Document of The World Bank Report No: PAD994 INTERNATIONAL DEVELOPMENT ASSOCIATION PROJECT APPRAISAL DOCUMENT ON PROPOSED CREDITS IN THE AMOUNT OF SDR 7.8 MILLION (US$12.00 MILLION EQUIVALENT) TO THE REPUBLIC OF HONDURAS AND SDR 7.8 MILLION (US$12.00 MILLION EQUIVALENT) TO THE REPUBLIC OF NICARAGUA FOR A HONDURAS AND NICARAGUA CATASTROPHE RISK INSURANCE PROJECT May 16, 2014 Disaster Risk Management and Urban Unit Latin America and the Caribbean Region 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. CURRENCY EQUIVALENTS (Exchange Rate Effective March 31, 2014) Currency Unit = USD United States Dollars SDR 0.64698537 = US$1 US$1.54563 = SDR 1 FISCAL YEAR January 1 – December 31 ABBREVIATIONS AND ACRONYMS CARICOM The Caribbean Community CCRIF Caribbean Catastrophe Risk Insurance Facility CIMA Cayman Islands Monetary Authority COSEFIN The Council of Ministers of Finance of Central America and the Dominican Republic DRFI Disaster Risk Financing and Insurance DRM Disaster Risk Management EM-DAT Emergency Events Database GDP Gross Domestic Product GFDRR Global Facility for Disaster Reduction and Recovery IBRD International Bank for Reconstruction and Development IDA International Development Association IDB Inter-American Development Bank IRM Immediate Response Mechanism MDTF Multi Donor Trust Fund M&E Monitoring and Evaluation OECS Organization of Eastern Caribbean States ORAF Operational Risk Assessment Framework PCGIR Comprehensive Central American Disaster Risk Management Policy PO / PDO Program/Project Objective / Project Development Objective RAAN North Atlantic Autonomous Region, Nicaragua SICA Central America Integration System SP Segregated Portfolio SPC Segregated Portfolio Company UNISDR United Nations International Strategy for Disaster Reduction USAID United States Agency for International Development UST United States Department of the Treasury W&S Water and Sanitation WBG World Bank Group Regional Vice President: Jorge Familiar Country Director: Maryanne Sharp Sector Director: Ede Jorge Ijjasz-Vasquez Sector Manager: Anna Wellenstein Task Team Leader: Ana Campos Garcia HONDURAS AND NICARAGUA CATASTROPHE RISK INSURANCE PROJECT TABLE OF CONTENTS Page I.  STRATEGIC CONTEXT .................................................................................................1  A. Country Context ............................................................................................................. 1  B. Sectoral and Institutional Context .................................................................................. 2  C. Higher Level Objectives to which the Project Contributes ............................................ 5  II.  PROJECT DEVELOPMENT OBJECTIVES ................................................................6  A. PDO................................................................................................................................ 6  B. Project Beneficiaries ...................................................................................................... 6  C. PDO Level Results Indicators ........................................................................................ 6  III.  PROJECT DESCRIPTION ..............................................................................................6  A.  Project Components ...................................................................................................... 6  B. Project Financing............................................................................................................ 7  C. Lessons Learned and Reflected in the Project Design ................................................... 9  IV.   IMPLEMENTATION .....................................................................................................10  A. Institutional and Implementation Arrangements.......................................................... 10  B. Results Monitoring and Evaluation .............................................................................. 11  C. Sustainability ............................................................................................................... 11  V. KEY RISKS AND MITIGATION MEASURES ...............................................................12  A. Risk Ratings Summary Table ...................................................................................... 12  B. Overall Risk Rating Explanation................................................................................. 12  VI. APPRAISAL SUMMARY ..................................................................................................13  A. Economic and Financial Analyses ............................................................................... 13  B.  Technical ..................................................................................................................... 14  C. Financial Management ................................................................................................. 14  D. Procurement ................................................................................................................. 15  E. Social (including Safeguards)...................................................................................... 15  F. Environment (including Safeguards) ........................................................................... 15  Annex 1: Results Framework and Monitoring .........................................................................16  Annex 2: Detailed Project Description .......................................................................................17  Annex 3: Implementation Arrangements ..................................................................................23  Annex 4: Operational Risk Assessment Framework (ORAF) .................................................30  Annex 5: Implementation Support Plan ....................................................................................35  Annex 6: Economic and Financial Analyses..............................................................................37  PAD DATA SHEET Central America Honduras and Nicaragua Catastrophe Risk Insurance Project (P149895) PROJECT APPRAISAL DOCUMENT . LATIN AMERICA AND CARIBBEAN Disaster Risk Management and Urban Unit Report No.: PAD994 . Basic Information Project ID EA Category Team Leader P149895 C - Not Required Ana Campos Garcia Lending Instrument Fragile and/or Capacity Constraints [ ] Investment Project Financing Financial Intermediaries [ ] Series of Projects [ ] Project Implementation Start Date Project Implementation End Date 01-Jul-2014 31-Jul-2021 Expected Effectiveness Date Expected Closing Date 01-Aug-2014 31-Jul-2021 Joint IFC No Sector Manager Sector Director Country Director Regional Vice President Anna Wellenstein Ede Jorge Ijjasz-Vasquez Maryanne Sharp Jorge Familiar . Borrower: Republic of Honduras, Republic of Nicaragua Responsible Agency: Ministry of Finance and Public Credit Contact: Ivan Acosta Title: Minister Telephone No.: 50522669744 Email: Responsible Agency: Ministry of Finance Contact: Wilfredo Cerrato Rodriguez Title: Minister Telephone No.: 50422221278 Email: . Project Financing Data(in USD Million) [ ] Loan [ ] Grant [ ] Guarantee [X] Credit [ ] IDA Grant [ ] Other Total Project Cost: 24.00 Total Bank Financing: 24.00 Financing Gap: 0.00 . Financing Source Amount BORROWER/RECIPIENT 0.00 International Development Association (IDA) 16.00 IDA recommitted as a Credit 8.00 Total 24.00 . Expected Disbursements (in USD Million) Fiscal 2014 2015 2016 2017 2018 2019 2020 2021 2022 Year Annual 0.00 9.00 4.50 3.00 3.00 1.50 1.50 1.50 0.00 Cumulati 0.00 9.00 13.50 16.50 19.50 21.00 22.50 24.00 24.00 ve . Proposed Development Objective(s) The Project Development Objective is to enable the access of Honduras and Nicaragua to efficient sovereign risk insurance associated with tropical cyclones, earthquakes, and/or excess rainfall. . Components Component Name Cost (USD Millions) Component 1: Payment of the entrance fee to the CCRIF for 4.50 Honduras and Nicaragua Component 2: Payment of annual insurance premium to the 19.50 CCRIF for Honduras and Nicaragua . Institutional Data Sector Board Financial Systems Practice . Sectors / Climate Change Sector (Maximum 5 and total % must equal 100) Major Sector Sector % Adaptation Mitigation Co-benefits % Co-benefits % Finance Non-compulsory 100 70 pensions and insurance Total 100 I certify that there is no Adaptation and Mitigation Climate Change Co-benefits information applicable to this project. . Themes Theme (Maximum 5 and total % must equal 100) Major theme Theme % Financial and private sector development Other Financial Sector Development 50 Financial and private sector development Other Private Sector Development 50 Total 100 . Compliance Policy Does the project depart from the CAS in content or in other significant Yes [ ] No [ X ] respects? . Does the project require any waivers of Bank policies? Yes [ ] No [ X ] Have these been approved by Bank management? Yes [ ] No [ X ] Is approval for any policy waiver sought from the Board? Yes [ ] No [ X ] Does the project meet the Regional criteria for readiness for implementation? Yes [ X ] No [ ] . Safeguard Policies Triggered by the Project Yes No Environmental Assessment OP/BP 4.01 X Natural Habitats OP/BP 4.04 X Forests OP/BP 4.36 X Pest Management OP 4.09 X Physical Cultural Resources OP/BP 4.11 X Indigenous Peoples OP/BP 4.10 X Involuntary Resettlement OP/BP 4.12 X Safety of Dams OP/BP 4.37 X Projects on International Waterways OP/BP 7.50 X Projects in Disputed Areas OP/BP 7.60 X . Legal Covenants Name Recurrent Due Date Frequency Description of Covenant . Conditions Name Type The Participation Agreement between the Recipient and CCRIF has been Effectiveness executed. Description of Condition For each of Honduras and Nicaragua, respectively as the Recipient: "The Participation Agreement between the Recipient and CCRIF has been executed" (Article V, Section 5.01). Name Type The Recipient has entered into the Insurance Agreement with CCRIF, in a Disbursement manner satisfactory to the Association. Description of Condition In relation to Component 2, for each of Honduras and Nicaragua, respectively as the Recipient: " The Recipient has entered into the Insurance Agreement with CCRIF, in a manner satisfactory to the Association.". (Schedule 2, Section III., B, 1, b) Team Composition Bank Staff Name Title Specialization Unit Niels B. Holm-Nielsen Lead Disaster Risk DRM LCSDU Management Specialist Patricia De la Fuente Senior Finance Officer Disbursements CTRLN Hoyes Enrique Pantoja Sr Land Administration Peer Reviewer LCSAR Specialist Antonio Leonardo Sr Financial Financial Management LCSFM Blasco Management Specialist Francis Ghesquiere Manager Peer Reviewer GCCDR Hector Ibarra Pando Lead Financial Officer Peer Reviewer FABBK Ana Campos Garcia Senior Disaster Risk Team Lead LCSDU Management Specialist Nancy Chaarani Meza Operations Officer Operations/DRM LCSDU Tomas Socias Senior Procurement Procurement LCSPT Specialist Jimena Garrote Senior Counsel Legal LEGLE Jose Angel Villalobos Senior Insurance Insurance FCMNB Specialist Concepcion Aisa Otin Financial Officer Financial Officer FABBK Oscar Anil Ishizawa Disaster Risk DRM LCSDU Escudero Management Specialist Ramiro Ignacio Counsel Legal LEGLE Jauregui-Zabalaga Carolina Diaz Giraldo E T Consultant Operations/DRM LCSDU Christopher J. Chung E T Consultant Operations/DRM LCSDU Bontje Marie Zangerling Junior Professional Operations/DRM LCSDU Associate Sara Gey Feria E T Temporary Team Assistant LCSDU Barry Patrick Maher Financial Sector Peer Reviewer FCMNB Specialist Non Bank Staff Name Title Office Phone City Mareile Dreschler . Locations Country First Location Planned Actual Comments Administrative Division I. STRATEGIC CONTEXT A. Country Context 1. Both Honduras and Nicaragua are highly vulnerable to the adverse effects associated with earthquakes, hurricanes and other major hydro-meteorological events such as excessive rainfall. Without adequate fiscal management strategies, major catastrophic events can jeopardize government efforts to end extreme poverty and boost shared prosperity while threatening to reverse hard-won development gains. Experiences from across Central America have shown that in the immediate aftermath of a disaster, countries experience significant macro-economic instability and major public sector budget variability1. 2. High levels of vulnerability to natural hazards aggravate the significant poverty and development challenges already experienced by Central American countries, including Honduras and Nicaragua. In 2012, Honduras and Nicaragua accounted for some of Latin America’s lowest rates of Gross National Income per capita – at US$2,120 and US$1,650 respectively. Additionally, both countries experience some of the highest rates of poverty in the region. In Honduras, 60 percent of the country’s population of 7.9 million citizens lived below the poverty line in 2010, a worrying figure as it represents an increase from the four previous years. In Nicaragua, while the situation has improved recently, approximately 42 percent of the country’s 5.9 million inhabitants still live below the poverty line and one out of every seven live in extreme poverty. In socio-economic contexts such as those of Honduras and Nicaragua, the negative impacts of catastrophic events can have particularly extreme effects on the poor, who are the least able to cope with reduced access to and quality of public services resulting from limited budgets and higher public debt levels incurred and transferred onto future generations. The adverse impacts of disasters can also be disproportionate by gender. Oftentimes, women experience higher rates than men of mortality, morbidity, and diminishment in their livelihoods post-disaster.2 3. Between 1990 and 2008, the total damages and losses associated with large-scale natural events (e.g. earthquakes and hurricanes) in Central America were estimated at over US$21 billion3. While earthquakes are associated with the highest probable maximum loss per event, adverse hydro-meteorological events are by far the most frequent in Honduras and Nicaragua. From 1990 to 2012, it is estimated that annual economic losses due to weather-related disasters (e.g. hurricanes, tropical storms, floods and landslides) were equivalent to 2.8 percent and 1.8 percent of GDP for Honduras and Nicaragua respectively.4 4. Public sector assets in the health, education, water, transport, agricultural and infrastructure sectors as well as in housing often incur most of the damages associated with catastrophic events. Such events contributed to large fiscal deficits and debt accumulations 1 The macroeconomic situation in all Central American countries is currently precarious. Countries have seen rising external debt levels in the wake of the global economic crisis of 2007-08, with total external debt in Central America reaching an average value of 48%of GDP in 2012. 2 EAP DRM Knowledge Notes No. 24: Making women’s voices count in natural disaster programs in EAP. 3 EM-DAT. 4 According to the Global Climate Risk Index 2013 compiled by S. Harmeling and D. Eckstein for Germanwatch, the average annual economic losses due to weather related disasters as a percent of GDP in the period from 1990 to 2012 were Honduras (2.84%), Nicaragua (1.89%), El Salvador (0.91%), Guatemala (0.62%), Panama (0.05%), and Costa Rica (0.02%). 1 requiring public debt restructurings while at the same time limiting country abilities to finance risk reduction activities. In Nicaragua, the Managua earthquake (1972) generated damages and losses equivalent to 93 percent of GDP, while Hurricane Felix (2007) caused damages and losses equivalent to 14.4 percent of GDP5, heavy rains of 2007 in the north-western region and the 2011 Tropical Depression 12E eliminated 3 percent and 6.8 percent of GDP, respectively. In Honduras, Hurricane Mitch (1998) represented the worst disaster in the country’s recent history, affecting 90 percent of its territory, leading to over 5,700 deaths and 8,000 missing as well as displacing nearly half a million individuals. The overall damage amounted to 81 percent of GDP. Subsequent extreme meteorological events since Hurricane Mitch6 would suggest that Honduras’ disaster vulnerability is on the rise. Between 1980 and 2010, over 15,000 people were killed and over 4 million were affected by disasters, while economic damage amounted to US$4.5 billion7. B. Sectoral and Institutional Context 5. Over the past few decades, Honduras and Nicaragua have made significant institutional and programmatic advances to improve their disaster risk management capabilities and capacities.8 Both countries have passed legislation, developed policies, and created institutions to enable more efficient emergency management, while procedures are currently in place to help provide early warnings to citizens prior to when a disaster strikes. As a result, fewer lives are lost today per hazard event than in past decades9. Efforts are also underway to increase national capacities to model risk, forecast potential disasters and utilize hazard data to inform public planning and development processes. 