47089 IEG MIGA INDEPENDENT GROUP EVALUATION Independent Evaluation Group-MIGA 2008 Annual Report Evaluating MIGA’s FYO5-08 Strategic Directions April 15,2008 Document of the Independent Evaluation Group-MIGA 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 Group authorization Abbreviations and Acronyms ABS Asset-backed security AMS Agribusiness, manufacturing, and services AR Annual Report ARDE Annual Report on Development Effectiveness (IFC) BU Berne Union CAS Country Assistance Strategy CODE Committee on Development Effectiveness CRM Customer relationship management EA Environmental assessment ECA Europe and Central Asia EHS Environmental, health & safety EIA Environmental impact assessment EMS Environmental management systems EROIC Economic return on invested capital ERR Economic rate of return FDI Foreign direct investment FIAS Foreign Investment Advisory Service FRR Financial rate of return FY Fiscal year GDP Gross Domestic Product HR Human Resources IBRD International Bank for Reconstruction and Development IDA International Development Association IDS Information Dissemination Services IEG-MIGA Independent Evaluation Group - MIGA IFC International Finance Corporation LAC Latin America & Caribbean M&E Monitoring and evaluation MBS Mortgage-backed securities MENA Middle East and North Africa MIGA Multilateral Investment Guarantee Agency OPIC Overseas Private Investment Corporation PFG Project Finance and Guarantee (WB) PPP Public-PrivatePartnership PRI Political risk insurance PWC PricewaterhouseCoopers RDE 2004 Review of Development Effectiveness in MIGA (OEU) RM Resource management ROC/ROOC Return on operating capital ROE 2003 Report on Operations Evaluationin MIGA (OEU) SIP Small Investment Program SME Small and medium-sized enterprise SMI Small and medium-sized investor TA Technical Assistance TRS Time Recording System WB World Bank WBG World Bank Group XPSR Expanded Project Supervision Report .. 11 Acknowledgments This report was written by a team of IEG-MIGA staff and consultants led by Stephan Wegner including Ethel Tarazona, Aurora Medina Siy, Louise Walker, Ian Webb, and Carlos Nunez, under the supervision of Marvin Taylor-Dormond. N i l s Fostvedt was a lead advisor. SangHee Park and Michael Batlogg provided inputs and research assistance. The authors would like to thank MIGA staff who provided valuable information and feedback during the evaluation and at a technical meeting. The report was produced under the general supervision of Vinod Thomas, DGE. Director-General, Evaluation: Mr. Vinod Thomas Acting Director, IEG-MIGA: Mr. Marvin Taylor-Dormond Task Manager: Mr. Stephan Wegner ... 111 Table of Contents 1. Introduction ......................................................................................................................................... 1 Background ......................... ....................................... Approach ............................. .............................................. Methodology ....................... ......................................................... 2. Background: The 2005 Strategic Directions........ .............................................................................. 4 3. Analyzing the Design ofthe Strategy ................................................................................................. 7 A. Financial and Development Perspective ..... ........ B. Customer Perspective: MIGA’s Comparative Advantage and Operational Prioriti C. Internal Perspective ...................................... 10 D. Human Capital and ...................................... 13 4. Implementation of the Strategy ........................................................................................................ 14 A. Customer Perspective ........................ B. Internal Perspective. C. Human Capital and Resources Perspective 5. Results o f the Strategy ....................................................................................................................... 26 A. Operational Results .............................................................................................................................. 26 B. Financial Results and Sustainability ................................................................................................... 35 C. Expected Development Results ........................................................................................................... 38 6. Outlook: M I G A ’ s Role and the Potential for M I G A Guarantees ................................................ 44 7. Summary o f Findings and Recommendations ................................................................................. 49 Tables Table 1: Key Characteristics o f MIGA’s Guarantee Activities FYOO-08 ..................................................... 27 Table 2: MIGA’s Guarantee Activities NOO-07 and MIGA Financials (in US$ Thousands) ..................... 37 Figures Figure 1: Strategic Management ..................................................................................................................... 2 Figure 2. M I G A Guarantee Volume (FY90-08) .............................................. Figure 3: Concentration of MIGA Guarantees b and Sector ( i n Percent o f E x Figure 4: Concentration o f MIGA Guarantees b y Region, b y FY ( Figure 5: Share of N e w MIGA Guarantee Exposure b y Business Sector Figure 6: Share o f New MIGA Guarantee Exposure b y Sector, by IT (i .................... 31 Figure 10: M I G A Guarantees in Conflict-Afflicted Countries (Annual new exposure b y FY, USD millions) .......... ......................... .............................................................. Figure uarantees for Infrastructu (Annual new exposure b Figure 12: M I G A Guarantees for South-South Projects (Annual new ex Figure 13 : Risk Profile o f Countries with MIGA Exposur Figure 14 : FDI Flows vs. MIGA’s N e w Exposure in Sub Outcome and MIGA’s Effective ...................................................... .................................................................. 39 Figure 16: MIGA’s Effectiveness Results (Sample o f 12 Most Recent Evaluated Projects) ........................ 39 V Boxes Box 1: Realignment of MIGA’s Technical Assistance (TA) Function ......................................................... 18 Box 2: IEG Project Risk Profiling ................................................................................................................. 42 Annexes Annex 1: An Illustrative Strategy Map ........................................................................................................ 53 Annex 2: References .................................................................................................................................... 55 vi Executive Summary MIGA i s at an important juncture as i t reviews i t s role and strategy. The past five years have seen foreign capital flows to developing countries soar to record highs. The distribution o f these flows, however, has been highly concentrated, and political risk has been a factor in determining these flows. Global demand for political risk insurance - an important instrument to mitigate the aversion to investing in difficult settings - has also increased significantly since 2002. Much of this increase has been met by private insurers and national insurance agencies, while MIGA’s market share has declined. This I E G - M I G A 2008 Annual Report evaluates key aspects o f MIGA’s FYO5-08 strategic directions. This was the Agency’s first comprehensive strategic exercise, and i t emphasized MIGA’s development mandate and collaboration with other parts o f the World Bank Group (WBG). Yet the strategy document had structural weaknesses, with links missing between different strategic levels. During implementation, MIGA began project level consultation with the World Bank to ensure the consistency o f i t s projects, i t put in place improved policies and analytics, and has also shown considerable support for innovative projects. But IEG notes lack o f progress in important areas such as general product innovation, systematic business development, and performance monitoring. The ultimate test o f a strategy lies in results. MIGA’s operational results during FYO5-08 have shown a steady increase in new business from the nadir o f FY04, even though, except for FY08, i t was short o f the business targets in the strategy. The Agency has supported projects in the priority areas identified in the strategy. MIGA’s ability to insure complex projects in difficult markets continues to be a key strength. The crucial challenge w i l l be to adopt a more integrated vision and strategy, and to develop products to better serve clients, while strengthening processes and performance metrics. The 2005 Strategy o f performance metrics that would allow monitoring and evaluation o f achievement The FYO5-08 strategy integrated business, o f objectives. development impact, and risk management aspects. The strategy had important gaps in Strategy Implementation linking MIGA’s objectives (development, Limitations o f a strategic framework can be risk, and growth) and operational priorities corrected by strong and adaptive at the client, internal process, and human implementation. In this respect, MIGA has capital levels. The operational priorities emphasized several aspects during the were aligned with WBG priorities and implementation o f i t s strategy. In a mainly reflected MIGA’ s internal strengths significant departure from past practice, i t and continuity with previous priorities. has changed i t s business model to better Implications for MIGA’s financial situation, align i t s operations with Bank Group risk profile, and development impact were strategies and policies, and has in this regard not made clear. Similarly, although MIGA scaled up consultations and collaboration at identified resource needs to implement the the project level with the World Bank. strategy, i t has not been clear how these Increased coordination and collaboration resources would be allocated to achieve with the WBG, while an important and performance outcomes and how these positive aspect o f MIGA’s effectiveness as outcomes would link to the organization’s an insurance agency valued b y clients, has macro level performance objectives. The strategy also had a significant gap in the area vii entailed increased transaction costs for the Adapting and developing i t s product would Agency. be vital for the Agency to serve i t s clients better. Decision-making has been modified. MIGA has made progress in developing i t s MIGA requested additional resources to methodology for assessing development support implementation o f the strategic impact, and in using this methodology in i t s directions. However, the connection project assessments, but this has not yet between expected increases and planned reached consistent application. The Agency business growth was not explicit and actual has also harmonized i t s policy and administrative costs remained flat during performance standards on social and implementation. environmental sustainability with those o f Results IFC: i t i s too early to assess the results o f this shift. The 2005-08 strategic directions anticipated business growth targets and announced an Processing times for guarantees have increased focus on the four operational increased, due at least in part to MIGA now priority areas--frontier countries, conflict- undertaking more complex guarantee afflicted countries, infrastructure, and south- operations with longer gestation periods. south investments. MIGA has steadily In addition, the Agency has improved i t s increased i t s business volume from the very risk and finance analytics underpinning i t s l o w level o f FY04: but i t has fallen short, decision making with respect to pricing, until this fiscal year, o f the annual business provisioning, reinsurance and capital target range o f $1.6-$1.8 billion. At the deployment. More work remains in this same time, the