning and implementation support as well as the identification of the policy actions that would be needed to support the implementation process.

There will be fiscal consequences whichever alternative is ultimately chosen by the government, caused by the poor benefit design and the implicit government guarantee. The quantum and timing of each fiscal impact will only be ascertained once an actuarial review of the state of each scheme is done using realistic and consistent assumptions. The fiscal consequences of reforms may have a beneficial indirect effect on the level of poverty. Any reduction in the long term fiscal impact through efficiencies will free up government resources for other poverty reduction measures.

In the short-term, it is likely that the government will require financial assistance to deal with the fiscal impact. In the longer term, the government will need to increase its revenues. Possible options are to reintroduce capital gains tax that was recently abolished, increase the rate of corporate tax which is currently fairly low at 30% or increase the individual marginal tax rates which are also fairly low.

3. Preliminary description

The PHFR program is envisaged to be structured in the following two phases:

I – Analysis of the Pension and Health Financing Systems and Reform Options. During this phase, a comprehensive assessment of the current situation will be canvassed. Based on that assessment, it will be produced a document with the different alternatives for pension reform with an estimation of the fiscal liabilities of each alternative strategy. A similar arrangement with appropriate linkages to the pension work would be created to guide the health financing reform efforts.

II – Design of Policy Reform Program. After discussing with the government, one of the above mentioned options will be chosen as the new pension and health financing system. Regardless which the final system is, the first action is to set up the regulatory and supervisory framework that is acceptable to IDA terms and that gives a robust structure to the new system.

The new pension and health financing system will be established and evaluated regularly to see the existing and future financing needs. As the new pension and health finance system complies with its functions, retirees get their annuities, and in turn, potential contributors join the system, the need of the DPC to close the financing gap will gradually decline. The project would make use of the following World Bank instrument:

- IDA credit for the funding of the pension reform program, provision of TA and capacity building

The foreign exchange risk associated with the World Bank DPC would be assumed by the BOT.

4. Environment Aspects

The proposed PHFR is not expected to have a significant effect on Tanzania’s environmental and natural resources. However, the Environmental Safeguard Specialist will be identified before the appraisal of the project.

5. Tentative Financing ($m.) IDA credit (FY2011) 300

6. Contact point

Michel Noel, Task Team Leader Email: [email protected] Telephone: (+1 202) 473-0062

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