6. Nevertheless, Honduras and Nicaragua remain fiscally vulnerable to disasters. Disaster losses and damages continue to be associated with large fiscal costs and represent a significant and explicit contingent liability for these two countries and their national budgets. The economic costs of disasters continue to rise due to the high level of exposure to risk and inadequate integration of disaster risk management in private and public decision-making. The limited ability of Honduras and Nicaragua to absorb fiscal shocks associated with natural hazard impacts is related to restricted capacity for external borrowing as well as limited use of financial tools to manage fiscal volatilities. A summary of current Inter-American Development Bank (IDB) and World Bank Group (WBG) development projects which provide immediate financial liquidity in a disaster’s aftermath is summarized in Table 2.1 in Annex 2. 7. Honduras and Nicaragua would therefore benefit from applying a comprehensive budget protection strategy against natural hazards to safeguard fiscal accounts and balances, while allowing for rapid resource mobilization in the wake of a disaster. Both countries could increase their disaster resilience by utilizing market based risk transfer instruments combined with other financial mechanisms. 5 Adjustments to the country program under the 2008-2012 WBG’s Country Partnership Strategy were required to accommodate government requests for assistance after Hurricane Felix (2007) 6 Source: Charles, Keren Carla. 2013. Fiscal Risks Related to Catastrophes in LAC. The World Bank Group (in press) 7 Emergency Events Database (EM-DAT): The OFDA/CRED International Disaster Database, Université Catholique de Louvain, Brussels, Belgium 8 References to specific World Bank-financed disaster risk management operations in Honduras and Nicaragua (including ongoing and past projects) can be found in section C 9 UNISDR Global Assessment Report 2011. 2 8. Catastrophe risk pooling at the regional level is a cost-efficient means to safeguard against extreme events – as it enables the aggregation of risk into larger, more diversified portfolios thereby resulting in more affordable premiums and wider access to international reinsurance and capital markets. Insurance would mobilize additional funds, which could contribute to the overall reduction of the gap between the contingent liability of Central American countries, including Honduras and Nicaragua, to natural catastrophes and the amount of readily available resources that can be mobilized following a natural catastrophe. Box 1: Detailed Description of the Caribbean Catastrophe Risk Insurance Facility (CCRIF) Established in 2007, CCRIF is the world’s first multi-country catastrophe risk pooling mechanism. Registered as an insurance company in the Cayman Islands, CCRIF is also the first facility to develop and successfully offer its members parametric insurance against tropical cyclones and earthquakes. Backed by both traditional reinsurance and capital markets, CCRIF functions as a joint reserve mechanism and enhances its members’ fiscal resilience to disasters triggered by natural events by providing a policy payout (in cash and within two weeks) in the event of a hurricane or earthquake of sufficient fiscal impact in line with pre-agreed fiscal trigger levels. CCRIF membership provides parametric insurance coverage, where payouts to countries are based on the modeled loss to a Government from an event for which the characteristics are independently and objectively measured. The estimated government fiscal loss is derived from a catastrophe risk model developed specifically for each country and operated by CCRIF. Since 2007, CCRIF has made eight payouts to its current members, and these have proven useful to manage budget volatility in the immediate aftermaths of a disaster. CCRIF currently comprises of 16 member states, namely: Anguilla, Antigua and Barbuda, the Bahamas, Barbados, Belize, Bermuda, Cayman Islands, Dominica, Grenada, Jamaica, Haiti, Saint Kitts and Nevis, Saint Lucia, Saint Vincent and the Grenadines, Trinidad and Tobago, and Turks and Caicos Islands. Since joining, all original 16 member states continue to pay annual premiums for tropical cyclone and earthquake coverage. 9. An example of regional risk pooling and transfer is the Caribbean Catastrophe Risk Insurance Facility (CCRIF), which has covered 16 countries of the Caribbean Community (CARICOM) with tropical cyclone (wind and storm surge) and earthquake risk insurance since 2007. A typical CCRIF policy in the Caribbean will cover 10-15 percent of expected government losses for disaster events that occur less than once every 20 years and provide the cheapest possible option for quick liquidity in the immediate aftermath of large disasters. Expanding the membership of the CCRIF to Honduras and Nicaragua – as well as other COSEFIN10 member countries as part of a regional risk pooling and transfer initiative – would provide greater diversification benefits, thereby enabling better access to reinsurance and capital markets. Such a partnership would therefore provide participating countries with strategic and more cost-effective fiscal protection from disasters and help maintain essential government services until additional resources become available. 10. In the context of the above, the proposed Project stems from an extensive history of World Bank support to Central American countries, including Honduras and Nicaragua, in disaster risk management (DRM) as well as from the Bank’s convening and financing support in the original establishment of the CCRIF. In Nicaragua, in the aftermath of Hurricane Mitch, 10 The Council of Ministers of Finance of Central America, Panama and the Dominican Republic (COSEFIN) is a regional body part of the Central America Integration System (SICA). The 7 current members of COSEFIN are: Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua, and Panama. 3 the World Bank supported the legal reforms for the establishment of the National System for DRM through the Natural Disaster Vulnerability Reduction Project (P064916). Following the devastation caused by Hurricane Felix (September 2007), the World Bank assisted Nicaragua with an Emergency Recovery Credit of US$17.0 million, later to be augmented with US$5.0 million in additional finance. In Honduras, the Natural Disaster Mitigation Project (P06491) was a pioneering operation that supported Honduras in its recovery from Hurricane Mitch, including the establishment of a formal DRM system in the country. Building upon the success of that Project (closed in 2010), the World Bank approved a new Disaster Risk Management Project in December 2012 (US$30 million in IDA resources).11 11. To safeguard against natural hazards, the Ministers of Finance of Honduras and Nicaragua have sought World Bank support to determine cheaper options for catastrophe risk insurance coverage in order to have access to quick liquidity following disaster events. In response to this request, and in partnership with the United States Department of Treasury (UST), the World Bank carried out analysis of various options to strengthen the fiscal resilience of Honduras and Nicaragua – along with other COSEFIN members – to catastrophic events and determined that joining the CCRIF was the best option in terms of costs and timing. For a detailed summary of this analysis as well as the benefits associated with pooling risk amongst the 16 existing CARICOM members, refer to Annex 6 for the Economic and Financial Analyses. COSEFIN countries, including Honduras and Nicaragua, subsequently sought World Bank support to enable COSEFIN membership in the CCRIF and expressed their strong interest in gaining coverage against excess rainfall. 12. Given the World Bank’s role in supporting CARICOM countries to successfully establish the CCRIF in 2007, its reputation of impartiality in international financial markets as well as its in-depth knowledge of Honduran and Nicaraguan DRM needs, the World Bank can play a catalytic role in supporting the fiscal resilience of Honduras and Nicaragua to disasters. For seven consecutive years, the CCRIF has worked with the World Bank in the execution of their risk transfer/reinsurance programs, using IBRD intermediation services to approach capital markets to further diversify its credit exposure as well as access non-traditional sources of risk capital. World Bank support could also potentially be used towards extending the tenure and quality of CCRIF’s products, thereby equating to more competitive pricing to client countries. In addition, experience acquired from advising Clients on Disaster Risk Financing and Insurance (DRFI)12 as well as establishing other regional risk pooling initiatives (e.g. the Pacific Catastrophe Risk Assessment and Financing Initiative), has provided the Bank with a wide spectrum of expertise to support legal, fiduciary, and catastrophe risk modeling and financing aspects of the initiative, including affordability and sustainability in the longer term. The World 11 While the new Project seeks to continue strengthening its capacity for integrated DRM at the municipal and national levels, the Project also aims to improve Honduras’ capacity to respond promptly and effectively to an eligible emergency, with US$10 million committed towards contingency. These operations have been complemented through technical assistance activities, which aim to increase awareness, knowledge and sense of empowerment amongst Hondurans in managing disaster risk. 12 To date, the Bank has supported the development of national DRFI strategies in countries such as Brazil, Colombia, India, Indonesia, Pakistan, Peru, Mexico, the Philippines and Vietnam. Given its in-depth knowledge of the client countries in Central America and the Caribbean, its relationship with donors and the reputation of impartiality in international financial markets, the World Bank can play a catalytic role in supporting the proposed Project. 4 Bank Treasury has also played a significant role in supporting the CCRIF as it negotiates on the private market. 13. The proposed Project is being prepared in parallel to the Central America and Caribbean Catastrophe Risk Insurance Project (P149670)13 to be financed by a Multi-Donor Trust Fund (MDTF), currently being established. IDA resources will be used to leverage donor contributions managed by the MDTF and implemented by CCRIF through the Central America and Caribbean Catastrophe Risk Insurance Project. IDA resources will support country entrance fees and premium payments and, while MDTF resources will finance CCRIF´s risk transfer and retention expenditures (reinsurance premiums/access to capital markets and payouts not covered by reinsurance contracts) associated with the catastrophe risk that CCRIF members have placed with the Facility for a period of four years. As a result of the two Projects, CCRIF will not only be able to offer cheaper catastrophe coverage options, but also build its capital for the sustainable continuation of its operations after the projects close. The MDTF will also support technical assistance to design national catastrophe risk financing strategies and strengthen transparency and accountability related to post-disaster budgetary management. More information on the Central America and Caribbean Catastrophe Risk Insurance Project and corresponding MDTF is provided in Annex 3. C. Higher Level Objectives to which the Project Contributes 14. In the higher-level strategic context, the proposed Project will work towards achieving the World Bank Group’s dual goals of ending extreme poverty and promoting shared prosperity. The proposed Project will support Honduras and Nicaragua achieve their priority of reducing and better managing the fiscal effects of catastrophic events arising from tropical cyclones, earthquakes, and excess rainfall. Budget shortfalls and competing demands on limited resources following a disaster leads to emergency budget reallocations at the expense of public and social service delivery to citizens. Such reallocations threaten long-term development agendas and disproportionately affect the most vulnerable populations. Strengthening the capacity of Ministries of Finance to fiscally manage disaster risk will safeguard efforts which work towards achieving the World Bank Group’s dual goals. 15. Additionally, the proposed Project will help Honduras and Nicaragua achieve their national priorities set out in the regional Central America Integration System (SICA) agreements reflected in the Comprehensive Central American Disaster Risk Management Policy (PCGIR). The Project is also consistent with the World Bank Group’s Country Partnership Strategy 2012-14 for Honduras14 and Country Partnership Strategy 2013-17 for Nicaragua15, in which DRM is a critical theme for both countries. 13 This project is under preparation and is expected to be approved by early May 2014. Financing for this operation would come from the proceeds of a Multi-Donor Trust Fund (MDTF) which is being established for this purpose. It is expected that initial contributions to the MDTF would amount to approximately US$ 60 million. 14 Report No. 63370-HN, discussed by the Board of Executive Directors on November 1, 2011 15 Report No. 69231-NI, discussed by the Board of Executive Directors on October 3, 2012 5 II. PROJECT DEVELOPMENT OBJECTIVES A. PDO 16. The Project Development Objective is to enable the access of Honduras and Nicaragua to efficient sovereign risk insurance associated with tropical cyclones, earthquakes, and/or excess rainfall. This will be achieved by financing the entrance fee and insurance premium for Honduras for seven years and Nicaragua for four years in a regional initiative linking current CARICOM members of the CCRIF together with COSEFIN countries. To extend the timeline of the proposed Project, individual countries may choose to pay a portion of the annual premium, thereby allowing remaining project finance to be used towards additional years of insurance premium payments. B. Project Beneficiaries 17. Direct project beneficiaries include the governments of Honduras and Nicaragua, which will be better able to respond to the initial needs of populations affected by adverse catastrophic events. The proposed Project would reduce the likelihood of governments having to interrupt or cancel other public and social services, such as those related to health and education, in order to finance their disaster response. Indirect project beneficiaries include the people of Honduras and Nicaragua who will benefit from the enhanced resilience of their respective governments to withstand catastrophic fiscal shocks, thereby better enabling appropriate response and continued service delivery in the aftermath of a disaster. As women oftentimes experience higher rates than men of mortality, morbidity and diminishment in their livelihoods post-disaster, the proposed Project would have significantly positive impacts on women. C. PDO Level Results Indicators 18. The PDO level result indicator is linked to coverage: Honduras and Nicaragua as members of CCRIF are eligible for catastrophe risk coverage and have received payment in the case of a covered (insured) event. III. PROJECT DESCRIPTION A. Project Components 19. The Project will finance the entrance fee and the annual insurance premiums necessary for Honduras (for seven years) and Nicaragua (for four years) to participate in the CCRIF. In the event that individual countries choose to pay a portion of the annual premium payment, remaining project finance would be used towards additional years of insurance premium payments. Project components have been designed in the context of the broader Central America and Caribbean Catastrophe Risk Insurance Project (P149670) and fully complement its objectives and activities. 