international political risk area-induding the need to further refine insurance industry has seen rapid growth- MIGA’s pricing vis-&vis insurance market tripling in size since 2004, and business cycles. Performance management, consequently, MIGA’s share in the market internal reporting, and monitoring continued declined from 6 percent to 4 percent during to be weak during implementation. MIGA 2004 and 2007. This in part reflects growth should build on i t s recent improvements in in business lines o f PRI that MIGA cannot this regard and systematize i t s efforts. offer at present. The growth in MIGA’s annual business volume has come from an MIGA’s internal organization has become increase in the average size o f guarantees; more aligned functionally. Some improvements have been made in client during FYO5-07, the number o f projects supported annually b y MIGA has declined relationship management, but i t i s important compared with i t s level in WOO-04. to do much more to improve and clarify roles and responsibilities o f individual staff MIGA has supported projects in its in business origination, including a business operational priority areas and has increased development plan, performance incentives, the share o f new business in Africa and in and measures o f effectiveness, and to IDA countries (within the frontier country systematize client relationship management. priority), with much continuity seen in patterns o f i t s business volume in priority The Agency has underwritten innovative areas compared with the previous strategy projects within i t s limited product range. period. Efforts were made to diversify the But, partly due to constraints in i t s portfolio, which was highly concentrated in Convention, MIGA has not been able to terms o f regions and sectors in FVO4-WO5, make progress in more general and and MIGA achieved significant systematic product development as improvements during FY06-FY07. Yet, envisioned in the Strategic Directions. ... VI11 more recent results indicate a return to high Recommendations concentration level. In order to i) consolidate i t s long term MIGA has a strong capital base and an viability; ii) ensure the sustainability o f excellent claims record to date. However, recent operational results; and iii)strengthen i t s net premium income has declined and i t s development results, MIGA needs to: effective premium rates remain above industry averages. With net premium I . On MZGA ’s long-term viability: income declining since FY04, the ratio o f a) Develop a new strategic directions administrative cost to net guarantee income framework that carefully considers the has increased to 80 percent in FY07--up external and internal context in which from 68 percent in FY04. Should this trend MIGA i s involved, the proposed continue, i t could raise concerns about performance dimensions and the linkages financial sustainability. MIGA has been between the latter, the expected value to recovering administrative costs through i t s i t s customers, the necessary changes in premium income. I t has priced guarantees internal processes, and the human capital consistent with i t s pricing model, although and technological demands of the larger projects were more likely to be under strategy. or overpriced relative to MIGA’s model. Aspects to be considered include: the I t i s too early to assess the development potential demand and appetite for risk outcomes o f MIGA projects approved mitigation products, the agency’s market during the €3’0.5-08 period. Quality at entry position vis-h-vis other providers o f political assessments suggest MIGA has strengthened risk mitigation tools, the changing several aspects o f i t s work quality at entry. international market conditions, the The Agency retains strengths due to i t s effectiveness of delivering guarantee ability to underwrite complex projects in I instruments and potential synergies across difficult markets, and there i s room for i t to the World Bank Group, remedies to address grow. However, MIGA faces challenges in institutional and external restrictions i t s business environment due to a imposed b y MIGA’s Convention, i t s proliferation o f risk mitigation instruments competitive advantage, potential areas o f and thus, i t s regulations, product, and growth and high development impact, and processes need updating. The Agency can factors affecting the achievement o f the also strengthen i t s responsiveness to clients objectives o f the FYO5-08 strategy. I t would and i t s client relationship management. The need to address the weaknesses o f the challenge i s to take advantage o f growing current strategy, b y linking objectives, demand for risk mitigation instruments and resource allocation, processes, and expected find solutions to address institutional development results. constraints. As part o f this strategic exercise MIGA MIGA’s support in some evaluated projects management would need to consider: was crucial for investments to go forward. 0 Tackling the issue o f administrative I t has provided comfort to investors dealing costs, as reflected b y the increasing ratio with local communities and those entering a administrative costs to net premium new country. The Agency’s role has been income; especially important for investments in post conflict countries. The Agency has the 0 Improving the effectiveness o f i t s potential to play an important development business development and client role. relationship functions; and ix 0 Continuing enhancing the value added b) Build on recent developments to and the efficiency o f business processes improve tracking and management of and decision making to ensure impact progress during implementation. MIGA and cost-efficiency in underwriting. should systematize i t s recent efforts to develop metrics t o monitor progress for b) Ensure that the new strategic improving management decision making, directions make explicit the link between allocating resources to the desired areas o f risk levels, pricing, and financial, growth and impact and communicating operational, and development impact results to the Board and other stakeholders. objectives. The strategy should include a portfolio perspective that would consider net 3. On strengthening development results: guarantee income across risk, financial Make significant progress in performance, and development objectives to implementing initiatives related to facilitate decision making and performance development impact assessment and monitoring o f indicators such as expected monitoring, recommended in previous income, costs, risk, and development evaluations of the Agency by IEG, impact. Similarly, MIGA should obtain including the development of self- more accurate unit cost data for evaluation. underwriting individual guarantees. Finally, i t should clarify further i t s pricing relative to i) The test o f a sounder strategic and market pricing throughout the insurance implementation framework w i l l be in the business cycle. accomplishment o f development results in supporting inclusive and environmentally c) Ensure that the new strategy identifies sustainable growth. In this respect, to the set of performance indicators to track ensure that projects MIGA supports are progress in implementation. The strategic economically sound and have positive and exercise needs to include the development of sustainable development impact, the a framework o f strategy metrics as well as consistent application of MIGA’s the further improvements in internal systems development impact assessment guidelines for performance measurement, reporting, i s crucial: i t w i l l underscore the Agency’s and monitoring. unique role. 2. On sustainability of MIGA’s recent ii)Likewise, the Agency should give high growth: priority to continuing the steps i t i s initiating a) Strengthen systematic support to to implement a monitoring and self- innovative projects and improve evaluation system that would allow i t to product innovation and internal gauge, understand, manage, and report the processes to meet investors’ changing development impact o f its interventions. risk mitigation needs. The Agency needs to strengthen innovation through systematic support to innovative projects and for new product development and innovation. I t should address changes t o i t s eligibility requirements not demanding amendments t o the Convention. In the medium term, ensuring MIGA’s innovation capability, vital f o r i t s relevance and sustainability, m a y require changes t o the Convention. X 1. INTRODUCTION Background 1.1. The Independent Evaluation Group-MIGA (IEG-MIGA)’ has prepared annual reports to the Committee on Development Effectiveness (CODE) and the Board of Directors since 2003, to update them on i t s evaluation findings about MIGA, and to present relevant information on issues critical to MIGA’s performance as a development institution and insurance agency. T h i s 2008 Annual Report i s IEG-MIGA’s first with a thematic focus. I t evaluates some k e y aspects pertaining to the design, implementation, and results of M I G A ’ s three-year strategy (FY05-08).2 1.2. The Multilateral Investment Guarantee Agency (MIGA) contributes to the mission of the World B a n k Group by promoting foreign direct investment for the purpose of economic development in i t s developing member countries. MIGA fulfils i t s mandate m a i n l y through offering political risk insurance to private investments in developing countries, complementing the services of private and public insurance agencies. 1.3. In 2005, MIGA proposed n e w strategic directions for the Agency for FY05-083 in order to enhance i t s insurance business and financial sustainability, strengthen the development effectiveness of i t s projects, and improve risk management. T h e purpose of this Annual Report i s to present a forward-looking evaluation that w i l l inform the formulation o f M I G A ’ s n e w strategic directions f o r FY09-11. Approach 1.4. For i t s evaluation, IEG has drawn o n analytical frameworks commonly used in strategic management.4 T h e role o f strategy i s to guide the specific decisions an organization takes as i t moves forward. Strategies do not generally involve particular actions, but rather define a framework for taking actions. In the framework presented in Figure 1, the ability of an organization to achieve i t s objectives (performance) depends on b o t h the actions i t takes and on the context in w h i c h these steps are taken.’ ’ IEG-MIGA i s hereafter referred to as “IEG’ unless the full acronym should be required by context. See CODE2008-0003: Approach Paper, IEG-MIGA 2008 Annual Report. January 15,2008. MIGNR2005-0019: MIGA 2005 Review for FY00-04 and Strategic Directions for FYO5-08. April 20, 2005. See Saloner, G., A. Shepard, and J. Podolny: Strategic Management (2001). The links between performance and actions are examined using concepts developed in Kaplan, R., and D. Norton: The Strategy-Focused Organization (2000), which described a balanced scorecard to measure the achievement of strategic objectives. In this framework, the external context describes industry characteristics such as competitors, buyers, and non-market factors (e.g., the regulatory and political environment in which the organization operates), while internal factors refer to the assets and resources o f an organization and the way in which i t i s organized. Actions the organization takes involve deploying and acquiring assets (such as knowledge, processes, organizational structure, and resources). Figure 1: Strategic Management CONTEXT External Internal PERFORMANCE Asset Acquisition and Deployment Objectives and Scope 1.5. This Annual Report provides evaluative material to address k e y aspects of M I G A ' s current strategy and the extent t o w h i c h MIGA has been effective in implementing i t and in achieving i t s strategic objectives over the FY05-07 period.6 The evaluation identifies issues and lessons relevant for MIGA going forward. Where appropriate, findings and recommendations are forward-looking and actionable to inform MIGA's future strategy in the context o f i t s changing business environment and the ongoing World B a n k Group-wide strategy development. Using the framework noted above, the report assesses three m a i n issues: (i) design, or strategy formulation, (ii) strategy implementation, and (iii) results MIGA has achieved so far f r o m an operational and development perspective, identifying h o w results can b e strengthened going forward. Methodology 1.6. IEG has f o l l o w e d where possible an objectives-based approach, evaluating the relevance and implementation of the strategy using a strategic management framework. The effectiveness of implementation was assessed p r i m a r i l y against MIGA's indicators o f progress identified in the 2005 Strategic Directions and supplemented by indicators f r o m other relevant documents. 