6 Component 1: Payment of the entrance fee to the CCRIF for Honduras and Nicaragua (US$ 4.5 million) 20. The objective of this Component is to assist Honduras and Nicaragua to join the CCRIF by financing their entrance fees. This fee is equivalent to the first year’s insurance premium for each of the two participating countries, which is estimated to be US$ 1.5 million for Honduras and US$ 3.0 million for Nicaragua. Component 2: Payment of annual insurance premium to the CCRIF for Honduras and Nicaragua (US$ 19.5 million) 21. The objective of this Component is to assist Honduras and Nicaragua to purchase the catastrophe insurance coverage offered by the CCRIF for seven years for Honduras and four years for Nicaragua. Annual insurance premiums will be financed on a decreasing basis for Nicaragua in the final two years. Risk coverage could be associated with tropical cyclone (wind and storm surge) and/or earthquake risk in the first years. Upon availability of an additional excess rainfall product offered by CCRIF, financing may also be used towards coverage against excess rainfall. Every year, Honduras and Nicaragua will have the choice of selecting the amount of insurance coverage per peril, depending on country risk profile and priority needs. B. Project Financing 22. The proposed Project will be financed by two IDA credits for a total amount of SDR 15.6 million (US$ 24.0 million equivalent), including Regional IDA financing in the amount of SDR 10.4 million (US$ 16.0 million equivalent) and national IDA (IDA recommitted as a Credit) in the amount of SDR 5.2 million (US$ 8 million equivalent). The national IDA allocation for Honduras will come from the cancellation of US$ 4 million equivalent from Component 5: Contingency Emergency Response Component – CERC of the Honduras Disaster Risk Management Project (P131094). The national IDA allocation for Nicaragua will come from the cancellation of US$ 4 million equivalent from Component 5: Contingency Emergency Response Component – CERC of the Nicaragua Second Land Administration Project (P121152). Project costs are shown in Table 1. Table 1: Project Costs by Country and Component Honduras Nicaragua Project Components Project cost IDA Financing % Financing Project cost IDA Financing % Financing 1. Payment of the entrance fee to the US$ 1.5 million US$ 1.5 million 100% US$ 3.0 million U$ 3.0 million 100% CCRIF for Honduras and Nicaragua 2. Payment of annual insurance premium US$ 10.5 million US$ 10.5 million 100% US$ 9.0 million US$ 9.0 million 100% for Honduras and Nicaragua Total Project Costs US$ 12.0 million US$ 12.0 million 100% US$ 12.0 million US$ 12.0 million 100% Interest During Implementation Front-End Fees Total Financing Required US$ 12.0 million US$ 12.0 million 100% US$ 12.0 million US$ 12.0 million 100% 7 23. Regional IDA resources have been secured as the proposed Project is fully aligned with Regional IDA objectives as follows: i. By working with other COSEFIN countries through CCRIF and by collaborating inter- regionally with CARICOM members,16 Honduras and Nicaragua could increase insurance coverage per premium dollar by up to 50 percent, compared to acting individually: Honduras and Nicaragua would benefit from joining CCRIF by gaining increased coverage per dollar of premium, derived from the benefits of distributing risk across a geographically diverse portfolio of multiple non-correlated perils, and from structuring a better-defined and larger risk portfolio to take to the global reinsurance or capital markets. The more countries that join the COSEFIN risk pool, the larger the increase in coverage for the same premium amount. In addition, establishing a catastrophic risk facility for COSEFIN countries would not be as efficient as joining CARICOM countries in CCRIF, which would allow to share operating cost and benefits from CCRIF’s extensive experience working as a regional insurance entity, helping guarantee the quality of service required by new members. ii. Benefits will spill over country boundaries: Catastrophe risk bundling both intra and inter- regional creates financial benefits that would be shared between COSEFIN and current CCRIF member countries, including five IDA CARICOM countries currently members of CCRIF, resulting in a win-win situation for all parties. iii. Evidence of country and regional ownership: Regional and country ownership is evidenced by the high-level dialogue led by the COSEFIN group of ministers and the COSEFIN secretariat, putting the CCRIF initiative as priority in the quarterly meetings during the last year. The individual commitment letters sent by the six COSEFIN countries, including Honduras and Nicaragua, to express their interest in joining the Facility further evidence country ownership. Confirmation by the CCRIF’s board to enable the establishment of a segregated cell company further demonstrates the CCRIF’s commitment to allow COSEFIN countries to become partners. iv. Provides a platform for a high level of policy harmonization between countries, increases regional cooperation and collaboration: A partnership through CCRIF can further solidify an existing cooperation agreement in the field of disaster risk management among CARICOM and SICA.17 Additionally, such a partnership could also strengthen diplomatic and economic engagement among the countries of the region at a time when countries in Central America and the Caribbean are seeking new economic opportunities and markets. 16 The proposed Project will enable the CCRIF to expand its membership base. While the proposed Project will only finance entrance fees and annual premium payments for Honduras and Nicaragua, this initiative is part of a wider initiative aiming to join 23 countries regionally, which include CCRIF’s current 16 members, as well as up to 7 COSEFIN countries. 17 Both SICA and CARICOM have begun efforts to increase cross-regional cooperation as demonstrated by the SICA- CARICOM Summits. During the Third CARICOM-SICA Summit (San Salvador, August 2011), the Joint Declaration following the Third CARICOM-SICA Summit of Heads of State and Government was signed, which (amongst other commitments), aims to “Strengthen cooperation and complementary actions in the areas of integrated disaster risk management and climate change, within the framework of existing international and regional mechanisms that address the impact of natural disasters, given the vulnerability of both subregions.” 8 C. Lessons Learned and Reflected in the Project Design 24. Lessons learned from the initial establishment of the CCRIF, including the Caribbean Catastrophe Risk Insurance Project (P108058) and the Organization of Eastern Caribbean States (OECS) and Haiti Catastrophe Insurance Projects (P094539 and P104690), have been integrated in the proposed Project. The experience of establishing the Pacific Catastrophe Risk Insurance Project (P133255) as well as lessons learned from the IDA 16 Mid-Term Review have also been accounted for in project design. The Caribbean Catastrophe Risk Insurance Project closed in January 2012 and was subsequently assessed by both World Bank Management and the Independent Evaluation Group to have been Highly Satisfactory. The following lessons have been accounted for in project design. 25. Using IDA resources for targeted and limited subsidies can help countries establish lasting insurance programs such as the CCRIF. The OECS Catastrophe Risk Insurance Project, which used National and Regional IDA financing to cover the cost of entrance fees and insurance premiums for the first three to four years of the operation of the CCRIF, proved to be successful in that it made CCRIF coverage affordable to OECS countries, enabled them to experience the use of the instrument (two of the four countries had insurance pay-outs during the project), which then led to the countries internalizing the premium cost in their annual budget decision making processes and continue membership following project closing. The IDA finance also served to deepen the Bank’s dialogue with the four countries on their DRM and climate adaptation strategies. 26. In addition, in an effort to reflect general lessons learned from past regional IDA projects, project design has been simplified to the extent possible to ensure flexibility to provide CCRIF members with the most timely and cost-effective coverage options according with their risk profile and financial possibilities. The task team has further committed significant front-end time to preparation work meant to pragmatically address potential procurement and project management bottlenecks prior to project launch. 27. In order to ensure the effective utilization of the DRFI provided by the CCRIF, the instrument should be embedded in a broader DRFI strategy. In particular, it is important that when a payout occurs, the mechanisms and institutions are in place to ensure that the funds received are effectively utilized along with other risk financing instruments, such as reserve funds, contingent credit and budget allocations. Since this Project forms part of a wider engagement on DRFI and DRM with both countries, the Bank is in a position to provide significant technical assistance to each government throughout project implementation. 28. Monitoring and evaluation (M&E) systems should be designed to better capture project results, notably outcomes, and build-in stakeholder assessments. Experience with the first MDTF that supported the CCRIF showed the value of designing an M&E framework to better capture project results, notably outcomes, and build in stakeholder assessments. 9 IV. IMPLEMENTATION A. Institutional and Implementation Arrangements 29. The proposed Project will disburse IDA financing to the CCRIF at the request of the Ministries of Finance of Honduras and Nicaragua. The credit proceeds will be transferred on an annual basis as a direct payment from Honduras and Nicaragua’s respective credit accounts at the World Bank to the Facility’s account at the request of each country’s Ministry of Finance. After the approval and declaration of effectiveness of the proposed Project, each country’s Ministry of Finance will submit a withdrawal application for the value of the entrance fee and the first-year premium to join the CCRIF and obtain coverage for the full year (from June 1 to May 31). Every April, the participating countries negotiate their individual insurance policies with the CCRIF. Signature of the policy and payment of the annual premium to the Facility will need to be made annually by the end of May. The disbursement of approximately 75% of the total amount of each credit is conditional to the signing of the annual Insurance Agreements between CCRIF and each of the Recipients. 30. The CCRIF will conduct its operations in line with a detailed Operations Manual, which is subject to annual review and amendment by the CCRIF Board as necessary. The Bank approved the first version of the Operations Manual and subsequent amendments made to it between 2007 and 2012 under the first CCRIF Project (P108058). The current Operations Manual and Business Plan will be updated to reflect the entrance of new member countries and the change of the CCRIF’s legal status to a segregated portfolio company. Any amendments to the operations manual within the duration of the Project will require World Bank clearance. 31. Project implementation teams will be identified within the Ministries of Finance of Honduras and Nicaragua to foster the ownership and understanding of CCRIF activities at the country level. These teams will be responsible for monitoring the Project as well as serve as the main interlocutors with the CCRIF and the World Bank in relation to Project implementation. 32. The proposed Project will be implemented in parallel to the Central America and Caribbean Catastrophe Risk Insurance Project (P149670) and corresponding MDTF18. Under such an arrangement, IDA resources will be used to guarantee the membership of Honduras and Nicaragua in the CCRIF and will leverage donor resources to help build the needed reserves at an accelerated pace as well as ensure cheaper premium payments shared by all participating countries in the Central America and Caribbean region. Contributions to the MDTF have already been secured, from the Department of Foreign Affairs, Trade and Development of Canada (DFATD); Ministry of Finance and Public Credit of Mexico; and the United States Agency for International Development (USAID), while other donors have expressed interest. Donor contributions will be used towards financing CCRIF’s transfer of part of its members’ catastrophe risk to reinsurance and capital markets and finance insurance payouts to its members not covered by the insurance contracts, technical assistance to build national risk financing capacity and analysis related to the launch of the new excess rainfall product. 18 This MDTF is currently under preparation. It is expected that initial contributions to the MDTF would amount to approximately US$ 60 to 160 million. 10 B. Results Monitoring and Evaluation 33. M&E of the proposed Project will be conducted on a biannual basis in line with standard Bank reporting procedures. The project will meet its development objectives if the participating countries benefit from catastrophe insurance coverage for the period of the project. On an annual basis, the World Bank will liaise with the participating Ministries of Finance and the CCRIF to ensure that the premium payment has been made on time and that each country has its selected risks covered by the Facility. World Bank will conduct implementation support missions to benefited countries as well as to CCRIF implementing agents throughout the duration of the Project. CCRIF biannual reports would be used for M&E. Findings from M&E activities will be duly reflected in Implementation Status and Results Reports and the project Implementation Completion Report. C. Sustainability 34. The sustainability of the Project depends on both the CCRIF’s continuous operation and on the participating countries’ continued ability to buy insurance coverage annually. Both factors depend on the CCRIF’s capacity to cover payouts to its members for eligible disasters without having to deplete its financial reserves and its capacity to attract and sustain business. Additionally, the countries’ willingness to continue purchasing insurance coverage annually after the Project closes depends on their respective understanding of the parametric insurance instrument and the added value it provides for their DRFI strategy, as well as on their general fiscal situation. Experiences from the first CCRIF projects have underlined the importance of continued technical assistance to Ministries of Finance to help them assess and improve the value of CCRIF membership in the context of their countries disaster risk financing needs. 35. The CCRIF has proven to be robust with seven years of demonstrated experience in successfully securing reinsurance contracts and making timely payouts to participating countries in the event of an eligible catastrophe. At the end of its last fiscal year (May 31, 2013), the CCRIF’s externally audited financial statements showed assets of US$125.1 million, while confirming the CCRIF has followed standard commercial practices and transparent audit reports. For its fiscal year 2013-2014 (beginning June 1, 2013), the CCRIF retained US$27.5 million of risk and reinsured an additional US$107.5 million, giving it the capacity to make payouts arising from a series of catastrophic events having a modeled probability of occurring only once in every 536 years without drawing on more than US$27.5 million of its own assets. 36. On the demand side, the CCRIF has established trust and loyalty amongst its current members as a result of its consistent track record of rapidly disbursing payouts in the wake of catastrophic events. Although some of the original CCRIF members in the Caribbean initially needed concessional finance to pay their entrance fee and annual premiums, all 16 states have renewed their insurance policies annually and even gradually increased their respective amounts of coverage since 2007. This is largely a result of their positive experience and the added value seen in participating in the CCRIF. In addition, while donor finance was also initially utilized to establish the CCRIF, the Facility has since then become self-sufficient and operates purely on its net underwriting and investment income. 11 37. Both Honduras and Nicaragua, together with four other COSEFIN countries, have expressed their strong intention of joining the CCRIF as demonstrated in Letters of Commitment signed by each Minister of Finance. And as early analysis has shown that pooling risk amongst Central American and Caribbean states will not only result in lower premiums and cost-savings associated with efficiency gains, but also improve access to international reinsurance and capital markets as well as increase regional cooperation and collaboration between member countries, significant monetary incentives exist to maintain CCRIF membership. In addition, to encourage continuous participation, CCRIF country members are required to pay an entrance fee, which will automatically be applied to one further year of coverage should a country decide to leave the Facility. The entry fee is nonrefundable and is equal to the annual insurance premium. Nevertheless, potential exists whereby participating countries may choose to exit the CCRIF. To mitigate against such risk, the Bank will implement technical assistance as a means to raise awareness amongst governments and incentivize continued coverage. 38. Complementary technical assistance activities will be financed by an MDTF specifically established to support the expansion of CCRIF membership to Central America as well as enhance government capacity to pursue more comprehensive DRFI initiatives. In addition, the Central American and Caribbean Catastrophe Risk Insurance Project (P149670) will also contribute towards the CCRIF reserves and capitalization of a Central American cell, which will work towards more competitively priced coverage options and lead to reduced premiums for all members, including Honduras and Nicaragua. V. KEY RISKS AND MITIGATION MEASURES A. Risk Ratings Summary Table Rating Stakeholder Risk L Implementing Agency Risk - Capacity L - Governance L Project Risk - Design M - Social and Environmental L - Project and Donor L - Delivery Monitoring and Sustainability M - Timeliness of the effectiveness of the credit M Overall Implementation Risk M B. Overall Risk Rating Explanation 39. The implementation of the overall Project is subject to Moderate Risks, due to challenges that may derive from Project design and the ability of Honduras and Nicaragua to continue as CCRIF members after project closing. Potential risks are summarized in the Operational Risk Assessment Framework included in Annex 4. 12 40. Moderate design risks result from CCRIF’s use of a modeled loss parametric coverage. In a modeled loss parametric coverage a country receives insurance payout on the basis of surpassing of the modeled losses associated with objectively verifiable physical parameters. There is no on the ground verification of losses before insurance payout. The modeled loss approach follows industry standard models and service delivery and enables CCRIF to keep its operating costs to a minimum as well as make insurance payouts within two weeks of a triggering event. However, the approach also means that there may be a difference between the modeled loss and the actual loss, which in the insurance industry is referred to as basis risk. The existence of basis risk does not, however, imply a pricing risk for the countries, as they objectively get everything they pay for. Basis risk implies a risk financing strategy risk for the countries because they could be receiving payouts above or below their actual losses. Design risks will be mitigated through technical assistance to provide Ministries of Finance/Governments with a better understanding of risk models and premium policies. 41. Moderate risks also exist with relation to non-renewal of CCRIF membership by Honduras and Nicaragua. To better ensure that Honduras and Nicaragua can afford premium payments, both countries will be supported by national and regional IDA resources to finance the entrance fee and initial insurance premiums to join the CCRIF. Through their initial participation and continued awareness-raising by the CCRIF, it is expected that governments will become more conscious of the benefits of such coverage – thereby helping to ensure long-term membership in the CCRIF and sustainability of the Project. Such an outcome has been demonstrated through the experience of the 16 original members of CCRIF, which have continued to pay their annual premiums for seven years. Risks associated with timeliness of the effectiveness of the credit have further been rated as Moderate due to potential implementation delays associated with internal government processing procedure. VI. APPRAISAL SUMMARY A. Economic and Financial Analyses 42. Disasters resulting from natural events represent a significant contingent liability (both explicit and implicit) for Honduras and Nicaragua and are often associated with large fiscal consequences. As country legal frameworks often fail to define the financial responsibility of the government in case of a disaster, its contingent liability is usually implicit. A government therefore serves as a (re)insurer of last resort, with limited knowledge of its exact level of disaster risk exposure. The ability to quantify potential losses from disasters as well as the cost associated with public interventions for recovery and reconstruction activities can help a government ascertain its contingent liabilities. Sovereign disaster risk financing and insurance can prevent against sudden macroeconomic shocks that negatively impact fiscal performance and country’s long-term economic development. 43. Catastrophe risk pooling, at the regional or national level, aggregates risk into larger, more diversified portfolios, with participants benefitting from cost savings and access to international markets. The cost of risk transfer to international markets depends on many factors, including the riskiness of the portfolio as a fraction of the size of the portfolio. Pooling risks generate diversification benefits that are reflected in reduced insurance premiums. 13 44. When analyzing five options for catastrophe risk transfer, an analysis demonstrated that Honduras and Nicaragua could reduce the cost of catastrophe risk insurance by 27 percent when pooling their risk with other COSEFIN members compared to approaching the reinsurance market individually. In addition, placing the portfolio of catastrophe risk insurance policies of COSEFIN countries through CCRIF could result in a premium reduction equal to 44-45 percent of the indicative commercial premium – compared to transferring catastrophe risk individually. Following the same rationale, pooling excess rainfall risk amongst and between COSEFIN and CARICOM countries would demonstrate significant economic benefits. For the full Economic and Financial Analyses, refer to Annex 6. B. Technical 45. The proposed Project builds upon the CCRIF’s extensive experience working as a regional insurance entity to guarantee the quality of service required for new members. The CCRIF is licensed and operating – with institutional arrangements established, service providers in place, and parametric risk transfer instruments already active – which means that new members will benefit from the time-efficiency associated with joining a mechanism which is tried and tested. Legal and regulatory process for changing CCRIF’s corporate structure to accommodate segregated portfolios is well advanced and expected to be completed by June 1, 2014. 46. The CCRIF is an efficient means for its members to reduce their fiscal vulnerability to disasters. Technical strengths of the Project include the uniqueness and attractive pricing of the insurance products that the CCRIF is able to offer as a diversified risk pool, the importance of those products as a component of the broader DRM strategies of its member countries, and the rapidity of its payouts. In addition, its emphasis on capacity building and professional development, and partnerships with regional organizations are valuable for its members. 47. The CCRIF, through its products, services, and contacts, contributes to an increased awareness of the importance of DRM among key government officials in the region. Through their involvement with CCRIF, finance, economy and planning, disaster management, environment, and meteorological officials in the region gain a common understanding of the role that fiscal risk transfer can play in broader DRM strategies, and also benefit from greater interaction on these matters. This is a result of the CCRIF’s technical capacity as the first multi-country, multi-peril pooled catastrophe risk insurance facility in the world. C. Financial Management 48. Since financing of project activities would be paid directly by the World Bank to the CCRIF, the Project will require no specific financial management arrangements for the clients. The Project will only finance the countries’ entrance fee and premium to the CCRIF. No other expenditures are eligible under the Project. Financing of these activities will be done via direct payments made at the request of the Ministry of Finance from the countries’ respective credit accounts at the World Bank to the Facility account. Payments to the Facility will be made annually by end May. For details on fiduciary aspects of the Project, refer to Annex 3. 14 D. Procurement 49. IDA Funds are earmarked for direct payment to the CCRIF. Due to the particular nature of the Project, procurement of the insurance will be through direct contracting. No works, goods or consulting services will be procured under this Project. With regards to procurement of non-consulting services, the only contracts that will be financed by the proposed Project will be the Participation Agreements and the Insurance Agreements between Honduras and Nicaragua respectively, and the CCRIF for the provision of insurance services by the CCRIF. The selection of the CCRIF to provide the insurance coverage will be made on a single-source basis using a modified version of the direct contracting method prescribed by Bank procurement guidelines. This direct contracting of the CCRIF is justified on the grounds that the CCRIF is the only source of the specific insurance coverage that the Project is intended to finance. The overall project risk for procurement is Low. No Procurement Plan is necessary, neither is Procurement Supervision. E. Social (including Safeguards) 50. The proposed Project is expected to have positive indirect poverty and social impacts by enhancing the ability of the Honduran and Nicaraguan governments – as well as other current and new CCRIF members – to meet the needs of their most vulnerable population in the aftermath of a major disaster. Quick access to liquidity following a catastrophic event will enable governments to start recovery efforts quickly and reduce the governments’ risk of having to interrupt or cancel delivery of social services to its population. The security of post-disaster financing provided will support better contingency planning, and hence better targeting of affected populations after an event. 51. Project design draws on extended engagements and consultations with national governments, donors and development partners, as well as technical agencies involved in DRM and emergency response. A number of World Bank missions have been carried out to conduct high-level dialogues with national ministries as well as to receive feedback from stakeholders to ensure critical needs and concerns have been accounted for in project design. 52. As the proposed Project does not contemplate any direct physical investments, but rather will finance entrance fees and annual insurance payments to the CCRIF for Honduras and Nicaragua, no social safeguards policies will be triggered by the Project. The insurance funds will not be tied or tracked to any specific investments, and as a result would not have any safeguards implications. F. Environment (including Safeguards) 53. As the proposed Project does not contemplate any direct physical investments, but rather will finance entrance fees and annual insurance payments to the CCRIF for Honduras and Nicaragua, no environmental safeguards policies will be triggered by the Project. The insurance funds will not be tied or tracked to any specific investments, and as a result would not have any safeguards implications. The proposed Project is therefore categorized as Category C. 15 Annex 1: Results Framework and Monitoring Countries: Honduras and Nicaragua Project Name: Catastrophe Risk Insurance Project (P149895) Project Development Objective (PDO): The Project Development Objective is to enable the access of Honduras and Nicaragua to efficient sovereign risk insurance associated with tropical cyclones, earthquakes, and/or excess rainfall. Target Values Responsibility Description Core PDO Level Results Unit of Data Source/ Baseline Frequency for Data (indicator Indicators Measure YR 1 YR 2 YR3 YR4 YR5 YR6 YR7 Methodology Collection definition etc.) Honduras and Percentage No 100 100 100 100 100 100 100 Annual CCRIF CCRIF Percentage of Nicaragua as members catastroph Annual policy-triggering of CCRIF are eligible e risk progress disaster events for for catastrophe risk coverage report which CCRIF has coverage and have provided payouts received payment within a month of within a month of the the occurrence in occurrence of a accordance with covered (insured) event policy terms every year (by peril) Intermediate Results Indicators Policies provide Yes/No Insurance Y Y Y Y Y Y Annual CCRIF CCRIF The attachment increasing insurance coverage Baseli Annual point (insurance coverage and/or lower and ne progress deductible) is the attachment point attachmen report value at which an (insurance deductible) t point for insurance payout for a given premium insurance is triggered and amount premium the coverage is the purchased maximum payout in Year 1 for a given peril during the policy period. CCRIF premiums for Yes/No Y Y Y Y Y Y Y Y Annual Annual CCRIF Percentage Honduras and progress savings, defined Nicaragua are lower report as (Simulated than the simulated individual market price for a comparable price - CCRIF coverage purchased price)/ Simulated individually in the individual market market price*100, are at least x% (TBD by June 15, 2014) 16 Annex 2: Detailed Project Description HONDURAS AND NICARAGUA: CATASTROPHE RISK INSURANCE PROJECT 1. Over the past few decades, Honduras and Nicaragua have made significant institutional and programmatic advances to improve their disaster risk management (DRM) capabilities and capacities.19 Both countries have passed legislation, developed policies, and created institutions to enable more efficient emergency management, while procedures are currently in place to help provide early warnings to citizens prior to when a disaster strikes. As a result, fewer lives are lost today per hazard event than in past decades20. Efforts are also underway to increase national capacities to model risk, forecast potential disasters and utilize hazard data to inform public planning and development processes. In addition, both countries, through the XXXV Council of Presidents of the Central America Integration System (SICA) approved an ambitious program titled Comprehensive Central American Disaster Risk Management Policy (Política Centroamericana de Gestión Integral del Riesgo, PCGIR) on June 30, 2010. The program, adopted by the participating countries, calls for the integration of DRM and climate adaptation into economic, social, and environmental regional policy frameworks. The PCGIR policy further commits SICA to invest in fiscal protection against disasters through insurance mechanisms, promoting the creation of products and frameworks of subsidiary protection that cover social groups traditionally considered "non-insurable". 2. Nevertheless, Honduras and Nicaragua remain fiscally vulnerable to disasters. Disaster losses and damages continue to be associated with large fiscal costs and represent a significant and explicit contingent liability for these two countries and their national budgets. The economic costs of disasters continue to rise due to the high level of exposure to risk and inadequate degrees of incorporating DRM in private and public decision-making. The limited ability of Honduras and Nicaragua to absorb fiscal shocks associated with natural hazard impacts is related to restricted capacity for external borrowing as well as limited use of financial tools to manage fiscal volatilities. Such a trend is common throughout the region. In Central America, while countries maintain a degree of borrowing capacity for reconstruction purposes, the instruments currently utilized have not added up to a strategic set of fiscal safeguards against catastrophes. Disaster response frameworks continue to rely heavily on ad hoc budget reallocations (which interrupt delivery of public and social services), emergency calls upon donors for assistance, and on simply failing to replace or repair damaged capital stock. 