1.7. The evaluation has included a review of literature on the political risk industry and analyses of MIGA strategy, policy, and w o r k program documents, and has drawn on structured IEG interviews with senior MIGA staff, as w e l l as market studies and client surveys commissioned by MIGA in FY05 and FY08. U s i n g data from MIGA Annual Reports and databases, the evaluation has analyzed characteristics of MIGA guarantees issued under the current strategic directions and of i t s overall guarantee portfolio to identify shifts during FY05-08, compared with the previous strategy period (FY00-04). The findings from this review have been complemented with material from existing and some new IEG project-level evaluations to identify issues and trends. 1.8. The assessment o f aspects of M I G A ' s operational income, overall financial sustainability, and implementation of risk analytics tools was based on a review of financial statements, B o a r d papers, other documents, and an analysis of MIGA databases, While the focus i s on MIGA operational results in FY05-07, available trend data and information from FY08 (up to March 31, 2008) have also been used where appropriate. 2 and interviews with MIGA staff. Finally, the report draws on findings from previous or ongoing evaluations where appropriate, such as the parallel IEG evaluation o f the use of WBG guarantee instruments. 1.9. The report i s organized as follows: Section 2 describes MIGA’s 2005 Strategic Directions, and Section 3 analyzes the way the strategy was designed. Section 4 presents key aspects of the implementation of the strategy, and Section 5 discusses findings on results so far from MIGA’s operational and development perspective. Section 6 provides an outlook of MIGA’s role and potential. A summary o f findings and recommendations to MIGA management i s contained in Section 7. 3 2. BACKGROUND: THE 2005 STRATEGIC DIRECTIONS 2.1. The 2005 Strategic Directions were the first comprehensive strategy exercise since M I G A ’ s inception. Although the earlier MIGA 2000 Review proposed directions for the Agency, the 2005 document was the first to articulate a forward looking strategy and business model for the Agency with an integrated view on operational performance, development results, and risk management. The strategy also represented a first serious effort to thoroughly review MIGA’s market environment, comparative advantage, and the Agency’s strengths and weaknesses, in consultation with MIGA’s partners and clients. I t presented an important turning point for the Agency to move from an institution operating largely in isolation from the rest o f the World Bank Group (WBG) to one that redefined MIGA first and foremost as a member o f the WBG, emphasizing synergies, coordination, and collaboration with the Bank and IFC. 2.2. The strategy defined M I G A as a development institution. MIGA issued a mission statement in M a y 2004 defining the Agency as a development institution firmly grounded in the mandate o f the World Bank Group b y aiming “to support economic growth, reduce poverty, and improve people’s lives.” The statement further noted that MIGA was “committed to promoting projects with the greatest development impact, that are economically, environmentally, and socially sustainable.” 2.3. M I G A ’ s 2004 business model reflected i t s development mandate, and emphasized marketing, risk management, and collaboration with the WBG. In 2004, MIGA revised i t s business model both to emphasize i t s development mandate as laid out in the Convention and to address the significant decline in guarantees activities since FY02.* This work culminated in the formulation of the MIGA 2005 Review for FY00-04 and Strategic Directions for FY05-08, which was discussed b y CODE and the Budget Committee on March 16, 2005 and b y the Board o f Directors on M a y 10, 2005. The strategy confirmed a new business model with three elements: 1) proactive marketing and complementary product lines; 2) a comprehensive r i s k management framework; and 3) stepped-up collaboration with the WBG. Proactive marketing was part of the strategy especially in order to build a stronger and more diversified pipeline, thus giving MIGA a better chance to implement i t s strategic priorities by focusing on the sectors, regions, and themes where i t saw a comparative advantage. Another related aspect o f the business model was to remain more engaged with clients downstream.’ 2.4. A t the core of the FY05-FY08 strategic directions were four operational priorities, which largely reflected underserved markets: investment in infrastructure development, investment in frontier countries, investment in conflict-afflicted environments, and investment among developing countries (“south-south”). lo In addition, the strategy identified sub-Saharan Africa as i t s most important regional priority MIGA Mission Statement. May 2004. * MIGA. Operations Evaluation Unit 2005 Report. April 8,2005, p. 3. MIGA. Operations Evaluation Unit 2005 Report. April 8,2005, p. 3. loA series o f consultations and studies helped inform MIGA’s F’Y05-FY08 strategy (listed on pp. 77-79 of the FYO5-08 strategy document). Among these were a PRI Client Survey and a Technical Assistance Client Survey conducted by PricewaterhouseCoopers(PWC) which provided some insight into the external environment and MIGA’s comparative strengths and weaknesses. 4 and emphasized work in support o f small and medium-sized enterprises. The strategy document linked these priorities directly to expectations o f increasing overall business volume and guarantees in the priority areas over the three-year strategy cycle, to a strengthening o f MIGA’s development mandate, and o f i t s financial results. MIGA identified for each priority several planned results (including both outputs and outcomes in the results chain) with indicators o f progress but did not identify specific targets for each o f the priority areas. Selectively, these have served as benchmarks against which to evaluate implementation. 2.5. Among other outcomes, MIGA’s 2005 strategy document recognized the need to enhance the quality of i t s interventions as well as the quantity of foreign direct investment i t facilitates in order to stay relevant as a development institution. I t expected to improve quality by an increased focus on development impact both at appraisal and project implementation, greater selectivity, and a clear demonstration of the value added o f MIGA’s involvement for the projects i t supports.” In particular, MIGA’s strategic directions encompassed the following operational implications: e MIGA would take the lead on non-commercial risk guarantees within the WGB in order to ensure i t s core competitive advantage and avoid client confusion; e Business volume would increase to between $1.6-1.8 billion over the three year period (FY06-08), with further scaling up from expanded product offerings and closer alignment with the WB guarantees programs; e The three elements o f MIGA’s new business model-proactive marketing, comprehensive risk management, and collaboration with the WBG--would leverage i t s comparative advantages and reinforce each other; e MIGA would focus on higher risk markets and other areas where i t has a comparative advantage; e Scaling up o f business volume would need to be balanced with portfolio quality (development impact); e MIGA would focus on projects that reinforce the agenda o f the WBG, working with the Bank, investors, and governments to identify projects that would fit within the context o f the CAS; e MIGA Technical Assistance and other services would increasingly be part o f tailored risk mitigation solutions; e MIGA would pursue four operational priorities, based on MIGA’s core competencies and comparative advantage (see Section 5); e Initiatives in support o f S M E s would be an integral part o f the frontier strategy; e In the infrastructure sector, MIGA would engage early in concessions processes and work upstream with clients to develop a pipeline; e In frontier markets MIGA would apply i t s due diligence and effective risk management to encourage FDI; ‘I MIGA 2005 Review for FY00-04 and FYOS-08 Strategic Directions, p. 3 1. 5 MIGA would continue efforts to mobilize investments with high demonstration effect in conflict-affected countries; and MIGA would market i t s products proactively to developing countries with a solid base o f investors to increase south-south investments. 2.6. As MIGA now reviews i t s experience with i t s strategic directions and formulates new directions and operational priorities, this Annual Report seeks to provide evaluative feedback on the relevance and effectiveness o f key aspects o f the implementation of M I G A ' s strategic directions during the FYO5-08 period. I t also responds to a request from CODE members for IEG to conduct further work to contribute to the consideration of MIGA's future strategic directions.'2 ''See CODE2007-0061: Report to the Board from the Committee on Development Effectiveness, July 13, 2OO7. 6 3. ANALYZING THE DESIGN OF THE STRATEGY 3.1. This section seeks to assess key aspects o f the 2005 strategy and its alignment with relevant World Bank Group strategies and with MIGA’s market situation, comparative advantage, and resources. I t reviews the extent to which the design reflected MICA’S internal and external environment, was conceptually complete (including objectives, resource and organizational requirements, and performance metrics), and provided a logical structure for achieving the strategy’s objectives. I t also addresses the evaluability o f the strategy (the degree to which i t contained monitorable actions and objectives). Mapping MIGA ’s Strategy: An Analytical Framework 3.2. One approach to analyze the structure o f strategies and describe relationships between overarching performance goals for the organization, its value proposition to i t s customers/stakeholders, and its internal initiatives and activities i s to map the relationships among these strategic building blocks. IEG adopted Kaplan and Norton’s approach for Strategy-Focused Organizations and Strategy MapI3 and used i t as a lens through which to view and help analyze MIGA’s FY05-FY08 strategy. The approach i s further described in Annex 1. 3.3. Such an analytical tool i s useful (even if i t was not applied during the initial strategy design) to identify systematically components and relationships in the logical structure o f the FY05-FY08 strategy. Thus, this evaluation organizes the presentation o f analysis according to four perspectives o f strategy analysis identified by using this approach. These are (i) financial and development perspective, (ii)customer perspective, (iii)internal perspective, and (iv) human capital and resources perspective. 