3. Honduras and Nicaragua would therefore benefit from applying a comprehensive budget protection strategy against natural hazards to safeguard fiscal accounts and balances, while allowing for rapid resource mobilization in the wake of a disaster. A summary of current Inter-American Development Bank (IDB) and World Bank Group (WBG) development projects which provide immediate financial liquidity in a disaster’s aftermath is summarized in Table 2.1. These instruments build on the flexibility provided by both Banks’ emergency lending procedures, which permit rapid restructuring of project portfolios to meet emergency financing needs as well as the use of simplified procedures to execute emergency response. Nevertheless, both countries could increase their disaster resilience by utilizing these instruments with other financial mechanisms. Pursuing a risk-layering approach could involve combining the following instruments: (i) budget 19 References to specific World Bank-financed disaster risk management operations in Honduras and Nicaragua (including ongoing and past projects) can be found in section C 20 UNISDR Global Assessment Report 2011. 17 allocations and reserves for disaster events that occur frequently but have a minor impact (e.g. localized floods); (ii) use of contingent credits for medium-impact events that occur less frequently (e.g. tropical depressions, minor earthquakes); and (iii) risk transfer instruments such as parametric insurance to protect against less-frequent, high-impact events (e.g. major earthquakes, tropical cyclones).21 Spreading catastrophe risk across countries and regionally can also be considered an instrument of a wider disaster risk finance and insurance (DRFI) strategy. Table 2.1: Select Development Projects involving Contingency Resources for Disaster Honduras Operations Involving Disaster Risk Project Type Amount ($) Management (DRM) Contingent Loan for Natural Disaster IDB Loan 100m Emergencies Disaster Risk Management Project Contingent Component of a World Bank DRM Project 10m IRM Component of a WBG Social Development 0m Safer Municipalities Project Project IRM Component of a WBG Social Development 0m Social Protection Project Project Second Road Rehabilitation and Improvement IRM Component of a WBG Transport Project 0m Project Water and Sanitation Project IRM Component of a WBG W&S Project 0m Nicaragua MDB Operation Involving DRM Project Type Amount ($) Contingent Loan for Natural Disaster Emergencies IDB Loan 186m Contingent Component of a WBG Rural Development 8m Second Land Administration Project Project Fifth Roads Rehabilitation and Maintenance IRM Component of a WBG Transport Project 0m Project Second Rural Water Supply and Sanitation Project IRM Component of a WBG W&S Project 0m * IRM – Immediate Response Mechanism: Introduced in December 2011, the Immediate Response Mechanism (IRM) is an instrument included in IDA projects which allows borrowing countries to rapidly access up to 5 percent of their undisbursed IDA investment project balances following a crisis. The IRM complements longer-term emergency response tools available to IDA countries (e.g. Crisis Response Window), offering them financial support within weeks rather than months after an emergency. IRMs oftentimes exist as a window with zero dollars allocated and stand ready to receive a rapid reallocation of funds – without requiring prior project restructuring. * Contingent Component: A contingent emergency financing component is oftentimes included within a standard investment project to provide resources for an immediate response to an eligible emergency. Contingent components exist to finance public and private sector expenditures on a positive list of goods, both domestic and imported, and/or specific works, goods, services and emergency operation costs required for a borrowing country’s emergency recovery. 4. While fiscal protection against catastrophic events has received significant political support and is a necessary element of ensuring disaster resilience, Honduras and Nicaragua are still unable to access international reinsurance markets to reduce their fiscal vulnerabilities to disasters. The benefit of insurance stems from the ability to mobilize additional capital from outside the country, which could complement in-country multilateral finances rapidly reallocated from other development goals (e.g. through existing contingent loans and IRM mechanisms). 5. Catastrophe risk pooling at the regional level can be considered a cost-efficient means to safeguard against extreme events – as it enables the aggregation of risk into larger, more diversified portfolios thereby resulting in more affordable premiums and wider access to international reinsurance and capital markets. Insurance would mobilize additional funds, which could contribute to the overall reduction of the gap between the contingent liability of Central American countries, including Honduras and Nicaragua, to natural catastrophes and the amount of 21 See Annex 2 of the Project Appraisal Document (PAD) for the proposed Central America and Caribbean Catastrophe Risk Insurance Project (P149670) for more information on risk-layering disaster risk finance and insurance strategies. 18 readily available resources that can be mobilized following a natural catastrophe. Effectively transferring part of their disaster risk to capital and reinsurance markets would help solve a significant portion of Honduran and Nicaraguan immediate liquidity needs in the aftermath of a disaster. Engaging private capital and reinsurance markets could further help influence wider decision-making involving national emergency budget allocation and fiscal planning systems so as to be more disaster resilient. 6. An example of regional risk pooling and transfer is the Caribbean Catastrophe Risk Insurance Facility (CCRIF), which has covered 16 countries of the Caribbean Community (CARICOM) with tropical cyclone (wind and storm surge) and earthquake risk insurance since 2007. CCRIF is the first multi-country catastrophe risk pooling and financing facility that transfers partial sovereign disaster risk to the international reinsurance market and provides countries with much needed liquidity following disaster events (see Box 1). A typical CCRIF policy in the Caribbean will cover 10-15 percent of expected government losses for disaster events that occur less than once every 20 years and provide the cheapest possible option for quick liquidity in the immediate aftermath of large disasters. 7. As a risk aggregator, CCRIF provides insurance coverage to participating countries at a significantly lower cost than individual governments could obtain on their own, by enabling participating countries to pool their individual risks into a single, bigger and better diversified portfolio. CCRIF would seek to retain some of this risk through a buffer of reserve funds established with the assistance of donor partners. CCRIF will transfer the risks it cannot retain to the international financial markets. This will be done through reinsurance or through other fiscal coverage instruments (for example, catastrophe bonds). The accumulation of reserves over time should lessen CCRIF’s dependence on outside risk transfer, and smooth the catastrophe reinsurance underwriting cycle. 8. Following a request by COSEFIN Ministries of Finance to identify alternatives for catastrophe risk insurance pooling at the regional level, the World Bank – in partnership with the United States Department of Treasury – has identified the CCRIF as the best option. In the context of the broader Central American and Caribbean Catastrophe Risk Insurance Project (P149670), CCRIF will allow COSEFIN and CARICOM governments to purchase coverage akin to consequential loss insurance that would provide them with an immediate cash payment after the occurrence of a major earthquake, the passing of a hurricane or excess rainfall. Because of the speed at which a claim payment will be processed, the instrument will be particularly useful to finance the immediate post-disaster recovery, giving the affected government time to mobilize additional resources for longer-term reconstruction activities. Expanding the membership of the CCRIF to Honduras and Nicaragua – as well as other COSEFIN countries as part of a regional risk pooling and transfer initiative – would provide a strategic fiscal protection from disasters and help maintain essential government services until additional resources become available. 9. Insurance coverage will rely on parametric methods, which are a cost-effective way to finance any liquidity gap arising in the immediate aftermath of a disaster. CCRIF offers parametric insurance which disburses funds based on the occurrence of a pre-defined level of hazard and impact without having to wait for an on-site loss assessment. This feature is quite different from traditional indemnity-based insurance products in which claims are paid based on formal confirmation of the amount of a loss through on-site verification. Payouts will be calculated based on the modeled estimated fiscal impact of an adverse natural event. The estimated impact will 19 be derived from probabilistic catastrophe risk models developed specifically for the Facility. Participating countries will receive compensation depending on the level of coverage agreed upon in the insurance contract. For more information on parametric insurance offered by the CCRIF, refer to Box 2.1. (More details can be found in Annex 2 of the PAD for the Central America and Caribbean Catastrophe Risk Insurance Project – P149670). Box 2.1: Details of CCRIF Parametric Insurance Instrument Under the CCRIF parametric insurance instrument, payouts are made on the basis of exceeding a pre-established trigger event loss which is estimated in a model in which hazard inputs are generated (e.g. wind speed and storm surge in the case of tropical cyclones or ground shaking for earthquakes) from independently-provided input data (such as a tropical cyclone track or earthquake location/magnitude). These hazard levels are then applied to the pre-defined government exposure to produce a loss estimate. Payouts above the trigger level increase with the level of modeled loss, up to a pre-defined coverage limit. The use of parametric insurance brings important advantages. The selection of a parametric instrument as a basis for the CCRIF policies was largely driven by the fact that parametric insurance is generally less expensive than an equivalent traditional indemnity insurance product as it does not require a loss assessment procedure in case of a disaster. Parametric insurance also allows for claims to be settled quickly. This is an important feature considering the urgent need for liquidity after a catastrophe. In addition, the instrument is also less exposed to moral hazard and adverse selection problems (which are costly to monitor) because the cost of insurance can be immediately related to the probability of an event, and the payout is independent of any mitigation put in place after the policy is issued. The figure below details key concepts found under parametric insurance models. Payouts for earthquake would depend on the source magnitude and hypocenter (location and depth) of the earthquake using data obtained from the USGS. This is translated into a ground shaking intensity across each affected country, which in turn drives generation of a modeled loss. The payout increases as the level of losses increases, and losses are directly calculated from the amount of ground shaking in the affected country and what assets are exposed to what level of shaking. Payouts for hurricanes are determined based on government losses calculated using storm data from the National Hurricane Center and parameters fixed within the loss estimation model used to underpin CCRIF’s policies. The model calculates the level of wind and ocean hazards, such as storm surge, encountered across the affected area and use the pre-fixed value and distribution of government exposures to those hazards to calculate a government loss. 20 10. Through the activities planned under the Central America and Caribbean Catastrophe Risk Insurance Project, CCRIF will pool the hurricane and earthquake risk of participating COSEFIN member states in a segregated portfolio. This will allow for separation of risk management operations for COSEFIN countries (e.g. pricing, insurance policy format, reinsurance strategy) from those of Caribbean countries. The COSEFIN insurance pool will mimic the existing CARICOM portfolio within CCRIF, which provides parametric insurance for earthquake and hurricane coverage to CARICOM member countries. 11. CCRIF insured countries will pay an annual premium commensurate with their own specific risk exposure to tropical cyclones and earthquakes. Parametric insurance products will be priced for each country based on the individual country risk profile. Annual premiums will typically vary from US$200,000 to US$5 million, for coverage ranging from US$10 million to US$200 million. To encourage continuous participation, country members of the CCRIF will be required to pay an entrance fee, which will automatically be applied to one further year of coverage if a country should decide to leave the Facility. The entry fee is nonrefundable and is equal to the annual insurance premium. 12. In this context, the objective of the proposed Project is to enable the access of Honduras and Nicaragua to efficient sovereign risk insurance associated with tropical cyclones, earthquakes, and/or excess rainfall. This will be achieved by providing financing to allow participating countries to access regional risk insurance against tropical cyclones, earthquakes, and excess rainfall by joining the Caribbean Catastrophe Risk Insurance Facility (CCRIF) along with other Central American countries and the Dominican Republic (the COSEFIN countries) and purchase fiscal protection against tropical cyclones, earthquakes, and excess rainfall. Without this IDA credit, it is unlikely that Honduras and Nicaragua would be in a position to join this initiative with the other COSEFIN countries and obtain protection from the fiscal impact of disasters triggered by natural events. Through the Project, Honduras and Nicaragua will be able to obtain catastrophe insurance more efficiently and cheaply through CCRIF than through any other option available to them. 13. The Project will finance the entrance fee and the annual insurance premiums necessary for Honduras (for seven years) and Nicaragua (for four years) to participate in the CCRIF. The Project will include the following components, which are complementary to the objectives and activities of the Central America and Caribbean Catastrophe Risk Insurance Project: Component 1: Payment of the entrance fee to the CCRIF (US$ 4.5 million) 14. The objective of this Component is to assist Honduras and Nicaragua to join the CCRIF by financing their entrance fees. This fee is equivalent to the first year’s insurance premium for each of the two participating countries. Estimated entrance fees are detailed in Table 2.2. Table 2.2: Estimated Entrance Fees Countries Estimated Entrance Fee Honduras US$ 1.5 million Nicaragua US$ 3.0 million 21 Component 2: Payment of annual insurance premium to the CCRIF for Honduras and Nicaragua (US$ 19.5 million) 15. The objective of this Component is to assist Honduras and Nicaragua to purchase the catastrophe insurance coverage offered by the CCRIF for seven years for Honduras and four years for Nicaragua. Annual insurance premiums will be financed on a decreasing basis for Nicaragua in the final two years. Risk coverage could be associated with tropical cyclone (wind and storm surge) and/or earthquake risk in the first years. Upon availability of an additional excess rainfall product offered by CCRIF, financing may also be used towards coverage against excess rainfall. Every year, Honduras and Nicaragua will have the choice of selecting the amount of insurance coverage per peril, depending on country risk profile and priority needs. Table 2.3: Estimated Annual Insurance Premium Country Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Honduras Up to Up to Up to Up to Up to Up to Up to US$ 1.5 US$ 1.5 US$ 1.5 US$ 1.5 US$ 1.5 US$ 1.5 US$ 1.5 million million million million million million million (100%) (100%) (100%) (100%) (100%) (100%) (100%) Country Year 1 Year 2 Year 3 Year 4 Nicaragua Up to US$ 3 Up to US$ 3 Up to US$ 1.5 Up to US$ 1.5 million (100%) million (100%) million (50%) million (50%) 16. IDA financing will be provided in annual installments issued to CCRIF at the request of each country’s Ministry of Finance. The financing will be withdrawn by Honduras and Nicaragua from their respective credit accounts at the World Bank for direct payment into the Facility. After the approval and declaration of effectiveness of the proposed Project, the Facility will collect the entrance fee and first-year premium for each participating country. Policies are negotiated with members in April. Signature of the policy and payment of the premium are to be done before the end of May in order to obtain coverage during the full season (from June 1 to May 31 of each year). Payments to the Facility will therefore need to be made annually by the end of May. 22 Annex 3: Implementation Arrangements HONDURAS AND NICARAGUA: CATASTROPHE RISK INSURANCE PROJECT Project Institutional and Implementation Arrangements 1. While each country’s Ministry of Finance will be responsible for the management of this Project, no World Bank funds will flow directly into government accounts. The IDA financing will be provided to cover the entrance fee of both countries, as well as seven annual premiums for Honduras and four annual premiums for Nicaragua – issued directly to CCRIF at the request of the respective Ministry of Finance. After the approval and declaration of effectiveness of the proposed Project, each country’s Ministry of Finance will submit a withdrawal application for the value of the entrance fee and the first-year premium to join CCRIF and obtain coverage for the full year (from June 1 to May 31). Every April, the participating countries will negotiate their individual insurance policies with CCRIF. Signature of the policy and payment of the annual premium to the Facility will need to be made annually by the end of May. Since funds will not be channeled through the governments’ accounts, annual audits are not required for each individual country. Instead, audits of the CCRIF will be conducted on an annual basis. 