3.4. As indicated above, the 2005 Strategic Directions (described in more detail in Section 2) was MIGA’s first comprehensive exercise to develop strategic directions and to firmly articulate the Agency’s mission as a development institution. The strategy also emphasized M I G A ’ s role as a member o f the W o r l d Bank Group and i t s implications for increased alignment and collaboration among the institutions. The strategy was informed by analysis o f the different aspects of MIGA’s business environment and i t s operations. The remainder o f this section examines the structure o f the strategy in more detail according to each o f the aforementioned perspectives. Context 3.5. MIGA has a unique status within the WBG and among investment insurers alike in that i t offers only one narrowly defined product, political risk insurance. This has a number o f operational implications. First, it has to fully recover i t s costs and cover i t s r i s k s from the guarantees i t underwrites and does not have the ability to cross-support one business line with revenues from another during a time o f declining demand or price for l3Robert Kaplan & David Norton. The Strategy-Focused Organization: H o w Balanced Scorecard Companies Thrive in the N e w Business Environment. Harvard Business School Press, September 2000. The strategy map i s a way to view the relationships between the four components o f the traditional balanced scorecard. 7 i t s insurance product (while national insurance agencies or private insurers typically offer a portfolio o f financing or insurance products). Its administrative costs are also higher compared to many competitors due to costs associated with fulfilling its development mandate and complying with W o r l d Bank Group policies. Second, due to the nature o f i t s business, M I G A ’ s approach i s necessarily largely reactive to market demand rather than proactive as can be the case for a financier. Third, MIGA’s ability to offer products i s constrained b y i t s Convention and Operational Regulations, which make MIGA guarantees a more restrictive product than those offered by the W o r l d Bank and IFC. A. Financial and Development Perspective At the highest level, the strategy depicts MIGA’s dual mandate as a development institution, and as an insurance agency. MIGA ’s strategic directions emphasized the need to enhance its development impact and strengthen its financial sustainability. 3.6. In FY04, M I G A had faced challenges in i t s operating environment and performance. At the time o f its strategy formulation, MIGA had been experiencing a substantial decline in guarantees issued from a high of $2.0 billion in FYOl to $1.08 billion in FY04. MIGA had also experienced an increase in cancellation^,'^ and return on operating capital (ROOC) had declined over the same period from 6.7 percent to 3.2 percent. Despite these challenges, MIGA’s only explicit performance objective at this highest level o f the strategy related to the growth o f i t s business. 3.7. I t i s difficult to determine the assumptions underpinning M I G A ’ s growth projections. The strategy indicated that MIGA would increase its business substantially from an average o f $1.27 billion in the three years preceding the strategy to between $1.6 and $1.8 billion in FY06 to FY08. The strategy also stated that if MIGA were able to expand i t s product offerings, i t could further extend its business by up to 100 to 150 percent over its average performance during FYO1-04 to a level o f $2.5-3.0 bi1li0n.l~The assumptions that resulted in these projections were not explicitly stated. 3.8. M I G A ’ s four operational priorities appear to have been derived largely from internal (supply side) factors and provided continuity with M I G A ’ s previous strategic objectives. The operational priorities were similar to and extended MIGA’s priorities from its FYOO strategy, and they reflected MIGA’s access to capital, i t s development focus, and its relationship with the W o r l d Bank Group (WBG). They were also aligned with research showing that risks for projects in conflict areas favor public or multilateral providers, particularly for large or salient investments in a poor country, or projects across international boundaries. l6 M I G A ’ s analysis o f the external environment suggested a direct relationship between increased FDI flows and increased insurance l4 There i s a management point o f view that cancellations are a positive indicator. In Operations Evaluation Unit: 2005 Annual Report - Draft Management Response. p. 2, management asserts that “. . . cancellations are generally a positive reflection o n the project, and not a negative . . . once these projects are up and running and the country risks are seen b y the investor as moderate and n o longer a barrier to their involvement, MIGA’s objective has been achieved and we are supportive o f such cancellations.” IsMIGA. MIGA 2005 Review for WOO-04 and Strategic Directions for FY05-08. April 20,2005, pp. 31- 32. l6West, Gerald T. and Kristofer Hamel. P. 220. 8 demand, despite research showing a more complex relationship.” The strategy surmised that projected increases in FDI flows would not b e enough to harden market conditions for public insurers, but noted that the projected FDI flow increase was “broadly encouraging for the industry.”l* 3.9. M I G A ’ s capital i s a significant resource that has been underutilized during the period under review:’ MIGA’s strong capital base i s consistently highlighted as one of MIGA’s strengths by clients and competitors. The decline in return on capital during FY00-04 and MIGA’s subsequent implementation of an economic capital m o d e l indicated that i t s capital was not fully deployed. MIGA’s FY05-08 strategy document stated that i t was in the process of implementing an economic capital m o d e l in order to strengthen i t s ability to analyze and assess i t s balance sheet strength and deploy i t s capital on the basis of r i s k considerations,20 (see para. 4.24 ff. on risk management) but i t did not address how i t would more effectively deploy i t s operating capital or improve i t s return o n operating capital (ROOC). B. Customer Perspective: M I G A ’ s Comparative Advantage and Operational Priorities From this perspective, which refers to the components o f MIGA ’s customer value proposition that diflerentiates it from other providers, M I G A ’s strategy defined a concentration on customer segments in high risk member countries with an emphasis on infrastructure development. The strategy defined some o f the value proposition components for each customer segment by operational priority. 3.10. M I G A ’ s definition of its core competencies and comparative advantage was informed by perceptions and feedback provided by market participants and consequently had a sound supply side view of its strengths in the global market. M I G A ’ s FY05-FY08 strategy described i t s core competencies as understanding risk and providing protection; resolving disputes and leveraging World B a n k Group relationships; financial strength; and integrated technical assistance. I t identified i t s comparative advantage for i t s private sector clients as i t s deterrence effect, mediation abilities, certification effect (compliance with environmental and social best practices), financial strength, country knowledge, and l o w e r borrowing costs.21 A recent study for MIGA on the PRI industry has confirmed that MIGA remains at the top of i t s peer group with respect to i t s reputation, knowledge and expertise, financial strength, environmental and social standards requirements, ability to p a y claims, and capacity to resolve dispute^.^^)^' ” West, Gerald T. and Kristofer Hamel. “Whither the Political Risk Insurance Industry?’ in International Political Risk Management, Vol. 3: Looking to the Future. World Bank Publications, June 30 2005, p. 215. This study found that there i s no direct relationship between FDI flows and demand for political risk insurance. ’* MIGA. MIGA 2005 Review for FYOO-04 and Strategic Directions for FYO5-08. April 20, 2005, p. 27. l 9 l 9 MIGA. MIGA 2005 Review for FYOO-04 and Strategic Directions for FYO5-08. April 20, 2005, p. 17. MIGA strengthened its capital base with the approval in 1999 of a General Capital Increase (GCI) of $850MM and a transfer of $150MM from IBRD 2o MIGA. MIGA 2005 Review for FYOO-04 and Strategic Directions for FYO5-08. April 20, 2005, p. 58. 21 MIGA. MIGA 2005 Review for FYOO-04 and Strategic Directions for FYO5-08. April 20, 2005, pp. 2-3. 22 MIGA. Political Risk Insurance Study. PriceWaterhouseCoopers. March 10,2008, p. 46. 9 3.1 1. The analysis of the external environment to support the rationale for the operational priorities was useful but had some contradictions. MIGA research had identified several demand side factors affecting the PRI industry such as increasing reliance on self-insurance and commercial banks questioning the value o f political risk insurance and preferring comprehensive insurance instead.24 I t s analysis o f the external environment also observed that i t s ‘deal flow’ had fallen for the second year in a row, market capacity was in oversupply, and the political risks market was continuing to soften.25 However, i t s analysis did not reflect the fact that Berne Union had reported a surge o f overall PRI business in 2004.26 3.12. The operational priorities could have been strengthened by defining complementarities, the relative size of the opportunities they presented and how the portfolio as a whole would be managed. I t was not evident if MIGA expected to generate more o f i t s business from infrastructure or from south-south investment. The strategy did not explicitly discuss whether MIGA wanted to pursue other business in addition to i t s operational priorities in order to support i t s financial viability and balance i t s portfolio. Given MIGA management’s observations about the market conditions overall and the challenges o f developing business inherent in some o f the operational priorities, there was a gap in explicit analysis and rationale as to how MIGA expected to manage the complement o f operational priorities and meet performance objectives (risk management, growth and development impact) for i t s portfolio. C. Internal Perspective The strategy describes internal capabilities and initiatives needed to deliver M I G A ’s customer value proposition, and consequently its financial and development impact peg5ormance. Thus, MIGA ’s strategy identifed objectives and initiatives such as a better internal alignment, coordination and collaboration within the WBG, product development, improved marketing and business development, and improved risk management. Internal Processes, Methods and Alignment 3.13. The 2005 strategic directions called for a number of changes in MIGA’s internal processes and organization, including: Closer and more collaborative relationships with host countries to address constraints holding back foreign investment; 23 External studies also identified weaknesses such as cumbersome underwriting requirements, lack o f flexibility in product offerings, and l o w responsiveness. 24 The World Bank. MIGA Partners’ Study o n Political Risk Insurance, Technical Assistance and Mediation: Political Risk Insurance Study Final Report. PricewaterhouseCoopers. September, 2005, p. 16. 25 MIGA. MIGA 2005 Review for ROO-04 and Strategic Directions for R O 5 - 0 8 . April 20,2005, p. 26. 