2. CCRIF is domiciled in the Cayman Islands as a captive insurance company wholly owned by a START Trust established for the benefit of CCRIF members. It is regulated by the Cayman Islands Monetary Authority and governed by a Board of Directors. Reinforcing this governance structure are four Board Sub-committees: Audit and Risk Management, Risk Transfer and Underwriting, Investment Policy, and Technical Assistance. Figure 3.1 below details the Management Structure of CCRIF. Figure 3.1: Corporate Structure of the CCRIF 3. CCRIF conducts its operations in line with a detailed Operations Manual, which was approved by the Bank and is subject to annual review and amendment by the CCRIF Board 23 as necessary. The Bank approved the first version of the Operations Manual and subsequent amendments made to it between 2007 and 2012 under the first CCRIF Project (P108058). The current Operations Manual and Business Plan will be updated to reflect the entrance of new member countries and the change in CCRIF’s legal status to a segregated portfolio company. 4. CCRIF is restructuring itself as a Segregated Portfolio Company (SPC) under the laws of the Cayman Islands pertaining to captive insurance companies in order to, inter alia, manage COSEFIN risk effectively. It expects to complete the necessary documentation for this legal transformation by March-April 2014 and the transformation itself will take effect June 1, 2014. Once restructured as a SPC, CCRIF will be able establish a segregated portfolio (SP) for each of its business lines. Initially, CCRIF expects to establish SPs for: (i) tropical cyclone and earthquake risk in the Caribbean; and (ii) tropical cyclone and earthquake risk in the COSEFIN countries, including Honduras and Nicaragua.22 CCRIF will allocate a portion of its capital to underwrite risk in each SP, while also retaining a portion of its capital in the “core” SPC. An SPC structure has the effect of creating a “stop loss” for each business line because no SP has a legal right of automatic recourse to the capital of another, nor that of the core, in the event that payout obligations on the policies that it has written exceed its own capital and reinsurance lines. Thus, capital provided to underwrite risk in the Caribbean SPs will be shielded from losses associated with underwriting in the COSEFIN SP(s) and vice versa. CCRIF is considering whether establishing a third SP to combine both Caribbean and COSEFIN risk would, by virtue of the combination, have advantages in terms of securing reinsurance on better terms (although the Cayman regulatory regime does not yet allow such a vehicle to be formed). It is also considering whether excess rainfall risk should be held in SPs separate from the SPs that will hold the tropical cyclone and earthquake risk or managed within the same cells. The advantages of segregating risk in SPs must be balanced against the additional regulatory and audit fees and potentially higher reinsurance costs that would arise from such segregation. 5. The CCRIF SPC’s “core” Board of Directors will govern all of the SPs given that they are not separate legal entities. A figure of the CCRIF’s current board structure is included below (Figure 3.2). This said, as the assets of the COSEFIN SP(s) will be owned by a separate trust established for the benefit of those countries, it will be important to ensure that CCRIF’s COSEFIN members also have an appropriate voice in decisions pertaining to use of those assets. This issue is under review and the outcome will be influenced in part by the number of COSEFIN countries that join CCRIF and over what period of time. Initially, a management committee has been proposed to take decisions with independence, but within broad parameters established by the core Board, on matters pertaining to the segregated portfolios, such as strategic direction, policy parameters and pricing, risk transfer strategy, and the like. Members of this committee could be appointed by the Trustee of the COSEFIN Trust on instructions from an entity such as COSEFIN and by the CCRIF SPC Board of Directors, as it will be advisable for CCRIF’s CEO, Facility Supervisor, and one of the CCRIF SPC Directors also to be members of the committee, given that one of the primary objectives of the Central American countries and the Dominican Republic in associating themselves with CCRIF is to be able to benefit from CCRIF’s accumulated knowledge, expertise, and market and stakeholder relationships. 22 COSEFIN is the Council of Ministers of Finance of Central America, Panama, and the Dominican Republic. 24 Figure 3.2: Current Board Structure of the CCRIF Financial Management, Disbursements and Procurement Financial Management 6. Since all financing of project activities would be paid directly from the World Bank to the CCRIF, the Project will require no specific financial management arrangements for the clients. The Project will only finance the countries’ entrance fee and premiums to the CCRIF. No other expenditures are eligible under the Project. Financing of these activities will be done via direct payments made at the request of the Ministry of Finance from the countries’ respective credit accounts at the World Bank to the Facility account. Payments to the Facility will be made annually by end May. 7. Based on the above, many of the traditionally required financial management arrangements appear not to be relevant to the proposed project design. Since there is no direct involvement of a Project Coordination Unit or of the line ministries in the fiduciary aspects of project implementation, the need to use (and assess) their financial management systems and personnel is eliminated. 8. Similarly, annual audits are not required to be done by each individual country as the project funds will not be channeled through their governments’ accounts. Instead, the Facility will be subject to an annual audit by auditors acceptable to the World Bank. The audit costs will be covered by the CCRIF Trust Fund. The auditors’ terms of reference will be prepared by the Project and cleared by the World Bank before engagement of the auditor. The terms of reference will include both the audit of financial transactions and a review of the internal control mechanisms as well as any other required audits and/or assessments. The Annual audit reports will be prepared in a format in accordance with International Standards on Auditing and World Bank guidelines, and will include an opinion on the project financial statements, review of internal controls, a management letter, and any other required opinions. The Facility’s annual audit report will be required to be submitted to the World Bank for review no later than four months following the end of its fiscal year. 25 Disbursements 9. The credit proceeds will finance each country’s entrance fee to join CCRIF and the annual insurance premium for Honduras (for seven years) and for Nicaragua (for four years) of CCRIF membership. To request disbursement of the funds from the World Bank to CCRIF, each country’s Ministry of Finance will submit a withdrawal application following the instructions provided in the Disbursement Letter (Additional Instructions) for the value of the entrance fee and the annual insurance premium for the first year and for the value of the annual premium for the three subsequent years. Procurement 10. IDA Funds are earmarked for direct payment to the CCRIF. Due to the particular nature of the Project, procurement of the insurance will be through direct contracting. No works, goods or consulting services will be procured under this Project. With regards to procurement of non- consulting services, the only contracts that will be financed by the proposed Project will be the Participation Agreements and the Insurance Agreements between Honduras and Nicaragua respectively, and the CCRIF for the provision of insurance services by the CCRIF. The selection of the CCRIF to provide the insurance coverage will be made on a single-source basis using a modified version of the direct contracting method prescribed by the Bank’s “Guidelines: Procurement of Goods, Works, and Non-consulting services under IBRD Loans and Bank Credits & Grants”, dated January 2011. This direct contracting of the CCRIF is justified on the grounds that the CCRIF is the only source of the specific insurance coverage that the Project is intended to finance. 11. The overall project risk for procurement is Low. No Procurement Plan is necessary, neither is Procurement Supervision. Environmental and Social (including safeguards) 12. Project design draws from extended engagements and consultations with national governments, donors and development partners, as well as technical agencies involved in disaster risk management and emergency response. A number of World Bank missions have been carried out to conduct high-level dialogues with national ministries as well as to receive feedback from stakeholders to ensure critical needs and concerns have been accounted for in project design. 13. The proposed Project does not contemplate any direct physical investments, but rather will finance entrance fees and annual insurance payments for the participating countries to the CCRIF. The insurance funds will not be tied or tracked to any specific investments, and as a result would not have any safeguards implications. With regards environmental safeguards, the proposed Project is therefore categorized as Category C. Monitoring & Evaluation (M&E) 14. M&E of the Project will be conducted on an annual basis. The proposed Project aims to enable the access of the two participating countries to efficient sovereign risk insurance associated with catastrophic events resulting from tropical cyclones, earthquakes, and/or excess 26 rainfall by supporting them to access catastrophe risk insurance coverage through CCRIF. On an annual basis, the Bank will liaise with the participating Ministries of Finance and the CCRIF to ensure that the premium payment has been made on time and that each country has its selected risks covered by the Facility. Role of Partners 15. Donors will play an essential role in enabling Honduras and Nicaragua as well as other COSEFIN states to join the CCRIF in a similar fashion as when CARICOM countries established the CCRIF. Generous donor support enabled the CCRIF to build up its own reserves at an accelerated pace while financing initial operating expenditures and paying claims within its risk retention. These reserves will allow the Facility to retain some of the risk and dedicate a limited portion of the premium collected toward the purchase of reinsurance, giving it the opportunity to grow its reserves over time. The CCRIF’s financial stability and its capacity to attract and sustain business are the main factors that determine the sustainability of the proposed Project. 16. Based upon past experience and lessons learned during the initial creation of the CCRIF, the World Bank is establishing a Multi-Donor Trust Fund (MDTF) to facilitate the channeling of funds between donors and the proposed Program. Through the Central America and Caribbean Catastrophe Risk Insurance Project (P149670), a Grant Agreement will be signed between the World Bank and the CCRIF in the amount of donor pledges received and used towards the financing of reinsurance premiums and payouts within CCRIF risk retention. Under Component 1 of the MDTF, the CCRIF will pool the earthquake risk of participating COSEFIN member states in a segregated portfolio. Component 2 will finance climate risk insurance (including tropical cyclone and/or excess rainfall coverage) for COSEFIN countries within the CCRIF, while Component 3 will finance climate risk insurance for CARICOM countries within the CCRIF. Based on lessons highlighted from the previous MDTF and requests by both client countries and donors, a fourth component has been included to provide Bank-executed technical assistance and is meant to complement the implementation of Components 1, 2 and 3. Technical assistance will be strategically used to enhance Disaster Risk Financing and Insurance (DRFI) capacities amongst client countries as well as ensure timely delivery of the Program (See Figure 3.3 below). 27 Figure 3.3: Sources to finance Central America & Caribbean Catastrophe Risk Insurance Program 17. Donors will play an essential role in expanding CCRIF’s risk retention capacity for the COSEFIN portfolio, in a similar manner as when CARICOM countries established the CCRIF. During the first four years donor support will enable to build reserves at an accelerated pace while financing the largest operating costs, which are the risk transfer expenditures and claims that need to be paid within CCRIF’s risk retention. These reserves are essential as CCRIF will be required to have a minimum amount of reserves in order to be able to access the reinsurance market. Indeed, whether reinsurers provide risk capital through proportional or excess- of-loss treaties, they require that the primary insurer (in this case, CCRIF) retains at least some of the risk. 18. IDA resources will be used exclusively to support Honduras and Nicaragua’s entrance fees and premiums. A limited portion of the premiums collected from participating countries will be dedicated toward the payment of administrative costs (minimal), while donor contributions will reduce expenses incurred by client countries when participating in the CCRIF. The combination of country premium payments with IDA resources and donor contributions will result in cheaper premium payments and help build the needed reserves over the lifespan of the Trust Fund, thereby creating a self-sustaining initiative by the time of program close23 (see Figure 3.4). 23 Reinsurers provide risk capital through proportional or excess-of-loss treaties, they require that the primary insurer (in this case, CCRIF) retains at least some of the risk. More important, a critical level of initial reserves is essential to ensure the long- term sustainability of the Facility. 