26 Berne Union. In the press release Business Volumes up 21 percent to $788 billion for Berne Union members-Record Year for Export Credit and Investment Insurers. October 6,2005 10 A more proactive approach to marketing and business development i n v o l v i n g investor targeting and deepening relationships with k e y clients, better understanding of investor business strategies, w h i c h require the development of n e w client relationship approaches and systems; Expanded MIGA product offerings to better meet the needs of the marketplace, including n e w tools such as trust funds for S M E investors, and covering different types of investments such as stand-alone debt, existing investments, local investments, and portfolio treaty reinsurance for developing country insurance 21 agencies; Institutionalized coordination between the Bank’s Project Finance Guarantees unit and MIGA to establish a complementary basis for management and deployment of the instruments; In the area of finance and r i s k management, implementation of the economic capital m o d e l to strengthen risk-based analyses, mitigate and hedge insurance portfolio risk (including a review of the reinsurance program), set risk-based portfolio management policies (country and project exposure limits), and manage MIGA’s assets; An improved underwriting process aimed at advancing the project selection process; and Creation of a coherent and integrated monitoring and evaluation system across the Agency. T h e document did not explicitly refer to further organizational alignment within MIGA as a result of the strategy, in addition to the changes implemented as part o f the n e w business ‘model (see para. 4.9). Alignment within the World Bank Group 3.14. MIGA’s operational priorities aligned with the Bank’s anti-poverty strategy. At the institutional level, M I G A ’ s F Y 0 5 - F Y 0 8 strategy articulated the necessity of aligning with the World B a n W I D A and IFC. In particular, MIGA’s strategy aligned with the Bank’s focus on improving investment climates, w h i c h included a focus on revitalizing infrastructure and tackling risks and uncertainties affecting developing countries. Regionally, M I G A ’ s focus on A f r i c a aligned with the Bank’s priorities for that region. 28 3.15. M I G A ’ s F Y 0 5 - F Y 0 8 strategy stated that MIGA would focus on projects and activities that supported the agenda o f the WBG and that i t would work closely with the Bank, investors, and host governments in a selected set of countries to identify projects and programs that would fit with country assistance strategies (CAS).29 3.16. The strategy document also indicated that during the strategic review exercise, MIGA had considered whether i t should remain a stand-alone entity or b e incorporated 27 MIGA noted that i t was studying these areas and would revert to the Board with a proposed approach, including changes to the Convention. 28 World Bank. Annual Report 2005. p. 32. 29 MIGA. MIGA 2005 Review for FY00-04 and Strategic Directions for FYO5-08. April 20, 2005, p. 30. 11 into the World Bank or IFC. MIGA had concluded that i t would remain independent and also noted that “. . . i t i s essential that the agency must find ways to work with the W o r l d Bank and the IFC in a more systematic and coordinated way, to realize the benefits that can be achieved through complementary activities, and that this commitment must come from the top management o f each o f the institution^."^^ Structure to Link Objectives, Outcomes, and Performance Metrics 3.17. Some links and relationships between components of the strategy were not made explicit. For example, MIGA could have linked the customer perspective (value proposition b y operational priority) to the financial perspective to make clear which operational priorities MIGA expected would contribute more to i t s development mandate, which was expected to drive growth and whether there was an additional, implicit priority to underwrite projects for portfolio risk management purposes. In this regard, MIGA would also have benefited from linlung financial, growth, and developmental objectives. 3.18. MIGA’s FY05-08 strategy had few explicit targets against which to measure achievement of i t s objectives, with the exception of a growth target for overall business volume and projections for operating income. The strategy presented a broad range o f activities and initiatives to address i t s business model, four operational priorities, and a focus on Sub-Saharan Africa. The business plan supporting the strategy provided some additional targets such as increasing the share o f new business in infrastructure by 30-35 percent and building new business in the Africa region b y 20-25 percent.31 IEG recognizes that setting such business targets w i l l always i m p l y uncertainties given the primarily demand-driven nature o f much of MIGA’s guarantee business. However, difficulties do not imply impossibilities. The strategy had set some targets for overall business growth (see para. 5.3). The strategy’s approach o f listing activities against the operational priorities did not provide insight into the outcomes expected from these activities such as how achievement in implementing activities would help the Agency reach i t s strategic objectives. Although the strategy outlined by fiscal year a l i s t o f planned actions, outcomes, and indicator^,^^ the relationships among them were not clear. Structuring a clear and direct relationship among actions, outcomes and indicators would have better informed an understanding o f the interdependencies and priorities among the activities that the strategy identified. 3.19. Moreover, the strategy provided only partial indicators for the Agency’s performance. With only a growth target and projections for operating income, i t i s difficult to determine the expected and realized contributions o f actions to the Agency’s strategy. This also makes i t difficult to consider where management could later have changed course if initiatives were implemented but the expected outcomes were not achieved. 30 World Bank Group. MIGA 2005 Review for FYOO-04 and Strategic Directions for FYO5-08. May 10, 2005, p. iii. 3’ MIGA. MIGA’s Three-Year Business Plan (FY06-FY08) and FY06 Administrative Budget. May 31, 2005, pp. 29-30. 32 MIGA. MIGA 2005 Review for FYOO-04 and Strategic Directions for FY05-08. April 20,2005, pp. 63- 64. 12 Evaluability of the Strategy 3.20. The only apparent w a y t o monitor the strategy’s implementation would have been against the overall growth targets (by volume of guarantees) and by the completion of initiatives. The strategy did not clearly define a prioritized or interdependent set of outcomes and indicators and did not make evident how resources were to b e allocated. Therefore, i t i s difficult to clearly identify or address areas of strategic underperformance. D. Human Capital and Resources Perspective Concerning this perspective, MIGA would use its resources and enable delivery o f the other components o f the strategy, including capabilities and skills, stafing, and technology applications to support information tracking, analysis, and reporting. MIGA ’s strategic directions document addressed some of these needs. 3.21. The strategy contained little information or analysis to describe the resource requirements for each of the operational priorities and for ‘scaling up the business’, including for required staff capacity and capabilities. From the strategy and i t s accompanying business p l a n and administrative budget, i t was not clear how the budget was allocated in order to y i e l d w h i c h expected results, what were the ‘big ticket’ items, which activities were n e w investments or multi-year investments, and w h i c h allocations were dependent on or of higher priority than others. Similarly, as described in paras. 4.27 ff., the skills and staffing required to support delivery of the operational priorities were not evident. Conclusions 3.22. MIGA’s 2005 Strategic Direction document was the f i r s t for the Agency to incorporate development, business, and risk management aspects. I t stated objectives, priorities, and some of the resource requirements for achieving those objectives, but i t lacked a complete logical structure that would a l l o w to understand how overall objectives would be reached. T h e strategy did not connect effectively the two levels of the organization’s financial and development impact objectives to the operational priorities and subsequently to the m a n y initiatives and activities identified. I t did not adequately link achievement of individual activities and progress in priority areas to overall performance objectives. Doing so would have allowed a further focus on a clear and prioritized l i s t of actions, outcomes and indicators for how to achieve i t s macro (financial and developmental) objectives. Similarly, although MIGA identified resource needs to implement the strategy, it was not evident how these would be allocated to support strategic priorities and actions such as business development or development of n e w products, h o w these would fulfill the organization’s operational priorities, and ultimately lead to i t s financial and development impact performance goals. 13 4. IMPLEMENTATION OF THE STRATEGY 4.1. This section assesses whether MIGA has been consistent in implementing the concepts proposed in i t s strategy from the customer, internal, and human capital perspectives or whether i t adjusted the implementation process in response t o gaps in the conceptual strategic framework o r as a reaction to changes in the context. Implementation from the financial and development perspective i s examined in section 5. Accordingly, this section focuses on changes in organization, resource a l l ~ c a t i o n s ,~k i~ lls mix, processes, and procedures, assessing whether they were consistent with and strengthened M I G A ’ s ability to implement i t s strategic objectives, and whether MIGA’s core functions were aligned with the strategy. T h i s section also describes changes in risk analysis and risk management relative to M I G A ’ s business objectives. A. Customer Perspective Product Development and Leadership 4.2. M I G A has underwritten innovative projects and shown adaptability within i t s limited product range. During the F Y 0 5 - 0 8 strategy period, MIGA has supported several innovative deals. In F Y 0 5 , f o r example, MIGA issued guaranteed to the first cross-border issuance of mortgage-backed securities in the Baltic region, supported two large cross-border projects (West African Gas Pipeline, N a m Theun 2 Power Company Limited). In FY06, MIGA provided coverage t o i t s first carbon credit finance project in El Salvador and to a residential mortgage-backed securitization in Kazahkstan, the first such transactions in both countries. The Agency also issued i t s first guarantee of an international private placement (bond issue) to support financing a toll-road projects in the Dominican Republic. In F Y 0 8 , MIGA also issued i t s first guarantee for an Islamic financing facility to benefit a new container terminal in Djibouti. These projects involved guarantees covering m u l t i p l e countries, difficult environmental or social issues, and the participation of other multilateral donors o r insurance agencies. 4.3. Despite considerable support to innovative projects, M I G A has made little progress on more general product development, which i s constrained in part by its Convention and Operational Regulations. MIGA’ s basic product range for PRI has not changed since i t s Convention was adopted in the mid-l980s, under very different conditions in the global financial markets. M I G A ’ s Convention and Operational Regulations restrict the eligibility requirements and the types of risks MIGA i s able to cover, which hinders i t s adaptability to n e w market trends. MIGA’s 2005 PRI study noted that PRI providers were looking at a range of n e w products in response to changing market conditions. I t outlined in particular that respondents had suggested a leadership role for MIGA in assessing the risk of sub-sovereign transactions, and solutions to 33 Resources are defined to include financial resources, human resources, know-how, processes, procedures, and organizational structure. 