28 Figure 3.4: Flow of Funds DONOR Multi-donor Trust Fund Caribbean Catastrophe Risk Insurance Facility (CCRIF) COUNTRY CONTRIBUTION CONTRIBUTION • Relations with CCRIF are Reserve needs driven by a Grant Agreement • Initial reserves Country 1 contribution Initial donor contribution • Expenditure financed have to follow procedures established Operating expenditures Country 2 Initial donor contribution in an Operations Manual • Reinsurance needs contribution • Insurance payouts • Funds are released as Country 3 required • CCRIF administration contribution Initial donor contribution • Financial audits • Board meeting expenses Country n contribution Initial donor contribution Bank-Executed . Technical Assistance 19. Two bilateral donors have expressed strong interest and one has been confirmed at the time of Project Appraisal. The Program will initially be financed by the Department of Foreign Affairs, Trade and Development (DFATD) of Canada, the United States Agency for International Development (USAID) and the Ministry of Finance and Public Credit of Mexico. DFATD has confirmed funding of approximately US$15 million to support Components 1, 2 and 4 of the MDTF and has expressed interest in supporting Component 3 of the MDTF with an additional US$ 20 million. USAID is planning a contribution of approximately US$10 million, and the Ministry of Finance and Public Credit of Mexico has expressed interest to contribute with approximately US$10 million. CCRIF and the WBG are exploring with other donors (e.g. EU- Commission of the European Communities and Swiss Agency for Development and Cooperation SDC) the possibility of their contributing to raise the MDTF resources in an estimated amount of US$ 160 million. 29 Annex 4: Operational Risk Assessment Framework (ORAF) Central America: Honduras and Nicaragua Catastrophe Risk Insurance Project (P149895) Project Stakeholder Risks Stakeholder Risk Rating Low Risk Description: Risk Management: Delays on the part of Honduras and Nicaragua to take The WBG, US Treasury and CCRIF are sustaining a close, high-level dialogue with necessary steps to join CCRIF. Political and fiscal Honduras and Nicaragua to raise the necessary awareness of the vital role insurance constraints could result in reduced political and / or plays in a broader disaster risk management strategy and the necessary steps to join financial support. In addition, aside from Ministries of CCRIF. Furthermore, acting on lessons learned during implementation of the first Finance in Honduras and Nicaragua, other line ministries CCRIF Program, both the WBG and CCRIF have committed to reaching out beyond and implementing agencies will need to be involved in Ministries of Finance. By engaging a broader range of government agencies (e.g. discussions regarding a long-term disaster risk insurance Ministries of Environment and/or Public Works as well as national emergency strategy. management agencies and institutes of meteorology and hydrology), the communication strategy aims to build the needed consensus and support for CCRIF membership. Resp: Status: Stage: Recurrent: Due Date: Frequency: Both In Progress Preparation Implementing Agency (IA) Risks (including Fiduciary Risks) Capacity Rating Low Risk Description: Risk Management: While CCRIF’s capacity to meet its clients’ needs has proven excellent, the Facility will Insufficient capacity to include additional members within review its procedures and Operations Manual to ensure readiness for project CCRIF – including Honduras and Nicaragua. The implementation. The World Bank will subsequently review and approve any new Facility’s current technical and fiduciary capacity may protocols. become overwhelmed by the new memberships as well as additional products offered. Operations could Resp: Status: Stage: Recurrent: Due Date: Frequency: consequently become more complex. Preparation Risk of CCRIF default. The CCRIF will essentially Risk Management: function as an insurance company to its client countries. The CCRIF is designed using international best practice standards and its capacity to 30 As such, it bears a risk of default that could affect the meet its clients’ needs has proven excellent according to the experience of the first reputation of the World Bank. CCRIF Program. While all insurance ventures carry a probability of default, this annual probability should remain below 0.05% (i.e. CCRIF would sustain a 1-in-200-year event). Should the CCRIF’s claims-paying capacity be insufficient to pay all insured losses, claims will be prorated based on the remaining available funds. Resp: Status: Stage: Recurrent: Due Date: Frequency: Governance Rating Low Risk Description: Risk Management: Governance and representation on CCRIF’s board remain CCRIF’s legal and institutional arrangements are under review to establish the necessary undefined. While current CARICOM members have corporate structure as a Segregated Portfolio Institution. Restructuring is expected to agreed to extend CCRIF membership to COSEFIN take effect on June 1, 2014. Additionally, institutional and legal agreements are member states (including Honduras and Nicaragua), many currently under review and scheduled to be negotiated. Final agreements will reflect institutional elements related to guaranteeing COSEFIN agreed-to arrangements between CCRIF and potential new member countries. representation have yet to be defined and agreed upon. Resp: Status: Stage: Recurrent: Due Date: Frequency: Both Not Yet Due Implementation Risk Management: During project implementation, CCRIF will be subject to annual audits by external auditors acceptable to the Bank. As part of the Project Report, CCRIF will provide its internal control reports as well as its unaudited semiannual financial and externally audited annual entity financial statements to the Bank. In addition, the Bank will also be invited to attend all regular meetings of CCRIF’s Board of Directors as an observer. Resp: Status: Stage: Recurrent: Due Date: Frequency: Not Yet Due Implementation Project Risks Design Rating Moderate Risk Description: Risk Management: Mitigation measures will include the careful design of the terms and conditions of the Non-insured event is triggered and/or incomplete parametric insurance policy as a critical element to minimize these risks: (a) trigger 31 coverage. Honduras and Nicaragua may consider that points of the insurance contracts will be set to balance affordability and frequency of CCRIF is a failure if: payout; (b) participating countries will be recommended to limit the insurance coverage (a) After sustaining heavy losses, payouts are not triggered to a fraction of their potential government losses, using the CCRIF as a safety net rather because of the type of coverage selected. than full insurance; and (c) parametric contracts allow for transparent wording of the (b) There is a basic risk defined as the probability that the insurance policy provided. The CCRIF team has repeatedly underscored the limitations insurance payout does not exactly match the actual loss. of the coverage provided and will continue to do so through its communication strategy By definition, the index used in a parametric contract is a and when discussing individual policies with client countries. Documentation on the proxy for the real loss, and it thus cannot be excluded that CCRIF will include clear information to this effect. Furthermore, technical assistance the parametric insurance indemnity may slightly provided by CCRIF will help stakeholders to understand the policy limitations and that underestimate (or overestimate) the actual loss. the project is not meant to cover entire losses faced by affected states, but to guarantee a (c) Current coverage provided is limited to major wind, minimum liquidity in case of a major adverse natural event. As a complement, the storm surge and earthquakes events. Many risks, including technical assistance provided by the Bank will enhance governments’ capacity to flooding, volcanic eruptions, tidal waves, etc. are not address more comprehensive DRFI initiatives. covered by the policy provided creating reputational risk Resp: Status: Stage: Recurrent: Due Date: Frequency: to the CCRIF and indirectly to the Bank. Implementation Excess rainfall products are not available for Honduras Risk Management: and Nicaragua during the implementation of the project. The CCRIF team has advanced over the last three years in developing an excess rainfall The excess rainfall product is still under design, and modeling and calibration process for the CARICOM states. The associated should be available by June 2015. However, limitations in methodology is under advanced stages of development, with the CCRIF planning to the information available and calibration of models could secure an improved dataset to inform modeling. It is expected that an excess rainfall be a challenge for design of the final product. product for the Caribbean will be available during 2014. The experience gained from developing this product, coupled with donor resources provided through the MDTF, will help ensure timely development of an excess rainfall product for Central American countries (including Honduras and Nicaragua), within one year of launching the excess rainfall product for the Caribbean. The Bank will support and contribute to the process as needed. Resp: Status: Stage: Recurrent: Due Date: Frequency: Implementation Social and Environmental Rating Low Risk Description: Risk Management: No environmental or social safeguards will be triggered by N/A 32 the proposed Project. There are no social or environmental Resp: Status: Stage: Recurrent: Due Date: Frequency: risks associated with the project since the project will not finance physical investments and the insurance funds will not be tied to specific activities. Program and Donor Rating Low Risk Description: Risk Management: Insufficient reserves. Insufficient reserves in CCRIF, Besides national and regional IDA to finance the entrance fee and initial insurance leading to overdependence on risk transfer instruments premiums for Honduras and Nicaragua to join CCRIF, the WBG, UST, and CCRIF are (e.g., reinsurance). exploring feasible options for obtaining additional donor finance, which will be provided through a Multi-donor Trust Fund (MDTF). Such capital could support the capitalization of Honduras and Nicaragua and reduce the overdependence on risk transfer instruments. In this context, a key objective of donor resources will be to enhance the affordability of CCRIF coverage (including for excess rainfall coverage), and will enable CCRIF to hedge this risk by limiting its own risk retention during the initial years through the purchase of larger amounts of reinsurance than will be necessary once it has built its reserve capital to a sustainable level. Resp: Status: Stage: Recurrent: Due Date: Frequency: Bank In Progress Preparation Delivery Monitoring and Sustainability Rating Moderate Risk Description: Risk Management: Low rate of renewal. Participating countries choose to exit To ensure that the countries financed under this operation can afford premium payment, the CCRIF after they join— leading to higher premiums Honduras and Nicaragua will be supported by national and regional IDA resources to for remaining members. finance the entrance fee and initial insurance premiums to join CCRIF. Through their initial participation, governments and their citizenry will become sensitized to the benefits of such coverage. After understanding the benefits, governments will be heavily incentivized to remain a member of CCRIF. Resp: Status: Stage: Recurrent: Due Date: Frequency: Not Yet Due Implementation Other (Optional) Rating Moderate Risk Description: Risk Management: 33 Timeliness on the effectiveness of the credit: Delays in The Bank is in close discussions with the CCRIF Board to agree on degrees of time credit approval and effectiveness on the part of Honduras flexibility in cases of procedural lag. The Bank is further in close dialogue with multiple and Nicaragua could create delays in the financing of the government agencies (incl. Ministries of Finance) in both countries to reduce potential entrance fee and the annual insurance premiums necessary lags in implementation. for these two countries to participate in the CCRIF. In Resp: Status: Stage: Recurrent: Due Date: Frequency: addition, potential time lags may arise in implementation due to processing procedures within governments. Both Not Yet Due Implementation Overall Risk Overall Implementation Risk: Rating Moderate Risk Description: The implementation of the overall project is subject to Moderate Risks, due to challenges that may derive from the design of the project and the ability of Honduras and Nicaragua to continue as CCRIF members after project closing. 34 Annex 5: Implementation Support Plan HONDURAS AND NICARAGUA: CATASTROPHE RISK INSURANCE PROJECT Strategy and Approach for Implementation Support 1. The strategy for World Bank implementation support will focus initially on ensuring that stakeholder engagement mechanisms are adequately implemented. As per the ORAF of the Project, overall implementation risk is rated as Moderate, due to the challenges that may derive from the Project design and the ability of Honduras and Nicaragua to continue as CCRIF members after Project closing. At the same time, significant amounts of technical studies, analyses and reports will be generated with MDTF finance specifically earmarked for technical assistance and informed stakeholder engagement. 2. Targeted / follow up missions of particular team members will be undertaken. The World Bank team will continue to coordinate with other development partners supporting catastrophe risk insurance, especially through the Central America and Caribbean Catastrophe Risk Insurance Project, given the complementarity of the projects, but also DRM generally across the Central America and Caribbean sub-regions. The Bank Task Team will maintain a close interaction and will share mission findings promptly with relevant authorities and stakeholders. This strategy is proposed as an indicative and flexible instrument which will be adjusted during project implementation and as part of the Implementation Status and Results Reports and adjusted as needed. Implementation Support Plan 3. Task team leadership as well as fiduciary and technical aspects will be managed from the Bank’s Washington office. The Bank will hire international and national consultants if necessary to round out the skills mix of its implementation support team. The main focus of implementation support is summarized below. Time Focus Skills Needed Resource Partner Role Estimate First 24 Technical review of Legal Specialist 8 SWs N/A months documents for initial Actuarial Specialist activities to ensure Financial Specialist (SWs/year) accelerated implementation DRM Technical Specialists start FM supervision FM Specialist 2 SWs Project Management / Task Team Leader 4 SWs Operational Support and Lead Specialist 2 SWs Communication/Information ETC DRM Specialist(s) 4 SWs 25-84 months Evaluation Reports Evaluation STC 8 SWs (SWs/year) (days/year) Project Management / Task Team Leader 8 SWs 35 Operational Support and Lead Specialist 4 SWs Communication/Information ETC DRM Specialist(s) 8 SWs FM Supervision FM Specialist 4 SWs Skills Mix Required Skills Needed Number of Staff Weeks/year Number of Trips Comments Task Team Leader 12 SWs Minimum 3 field trips (combined with CCRIF missions) Lead Specialist 6 SWs Field trips as required ETC DRM Specialist(s) 12 SWs Field trips as required FM Specialist 6 SWs Minimum 1 field trips (combined with CCRIF missions) Technical Specialists 8 SWs Field trips as required Evaluation STC 8 SWs Field trips as required 36 Annex 6: Economic and Financial Analyses HONDURAS AND NICARAGUA: CATASTROPHE RISK INSURANCE PROJECT 1. Honduras and Nicaragua, like most countries in Central America and the Caribbean, have traditionally relied on ex-post financing mechanisms to fund their post- disaster needs. Given the fiscal and macroeconomic impact of disasters, these mechanisms are extremely costly. Their possibilities for fiscal risk transfer through affordable catastrophe insurance in traditional international insurance and reinsurance markets are limited by the high transaction costs that result from the limited volume of business they could bring to these markets. Furthermore, Honduras and Nicaragua have little to no fiscal space for ex-post budget reallocations, without adversely affecting availability of resources needed for vital social and other public services. This situation often forces them to borrow from international capital markets at high interest rates following a disaster event, further increasing their overall recovery costs. 