14 address regulatory risk.34 Respondents also suggested new types of political r i s k for w h i c h there would be demand such as comprehensive non-payment coverage, sovereign non-honoring coverage, existing equity and acquisitions, and stand-alone debt coverage. T h e 2005 strategy noted the limitations MIGA faced such as i t s inability to engage in certain types of transactions due to i t s Convention and indicated that n e w products c o u l d produce significant growth, but that the necessary studies would take some time.35 I t outlined several options for new product offerings including a trust fund to provide matching funds to S M E investors, coverage for stand-alone debt, coverage for existing investments, portfolio treaty reinsurance for developing country insurance providers and coverage for local investors in joint ventures with foreign partners. In addition, the FYOS business p l a n reiterated the critical need for MIGA to remain relevant and the importance of product development in this regard, but i progress on developing and innovating i t s product has been l i m i t e d over the current strategy period. Client Relationship Management and Business Development 4.4. MIGA has made some progress in i t s efforts to improve i t s client relationship management (CRM) but the role of and responsibility for business development i s not clearly defined. T h e FY05-FYOS strategy highlighted the need for i m p r o v e d client relationship management approaches and systems and described a number of activities to better understand and target investors as w e l l as to implement a CRM system.36 In its FYOS business plan, MIGA stated i t s intentions to implement a more systematic process of identifying k e y investors in each sector, cultivating relationships to encourage repeat clients and attract potential k e y clients.37 Recent IEG discussions with staff indicated that the roles and responsibilities with respect to managing client relationships and engaging in business development activities continue to require improvement and could be m o r e systematic. 4.5. Staff also noted the absence of business development plans for underwriting sector teams to help improve planning and coordination, which would include objectives, responsibilities, and resources, and would allow MIGA to measure at the end of each period i t s effectiveness in business development and origination. Similarly, there was an absence of performance incentives f o r individual staff to improve business origination and client responsiveness. MIGA has devoted some efforts and resources to improve i t s CRM function during the implementation period, and i s undertaking a multi-year effort to upgrade i t s management information system, w h i c h i s expected to become operational in FY09 and w i l l include a database linking a l l aspects of CRM. But m o r e efforts are needed in terms of assigning and clarifying responsibilities of individual staff for managing specific clients and k e y accounts. 34 The World Bank. MIGA Partners’ Study on Political Risk Insurance, Technical Assistance and Mediation: Political Risk Insurance Study Final Report. PriceWaterhouseCoopers. September, 2005, p. 20. 35 MIGA. 2005 Review for FY00-04 and Strategic Directions for FY05-08. April 20,2005, p. 62. 36 MIGA. MIGA 2005 Review for FY00-04 and Strategic Directions for FYO5-08. April 20, 2005, p. 39. 37 MIGA. MIGA’s FY08 Business Plan and Administrative Budget. M a y 16 2007, p19. 15 Small Investment Program 4.6. MIGA established a Small Investment Program (SIP) in FY06 to increase i t s business in the SME market and to streamline i t s procedures for small guarantees. T h e program, with an initial per project coverage limit o f US$5 million, targets small and m e d i u m investors (SMIs) investing in SMEs, offering standardized terms at l o w e r f i x e d p r e m i u m rates and a streamlined underwriting process to make i t m o r e accessible to small investors and cost efficient for MIGA. IEG evaluated in 2007 the implementation 38 of this program. 4.7. S I P projects reflected MIGA’s operational priorities, but the program’s implementation has had some shortcomings. Most projects were in the program’s target sectors and regions, and in some cases, MIGA had played an important role by assisting the investor in structuring successfully the deal for the project. There were some inconsistencies between the program’s stated objectives, the e l i g i b i l i t y criteria, and the type of projects underwritten under the SIP. The streamlined process, w h i c h intended to reduce underwriting costs and the burden on small investors, also resulted in little documentation on project financial viability and the analysis of expected development impact .39 4.8. T h e results of the S I P and i t s projects have not yet been evaluated. In January 2008, the B o a r d approved the expansion of the SIP program, increased the coverage limit t o $10 million, and clarified some eligibility criteria. Of the 15 projects that were provided coverage under SIP until December 2007,4 h a d been cancelled after 1 or 2 years, a somewhat higher rate of cancellation than for regular MIGA projects-- several of them due to the project not going forward or financial difficulties. The higher cancellation rate reflected the program’s focus on high risk markets such as frontier and conflict-afflicted countries and also meant that those projects that were not implemented have h a d no measurable development impact. B. Internal Perspective Alignment of Core Business Functions within MIGA 4.9. T o support implementation o f the 2005 strategy, the internal organization has become more functionally aligned. In FY04 MIGA adopted a n e w business model and a flatter organizational structure. T h e number of departments was reduced from nine to six as was the number of senior managers. In FY04 an Economics and P o l i c y Group 3s The review focused on the design o f the program and whether these first projects have met the original intent, objectives and eligibility requirements. I t is not an evaluation o f project or program outcomes since these projects are very recent and their development impact cannot yet be assessed. The assessment includes all 13 SIP projects underwritten since FY06 through the third quarter of FY07, corresponding to 20 Contracts o f Guarantee, for a net exposure of US$30 million. 39 IEG recommended that MIGA should tighten the SIP eligibility criteria to ensure that the program i s fully focused on its intended clients-small investors and small and medium sized enterprises. IEG also recommended that the program should exclude projects with concessions as well as those in the infrastructure, oil, gas and mining sectors, and that MIGA strengthen the quality and documentation o f the development impact analysis o f SIP projects. 16 was created along with the new role of Chief Economist. Country risk analysis, policy work, developmental assessments and environmental and social analysis was centralized in this group. In F Y 0 4 Online Services was moved to the External Outreach and Partnerships Department where marketing resided. Some initiatives to streamline the Agency did not increase synergies (see B o x 1). Operational Alignment with WBG 4.10. Although MIGA selectively participates in joint Country Assistance Strategies (CASs) and Country Partnership Strategies, this may not be the most effective instrument of coordination for a small agency. MIGA provides inputs in CASs based on whether the country i s important in terms of MIGA exposure or there are issues with MIGA project^.^' In i t s strategy, the Agency stated i t would be “playing an active role in the development o f country assistance strategies (CASs), being proactively involved in analytical work and ongoing policy dialogues, and tailoring interventions to support and complement World Bank Group operational work.”4’ Given the agency’s size and the nature and magnitude o f MIGA’s business in each country, and the Agency’s size, providing inputs to the CAS may not be the most effective way o f coordinating i t s operations with Bank Group strategies. During the FY05-08 strategy period, MIGA has become much more proactive in consulting with Bank staff to ensure that the projects i t underwrites are consistent with and support Bank priorities in the country or sector. This project level coordination approach may in fact be a more relevant way for MIGA to ensure alignment, reserving participation in the CAS process for those countries where MIGA’s participation in the policy dialogue with the host country i s considered essential. 4.11. M I G A has changed i t s business model to ensure i t s operations align well with Bank strategies and policies. The IEG 2004 Review o f Development Effectiveness found that at that time “guarantee projects fit MIGA’s mandate and the host country’s priorities for most o f the cases, but could be better linked with the C A S S . ” ~ ~ IEG’s 2007 Annual which looked at new MIGA projects underwritten between January 1,2005 and June 30, 2006, stated that “the projects are well aligned with country and WBG strategic priorities. In almost all cases, MIGA indicated how the project fit with the Country Assistance Strategy (CAS), and consulted with the Bank and I F C on macroeconomic and sector issues as needed.”44 With respect to Middle Income Countries, IEG noted that “Since 2004 MIGA has stepped up collaboration [with the World Bank] at all three levels [strategic, institutional and ~perational].”~’ 40 Interviewswith select MIGA staff. February 11, 2008. 41 MIGA. MIGA 2005 Review for WOO-04 and Strategic Directions for FY05-08. April 20,2005, p. 5. 42 MIGA. 2004 Review of Development Effectiveness in MIGA. August 19,2004, p. 2. 43 MIGA. Independent Evaluation Group - MIGA 2007 Annual Report. June 18,2007, p. 2. In this period there were 77 guarantee contracts underwritten for 46 guarantee projects. 44 MIGA. Independent Evaluation Group - MIGA 2007 Annual ReDort. June 18,2007, p. 12. 45 MIGA. Independent Evaluation Group - MIGA 2007 Annual Report. June 18,2007, p. 12. 17 Box 1: Realignment of MIGA’s Technical Assistance (TA) Function In 2004, MIGA merged the guarantees and TA departments into the Operations Group t o capitalize on the potential synergies between TA and the guarantees although MIGA thought at the time that linkages between TA and guarantees were typically indirect.47 The Strategy did not articulate the expected benefits for the underwriting teams or MIGA’s clients and partners from the realignment. According t o staff, in retrospect the integration o f guarantees and TA failed because linkages between the two were quite weak in practice. TA helped MIGA’s understanding o f country dynamics particularly in Africa but did not work as well as was hoped in linking TA work and business development for MIGA guarantee^.^^ Accordingly, in F Y 0 7 MIGA TA was integrated into the Foreign Investment Advisory Service (FIAS). The integration w i t h FIAS, which had traditionally been working further upstream from MIGA TA but addressing similar investment- related issues, seems to be a step towards greater alignment o f WBG entities offering complementary services, and a better fit for MIGA’s TA services. 4.12. MIGA has implemented systematic project level coordination with the World Bank. During the implementation of the FY05-FY08 strategy, MIGA began systematic consultations with the B a n k on the projects for w h i c h MIGA i s providing support. A l t h o u g h there are no f o r m a l mechanisms to structure these interactions, s t a f f indicate that this coordination happens systematically as part of the regular course of w91-k.~~ Staff describe these as w o r k i n g relationships with both the country teams a n d the B a n k sector specialists. In practice, consultations on whether a MIGA project f i t s within the B a n k p r o g r a m has clearly increased since 2004; MIGA also seeks and benefits from the Bank’s country, sector, and p o l i c y k n ~ w l e d g e . ~ M ’ o r e systematic consultations between B a n k country a n d sector departments have helped ensure that M I G A - s u p p o r t e d projects are consistent with B a n k Group strategies. All MIGA projects underwritten during FY06-07 were consistent with WBG country strategies or policies, based on a desk r e v i e w / p r o f i l i n g of n e w MIGA projects. W h i l e coordination with the B a n k i s an important w a y for MIGA to manage risks a n d to leverage i t s relationship with the WBG in projects, this has c o m e at a cost in terms of t i m e spent by MIGA staff on c o m p l e t i n g a transaction. 4.13. However, the principles governing the relationship between IFC and M I G A products have not been clear.51 T h e relationship between MIGA and IFC has not always been free of friction. MIGA and IFC have been jointly i n v o l v e d in about 10 projects over the last 10 years. However, staff indicate that coordination a n d collaboration with IFC has not been at the l e v e l of interaction reached with the World B a n k . This m a y b e due to perceived competition between the products the two institutions offer. IFC has emphasized with clients a n d in j u s t i f y i n g i t s r o l e in projects 46 MIGA. MIGA 2005 Review for FYOO-04 and Strategic Directions for FYO5-08. April 20,2005, p. 15. 47 MIGA. MIGA 2005 Review for FY00-04 and Strategic Directions for FY05-08. April 20,2005, p. 31. 48 Interviews with select MIGA staff. February 11,2008. 49 Interviews with select MIGA staff. February 11,2008. 50 Interviews with select MIGA staff. February 11, 2008. 5’ IEG: Catalyzing Private Investment for Development. 18 the substitutability o f the implicit risk cover o f i t s lending and equity investment instruments with MIGA’s political risk insurance.52 4.14. Infrastructure i s one area of MIGA operations that was identified a s an opportunity to align with and support the WBG’s work. According to IEG’s project reviews, a significant share o f the number o f new MIGA projects (25 percent) underwritten in FY06 and FY07 involved partners, and all o f these joint projects were undertaken in conjunction with either IBRD/IDA, or the IFC, or both. Five out o f the 13 projects undertaken jointly were in infrastructure. 4.15. A proposal to more closely align MIGA’s PRI and the Bank’s PRG instruments did not move forward. In FY05 MIGA proposed the full integration o f the Bank’s Project Finance and Guarantee (PFG) Unit into MIGA. PFG was to continue to operate as a World Bank program, but administratively i t was to be managed b y MIGA. The supporting business plan provided detail about the anticipated benefits o f the integration including optimal service delivery to private sector clients and government, enhanced coordination o f product offerings, closing o f potential product gaps, and creating an enhanced platform for knowledge sharing and i n n ~ v a t i o n .The~ ~ integration was to include co-locating PFG staff with MIGA underwriter^.^^ However, this proposal was initially delayed b y changes in the Bank Group’s senior management and the integration never materialized. Given the potential for overlaps in political risk mitigation products between the two institutions, such an approach could s t i l l be a viable proposal to strengthen product delivery across the WBG, but a subsequent World Bank reorganization resulting in the disbanding o f the PFG unit may have made organizational integration more challenging. IEG’s forthcoming evaluation of the use o f guarantees instruments notes that while several Bank Group products offer political risk mitigation in some form, these were originally conceived as complementary. In practice, however, there have been overlaps and competition among WBG institutions in the delivery o f political risk mitigation, driven by innovation and flexibility o f policies, especially in I F C and the Bank. Competition for MIGA has come in particular from traditional and new non-guarantee products offered b y IFC, which incorporate explicit or implicit risk cover. 55 Performance Management & Internal Reporting and Monitoring 4.16. MIGA lacks an enterprise performance management approach to guide its management of resources relative to the implementation of the strategic plan, and is now beginning to address seriously its internal reporting gaps. As far back as 2000 MIGA identified that i t needed to improve i t s performance management and that i t required technology systems and infrastructure to support this goal. One o f the gaps ’*See for example: OM2007-0065: Technical Briefing: IFC’s Additionality. P. 10. Also, IEG found that in approximately 10 percent of IFC projects (FYO5-07), implicit political risk cover was indicated as the primary reason for IFC ‘ s involvement (Catalyzing Private Investments, p. 63). 53 MIGA. MIGA’s Three-Year Business Plan (FY06-FY08) and FY06 Administrative Budget. May 31, 2005, pp. 35-36. 54 MIGA. MIGA’s Three-Year Business Plan (FY06-FY08) and FY06 Administrative Budget: Supplemental Note. June 22, 2005, p. 8. 55 IEG: Catalyzing Private Investment for Development, p. 61f. 19 where MIGA has made progress i s addressing (through the use of TRS) the lack of information on MIGA’s unit cost of underwriting and managing a g~arantee.~~ The FY08 business plan states that for the agency to be efficient and effective i t i s crucial that i t strengthen the links between resource allocation and work program deliverables. The plan states that MIGA will start using program budgeting methods in order to have the policies, procedures, systems, and necessary costing information in place.57 MIGA can build on recent efforts made in FY08 to systematize performance management and reporting going forward. 4.17. Performance monitoring of MIGA projects has been consistently weak throughout the implementation period. IEG’s annual reports since 2004 have identified the need for MIGA to introduce monitoring in order to have a better understanding of whether MIGA’s projects meet their development objectives. In i t s FY06 business plan MIGA indicated that i t intended to develop an integrated monitoring and evaluation system across the agency.” The IEG 2007 Annual Report noted that MIGA’s project monitoring framework to track project outcomes had made little progress in implementation and remained a challenge; no activities were highlighted to address project monitoring in the FY07 or FY08 business plans, and a monitoring framework i s s t i l l laclung in MIGA. Decision Making 4.18. M I G A has modified its processes, but these changes have not significantly improved client perceptions of M I G A ’ s service. MIGA modified some underwriting and decision malung processes in order to support implementation of i t s new business model and strategy. I t introduced a Project Review Committee to provide guidance to underwriting teams early in the process, thus malung underwriting more efficient. The PRI study that w i l l be an input into the FY05-FY08 strategy identified that among the areas which MIGA could improve were i t s decision malung and transaction rocesses, which were perceived as slow, with extensive documentation requirements3 MIGA simplified i t s contract of guarantee in 2004, and in 2005, MIGA approved new Guarantee Procedures to clarify the division of responsibilities among underwriting teams.60 The PRI study recently completed for the 2008 strategic planning exercise indicated that MIGA continues to be perceived as performin below i t s peer group in time needed to process applications and in customer service! and MIGA’s internal business process review also highlighted the need to improve client responsiveness through more efficient processes, improved decision-making, and delegation of authority while ensuring accountability and quality control. 56 IEG-MIGA 2006 Annual Report j7 MIGA. MIGA’s FY08 Business Plan and Administrative Budget. May 16 2007, p. 23. j8 MIGA. MIGA 2005 Review for WOO-04 and Strategic Directions for WO5-08. April 20,2005, p. 41. j9 The World Bank. MIGA Partners’ Study on Political Risk Insurance, Technical Assistance and Mediation: Political Risk Insurance Study Final Report. PriceWaterhouseCoopers. September, 2005, p. 21 6o MIGA. Independent Evaluation Grow - MIGA 2007 Annual Report. June 18,2007, p. 5. 61 MIGA. Political Risk Insurance Study. PriceWaterhouseCoopers, 2008, p. 46. 20 4.19. Average processing times for MIGA’s guarantee portfolio have increased during FY05-07. MIGA’s processing times vary widely between sectors and according to the type o f project. Larger projects and those with more complex environmental and social issues require the longest processing times.62 According to MIGA databases, for guarantees issued between FY05-07, the processing times averaged approximately 339 days, compared with approximately 250 days between FYOl-04. Increases in processing times were recorded in all sectors. The growth in average processing times reflects in part MIGA’s move into more complex projects, including those undertaken together with the W o r l d Bank, and other projects with longer gestation periods and requiring increased MIGA due diligence. Development Impact Analysis 4.20. The new business model helped to refocus the organization on its development impact. In 2004 and 2005, MIGA shored up i t s capabilities in this regard b y creating a new Economics and Policy Group and creating a Chief Economist position. I t built up its team and developed sound guidelines for underwriters (December 2004), which reflected the Board-endorsed methodology, to assess development impact, and support this dimension o f i t s critical ‘quality at entry’ process. 4.21. MIGA adopted a sound methodology to assess development impact, and its implementation i s improving. In i t s 2007 Annual Report, IEG found that MIGA’s performance had improved since 2004 in rigorously applying i t s assessment methodology spelled out in i t s guidelines for new projects63. However, i t s ability was s t i l l uneven to consistently analyze development issues. Out o f 18 projects for which a cost-benefit analysis was applicable, only five complied with presenting a full analysis in the decision documents, including an analysis o f potential economic costs, and the remainder demonstrated varying degrees of quality o f analysis.64 4.22. Staff awareness on development impact i s still limited. The IEG report also found that a majority (80 percent) o f staff preparing the decision documents were not fully familiar with all aspects o f specific requirements for development impact analysis. Underwriters considered the guidelines more as a general framework and saw the cost- benefit analysis required by MIGA’s own guidelines as ~ p t i o n a l . ~ ’ Environmental and Social Standards 4.23. MIGA has improved its performance in ensuring the application and monitoring of safeguards, and adopted in 2007 a new policy on social and environmental sustainability. MIGA’s attention to environmental and social standards has yielded more consistent results. Consistent with IEG recommendations to improve Measured from submission of a Definitive Application for a guarantee to the date when a guarantee contract became effective. I n i t s Operational Regulations, MIGA i s called upon to make prompt underwriting decisions, to be completed within 120 days from the receipt of a Definitive Application. 63 Guidelines on Assessing the Development Impact o f Operations Supported by MIGA Guarantees. December 30,2004. Frank. J. Lysy, MIGA Chief Economist. Paragraph 6. 64 MIGA. Independent Evaluation Group - MIGA 2007 Annual Report. June 18,2007, p. 15 65 MIGA. Independent Evaluation Group - MIGA 2007 Annual Report. June 18,2007, p. 16. 