2. Experience from across Central America and the Caribbean, including in Honduras and Nicaragua, has demonstrated that the primary fiscal impacts of such challenges include the following:  Adverse impact on public finance: A country’s fiscal balance weakens following disasters as the domestic tax base shrinks and expenditure needs escalate. This deterioration often adds to public debt, which could affect macroeconomic performance beyond the short-term and result in higher inflation and lower investment potential.  Deterioration in the balance of payments: A country’s account balance weakens as disasters impair export capacity due to deterioration of infrastructure and transportation services. Since 1980, nine countries in Central America and the Caribbean experienced a disaster event with an economic impact above 50 percent of its annual GDP (for the year of the impact).24 In the case of Honduras, Hurricane Mitch effected damages equivalent to 81 percent of GDP in 1998.  Increase in fiscal deficit: The adverse fiscal impacts in the wake of disasters typically entails a marked increase in public expenditures related to emergency assistance and reconstruction efforts coupled with reduced inflows of government revenues (e.g. taxes, customs duties, etc.).  Escalating cost of debt: A country’s fiscal flexibility is ultimately dependent on its initial fiscal position, its financing options, and its debt sustainability levels.  Limited donor contributions: Underinvestment in protective risk mitigation measures is a common symptom generally seen across Central America and the Caribbean, as governments sometimes expect that others will provide support if a disaster occurs. However, concerns about this approach have become more pressing given the increasingly finite willingness of donors to provide financial support, coupled with the rising trend in the frequency and 24 Saint Lucia (1980, 69% of GDP), Jamaica (1988, 65% of GDP), Antigua and Barbuda (1995, 71% of GDP), Dominica (1995, 78% of GDP), St. Kitts and Nevis (1995, 85% of GDP; 1998, 139% of GDP), Honduras (1998, 81% of GDP), Grenada (2004, 212% of GDP), Guyana (200, 56% of GDP), and Haiti (2010, 120% of GDP). Source: Charles, Keren Carla. 2013. Fiscal Risks Related to Catastrophes in LAC. The World Bank Group (in press) 37 magnitude of natural catastrophes. Grants and concessional loans from multilateral institutions and bilateral donors designed to finance post disaster mitigation and reconstruction costs are also often earmarked for specific projects and initiatives, as opposed to overall budget support. 3. Additionally, macroeconomic impacts commonly experienced in Honduras and Nicaragua as a result of catastrophic events include the following:  Declines in GDP: The impact of catastrophic events caused by natural phenomena have often proven to be significant on productive and service sectors, both in terms of direct monetized losses of physical destruction and indirect losses associated with business interruption. By extension, catastrophic events tend to make output more volatile than otherwise, resulting in immediate consequences for national GDP figures.  Depreciation and inflationary pressures: Due to the weak current account balance and investors' concerns about future losses of local companies, the exchange rate of a disaster- affected country will often face depreciation pressures. Inflationary pressures will also build due to an excess of money holdings in the face of reduced incomes and possible concerns about currency depreciation, in addition to monetization of the increased budget deficits.  Negative regional spillovers: Generally, catastrophic events generated by natural phenomena could affect other countries that have not been hit directly. Typically, spill-over effects of disasters are most pronounced in terms of regional input-output networks due to damages suffered near shared ports and disruptions in cross-border supply chains. Fiscal linkages are also evident, as there is often a rise in sovereign credit spreads and local banks and insurance companies are exposed to cross-border fluctuations. Such spillovers are of particular concern, especially at a time when Central American countries are seeking to build closer cross-border ties and promote greater economic connectivity. The Approach of the Catastrophe Coverage Using Risk Pooling 4. Market-based risk transfer, while usually effective, can be an expensive proposition for governments that otherwise have access to sovereign financing; yet the swiftness at which risk transfer instruments can provide liquidity without requiring access to credit makes them attractive to some governments. This is particularly the case for states such as Honduras and Nicaragua that generally do not have sufficient capacity to build reserves and are restricted in their access to credit due to already high debt ratios. CCRIF provides an example where, in its first phase, small island developing states acted together to create a regional reserve mechanism to secure access to immediate liquidity in case of major disasters. Risk transfer instruments can also be useful to manage the budget volatility on government accounts, for example when the speed of post-disaster budget reallocation is an issue. The cat bonds issued by Mexico in 2006, 2009, and 2012 provide an example of creative use of risk transfer instruments. 5. Catastrophe risk pooling, at the regional or national levels, aggregates risk into larger, more diversified portfolios, with participants benefitting from cost savings and access to international markets. The cost of risk transfer to international markets depends on many factors, including the riskiness of the portfolio as a fraction of the size of the portfolio. Pooling risks generates diversification benefits that are reflected in reduced insurance premiums. 38 Figure 6. 1: Conceptual benefits from risk pooling and improved information on an insurance premium Source: World Bank-GFDRR Disaster Risk Financing and Insurance Project. 6. During the preparation of this Project, five possible options for catastrophe risk transfer were considered for Honduras and Nicaragua as part of a wider Central America grouping. These options were intended to be neither exhaustive nor prescriptive or mutually exclusive. Table 6.1 below offers a description of such options. Table 6.1: Options considered for Central America risk transfer Option Description 1 Central American countries each independently transfer catastrophe risk to the international reinsurance/capital markets; 2 Central American countries jointly transfer catastrophe risk to the international reinsurance/capital markets, without joint reserves; 3 Central American countries jointly transfer catastrophe risk to the international reinsurance/capital markets, with joint reserves; 4 Central American countries work with CCRIF to jointly transfer catastrophe risk to the international reinsurance/capital markets; 5 Central American countries work with Mexico’s National Disaster Fund FONDEN, to jointly transfer catastrophe risk to the international reinsurance/capital markets25. 25 The underlying Mexican data used in the analysis was kindly provided by Mexico’s “Secretaría de Hacienda y Crédito Público” (Unidad de Seguros, Pensiones y Seguridad Social). 39 7. Table 6.2 below presents the estimated reduction in the indicative commercial premium across the options presented above in Table 6.2, compared to the baseline of Option 1 (independent catastrophe risk transfer). The benefits of collaboration among countries are measured with indicative commercial premium. Using a premium formula commonly used in the reinsurance market, parameterized to be consistent with recent sovereign parametric risk transfer deals, one can estimate how the benefits from risk diversification might translate into lower premiums.26 In addition to the technical benefits from risk diversification, there are likely to be potentially substantial operating cost savings from jointly approaching the market with a portfolio of policies. Table 6.2: Premium Reductions from Options 2-5, compared to baseline Option 1 Option 1 Option 2 Option 3 Option 4 Option 5 Reduction in indicative commercial - 27% 41% 44-45% 47-51% premium, prototype policy Source: World Bank-Global Facility for Disaster Reduction and Recovery (GFDRR) Disaster Risk Financing and Insurance Project. Notes: For Option 3, initial capital from donors of US$50 million is assumed. Ranges reflect uncertainty over the correlation of tropical cyclone losses between CA countries. Prototype CCRIF style policies are assumed, with partial coverage in excess of retention of annual losses equivalent to 1- in-15 years for hurricane and 1-in-25 years for earthquakes. Option 5, although it would produce the largest savings, was not viable because of institutional restrictions and issues with the timing of implementation 8. Preliminary analysis finds that Honduras and Nicaragua could reduce the cost of catastrophe risk insurance by 27 percent or 41 percent when transferring catastrophe risk with other COSEFIN states to the international reinsurance market – without and with joint reserves respectively. As a group, COSEFIN countries could reduce indicative commercial premiums paid by close to 45 percent should they chose to transfer risk through CCRIF. This premium reduction could be shared between participating COSEFIN countries and CCRIF member countries. These indicative premium reductions are due to a larger, more diversified portfolio of catastrophe risks placed on the international reinsurance markets. Table 6.3 details the estimated fiscal benefits of the Facility to Honduras and Nicaragua – more specifically, the estimated coverage (with lower and upper bounds) for hurricane and earthquake insurance with an annual premium of US$ 3 million and an estimated 1-in-20 year attachment point and a 1-in-150 year exhaustion point. 9. The benefits for Honduras and Nicaragua of partnering with CCRIF go beyond that of lowering premiums. Significant cost-savings are also associated with efficiency gains, increased access to reinsurance markets, relative ease associated with joining an established insurance facility with a demonstrated track record of success and enhanced regional collaboration. Benefits associated with each are further described below:  Cost-Savings Associated with Efficiency Gains: While partnership agreements would first need to be finalized in order to quantify the exact cost-savings benefits, efficiency gains will nevertheless result from the nature of parametric insurance in itself, partial sharing of capital as well as sharing of specific administrative and operating costs. 26 Analysis in terms of capital at risk (taken to be the 1-in-100 year emergency loss of the country or group of countries). 40  Increased Access: The CCRIF parametric model is a payout mechanism already accepted by reinsurance markets. Applying this model to COSEFIN states such as Honduras and Nicaragua will therefore enable greater access to key reinsurance markets and at the most competitive pricing available.  Demonstrated Experience: CCRIF’s extensive experience working as a regional insurance entity helps guarantee the quality of service required of new members. Importantly, the fact that CCRIF is already licensed and operating – with institutional arrangements established, service providers in place, and parametric risk transfer instruments already active – means that new members will benefit from the time-efficiency associated with joining a mechanism which is tried and tested.  Increased Regional Cooperation and Collaboration: Importantly, a CCRIF partnership joining COSEFIN and CARICOM states could strengthen diplomatic and economic engagement among the countries of the region at a time when countries in Central America and the Caribbean are seeking new economic opportunities and markets in their own region. A partnership with CCRIF can further solidify an existing cooperation agreement in the field of disaster risk management between CARICOM and COSEFIN. Table 6.3: Hypothetical Portfolio of Potential Payouts for Honduras and Nicaragua Associated with US$ 3 Million Premium Payments per Peril Attachment Loss Exhaustion Loss Coverage Limit Coverage Limit Rate on Line Country (20 years) (150 years) (Minimum) (Maximum) (Median) Honduras (Earthquake) 16 M 139 M 79 M 100 M 3.4% Nicaragua (Earthquake) 56 M 424 M 78 M 99 M 3.4% Honduras (Tropical 10 M 135 M 48 M 58 M 5.7% Cyclone) Nicaragua (Tropical 1M 93 M 49 M 60 M 5.5% Cyclone) Premium is $3M per peril Note: Estimated insurance coverage is subject to change based on countries’ participation, donors’ contribution, and reinsurance costs. The Increased Economic Benefits Associated with an Excess Rainfall Product 10. While the above analysis discusses the economic benefits for Honduras and Nicaragua of pooling hurricane and earthquake risk both within Central America and across the entire Caribbean basin, it is clear that significant benefits are also associated with pooling risk to safeguard against excess rainfall. Figures show that catastrophic events associated with excess rainfall (e.g. flooding, landslides) are more frequent than hurricanes and earthquakes, and can at times be just as intense. By some estimates, excess rainfall events are associated with economic damages equivalent to more than one percent of national GDP per year for 14 countries in the sub-regions and accounting for more than US$ 138 billion in damages in the Caribbean alone. In the case of Honduras and Nicaragua, average annual economic losses are estimated to be equivalent to 3 percent and 2 percent respectively. It is within this context that 41 the same rationale for developing a risk pooling mechanism for earthquakes and hurricanes applies and arguably more economic benefits could arise for Honduras and Nicaragua in the event they chose to pursue the CCRIF excess rainfall product line. Rationale for public sector provision 11. Disasters resulting from natural events represent a significant contingent liability (both explicit and implicit) to Honduras and Nicaragua and are often associated with large fiscal consequences. As country legal frameworks often fail to define the financial responsibility of the government in case of a disaster, its contingent liability is usually implicit. As in most other Central American and Caribbean states, government therefore serves as a (re)insurer of last resort, with limited knowledge of its exact level of disaster risk exposure. The ability to quantify potential losses from disasters as well as the cost associated with public interventions for recovery and reconstruction activities can help a government ascertain its contingent liabilities. Sovereign disaster risk financing and insurance can prevent against sudden macroeconomic shocks that negatively impact fiscal performance and country’s long-term economic development. Value added of Bank Involvement 12. The World Bank is well positioned to assist the Honduras and Nicaragua (and COSEFIN and CARICOM countries generally) in the design and implementation of the proposed Project given its: (a) technical expertise and past experience in establishing regional risk pooling mechanisms, (b) long engagement with Ministries of Finance, as well as (c) convening power of multiple stakeholders. With regards to technical expertise, the highly technical and specialized nature of setting up the CCRIF has necessitated the use of a wide spectrum of experts to tackle the legal, fiduciary, and catastrophe risk modeling and financing aspects of the initiative. To support the design of the CCRIF, the World Bank is able to bring together first hand experiences and recent developments including the initial establishment of CCRIF, the pilot for the Pacific Catastrophe Risk Assessment and Financing Initiative as well as advising client countries (e.g. Brazil, Colombia, India, Indonesia, Mexico, Pakistan, Peru, Philippines and Vietnam) on various DRFI strategies. Additionally, the proposed Project builds off a long history of Bank engagement with the Ministries of Finance – the key proponents of the proposed Project in all participating countries. The in-depth knowledge of client countries, the ability to intermediate between client and donor needs as well as a reputation of impartiality in the international financial markets further rationalizes the Bank involvement in the development of an efficient partnership among client countries, donors, and private markets in the financing of catastrophic risks. 42