21 i t s performance in this regard, MIGA upgraded the role o f environmental and social specialists by requiring site visits for all category A and most category B projects and issued a guideline to ensure their early involvement. MIGA has also recently (2007) adopted a new policy on social and environmental sustainability and performance standards, which are harmonized with those o f IFC. In i t s 2007 Annual Report, IEG observed that 86 percent o f all assessed projects (including SIP) adhered satisfactorily to MIGA’s review procedures for addressing environmental and social issues at entry.66IEG highlighted that there were notable improvements in the way MIGA ensures that relevant specific safeguard policies are addressed, with the greatest improvement in social safeguard policies.67 Risk Management Methods and Tools 4.24. M I G A has supported its business model and operational priorities by developing and applying risk and finance methods to improve i t s decision making with respect to pricing, provisioning, reinsurance and capital deployment. MIGA implemented a new pricing methodology in FY04, which was amended in FY07. In FY05, i t implemented an economic capital model to help management gain a better understanding on the deployment o f capital on the basis of risk considerations and to achieve consistency with MIGA’s cost/pricing methodologies and provisioning.68 This model continues to inform MIGA’s risk-related approaches and the F Y 0 8 business plan highlighted MIGA’s role in reporting on the exposure and capital consumption of segments o f the guarantees portfolio and to evaluate the financial attractiveness o f new products.69 Throughout the implementation period, MIGA continued to improve i t s r i s k methods to provide management insight into performance and inform decision making. 4.25. M I G A has updated and refined its pricing method. In 2007, MIGA implemented several changes in i t s pricing model, including the integration o f the economic capital model, updating o f model parameters such as administrative cost allocation method, based on a review o f MIGA’s cost structure, and a review o f cancellation parameters. MIGA staff noted that the original 2004 pricing model had problems related to the share o f administrative costs allocated to larger projects, leading to high premium for such project^,^' an aspect that has been addressed through the 2007 model revision. This has increased MIGA’s competitive advantage in larger projects. The pricing model modifications also more accurately reflected actual economic risk b y replacing actual capital with economic capital utilization. 4.26. Revisions to the allocation to MIGA’s administrative costs were guided by a n effort to better understand MIGA’s fixed and marginal costs. A better understanding b y MIGA o f the recovery o f cost (or profitability) from underwriting different types o f projects should facilitate a more comprehensive decision-making process for determining underwriting strategy. Going forward, MIGA management 66 MIGA. Independent Evaluation Group - MIGA 2007 Annual Report. June 18,2007, p. 17. MIGA. Independent EvaluationGroup - MIGA 2007 Annual Report. June 18,2007, p. 18. ‘* 67 MIGA. MIGA 2005 Review for FY00-04 and Strategic Directions for FYO5-08. April 20,2005, p. 58. 69 MIGA. MIGA’s FY08 Business Plan and Administrative Budget. M a y 16 2007, p21. ’O Interviews with select MIGA staff. February 11, 2008. 22 needs to formulate clearer pricing principles and objectives that reflect this understanding o f marginal and fixed costs. Such principles could address the expected consequences o f transferring cost burdens from projects with certain characteristics to others, and how these consequences fit into MIGA’s strategic underwriting objectives. T o follow up, MIGA needs to monitor carefully the implementation o f the modified pricing model to see if there are any unintended consequences, such as penalizing certain types o f projects, sectors, or affecting overall cost recovery. C. Human Capital and Resources Perspective Resource Allocation 4.27. MIGA received a budget increase to support t..e implementation a its strategic directions. In the FYOO to FY04 period, MIGA’s real administrative expenses had risen 27.8 percent while guarantee income had stagnated. Based on i t s strategy, MIGA submitted a work program and budget request for FY06 with three o tions where the difference was in the pace at which the strategy would be implemented! The Board approved the high budget scenario (real budget increase o f 6.12 percent), with an expectation that MIGA would expeditiously implement i t s planned directions. 4.28. However, MIGA did not make explicit the connection between the expected increase in expenditure and areas of planned business growth. In i t s FY06 Business . Plan and Administrative Budget that supported the strategy, MIGA indicated that i t s requested budget increase would be allocated to additional travel related to marketing and outreach to build i t s pipeline in priority areas, travel costs to support scaling up i t s infrastructure business, staff and travel costs to deploy TA, retaining specialized legal counsel for complex infrastructure projects and additional publication^.^^ These are largely variable costs and are not linked to specific performance objectives or outcomes, while MIGA’s overall budget i s largely fixed in terms o f staff costs and World Bank Group charges. 4.29. During execution, MIGA has contained expenses and its actual administrative costs have remained flat. After an increase in FY06, MIGA’s subsequent budget requests involved decreases in real terms b y 3.0 percent (FY07) and 4.5 percent (FY08). Actual administrative costs have remained largely flat during FY05- 07, registering underruns o f on average just under 20 percent per year compared to the approved budget envelope in each o f the years. Human Capital 4.30. Overall staffing numbers do not appear to reflect changes expected in the strategy document. MIGA estimated in that document that it would need to hire approximately 10 additional professional staff over the implementation period to support ’ 71 MIGA. MIGA’s Three-Year Business Plan (FY06-FY08) and FY06 Administrative Budget - Supplemental Note, June 22, 2005, p. 3. The three options includedreal budget increases of zero, 3.75 ercent and 6.12 percent respectively. MIGA. MIGA’s Three-Year Business Plan (FY06-FY08) and FY06 Administrative Budget. May 3 1, 2005, p. 48. 23 i t s growth, without connecting this to specific business needs that warranted ~trengthening.~ This ~ anticipated increase does not appear in the subsequent supporting budgets. Instead, the complement o f internationally recruited staff remained constant between FY05 and FY07,74and total staff levels declined between 2004 and 2006 b y 14, in part due to transferring MIGA staff in areas such as Human Resources and Information Technology to central units in the Bank. 4.31. MIGA has not yet articulated an explicit human resources strategy, but it has in practice invested in training and skills upgrading, and hiring has been targeted towards new and current skills needs. Although MIGA recognized at the time the strategy was developed that there were areas where the organization needed to develop i t s human capacity, focusing on training and s l u l l s development for addressing a broader range o f risk mitigation issues,75 this does not appear to have been planned or followed through systematically. Such a strategy could have also linked recruitment and retention and incentives to support implementation o f the strategy and the operational plans. 4.32. Throughout the period, concerns were raised on MIGA’s ability to retain institutional knowledge, as i t faced staff turnover and experienced in some instances difficulties in filling vacancies. Staff surveys have pointed to areas o f consistent underperformance in MIGA’s HR management relative to the rest o f the Bank Group, such as staff morale, staff performance evaluations and rewards, innovation, and managerial effectiveness. Conclusions 4.33. Consistent with i t s new business model, MIGA has implemented systematic project level coordination with World Bank and has the significantly scaled up i t s efforts to ensure i t s operations align well with Bank Group strategies and policies. MIGA has also increased collaboration at the strategic and project level with the World Bank and increased the number o f products supported jointly with the WB and IFC. While positive and beneficial to MIGA, increased alignment and coordination has involved costs to the Agency. 4.34. MIGA has adapted i t s existing product to underwrite innovative deals, but has yet to make progress on more general development o f i t s product range, which would benefit from amendments to i t s Convention and Operational Regulations, in order to meet i t s potential and meet demand from private investors. 4.35. MIGA’s improvements o f i t s processes and procedures was uneven and i t has made little progress in some important areas. I t has recently made some progress in improving performance management, monitoring, and internal reporting, and stronger attention i s needed in this area. 4.36. MIGA has made progress on improving i t s ability to assess development impact. I t developed i t s methodology in this regard but has not yet been consistent in i t s 73 MIGA. MIGA 2005 Review for FY00-04 and Strategic Directions for FY05-08. April 20,2005, p. 62. 74 World Bank Group. Annual Review of Human Resources FY2007. August 2007. 75 MIGA. MIGA 2005 Review for FYOO-04 and Strategic Directions for FY05-08. April 20,2005, p. 61. 24 implementation. MIGA has harmonized i t s policy on social and environmental sustainability and performance standards with those of IFC. In particular, MIGA has also improved how i t ensures that relevant specific safeguard policies are addressed. 4.37. MIGA has improved i t s client relationship management function, but more can be done to improve the effectiveness of i t s business development, by drafting annual business development plans, clarifying the roles and responsibilities of individual staff and aligning performance incentives with agreed outcomes. 4.38. MIGA has also improved i t s risk and finance analytics, culminating in a modified pricing model implemented in FY08 which has addressed some shortcomings resulting in pricing distortions. During implementation of i t s strategy MIGA has improved i t s decision making with respect to pricing, provisioning, reinsurance and capital deployment although some work remains in this regard. 25 5. RESULTS OF THE STRATEGY 5.1. T h i s section presents some findings on the results that MIGA has achieved so far from the financial and development perspective. T h e section intends to shed some light o n the question of the extent to w h i c h the implementation of M I G A ’ s strategy has l e d to expected results. I t presents findings in terms of growth, portfolio shifts, progress made on meeting some monitorable objectives and indicators established in the MIGA strategy document, trends and characteristics o f projects underwritten during FY05-07, and alignment at appraisal of individual MIGA projects with World B a n k Group country or sector strategies. I t does not include development outcomes of projects underwritten during the FY05-08 period. This assessment recognizes the t i m e lags i n v o l v e d with the implementation of changes to the business model, policies, and guidance discussed in Section 4, and that i t would take time for changes to b e reflected in M I G A ’ s operational performance. A. Operational Results Portfolio Growth and Composition 5.2. M I G A ’ s strategy document anticipated overall growth targets for the Agency during FY05-08 and an expectation of increased focus in four operational priorities. In addition to overall growth targets (para. 2.5), the identified operational outcomes included (i) increased level of S M E transactions through the SIP in A f r i c a and MENA (see 4.6 ff); (ii) growth and diversification of the portfolio; (iii) growth of portfolio in African post-conflict countries; and (iv) increased investor interest in non traditional sectordmarkets. Among the k e y indicators were total amounts of new MIGA business in infrastructure, new SIP business in A f r i c a and MENA, proportion of n e w business going to frontier countries; increased volume o f S M E and post-conflict business; and number of n e w sub-national projects supported and in the pipeline. However, the strategy largely did not set expected target ranges for these indicators (see para. 3.17), other than in broad, qualitative terms, and there was clearly an expectation of directional changes in M I G A ’ s n e w business volume towards the four priority areas. 5.3. M I G A ’ s business volume has increased steadily since i t s low point in FY04 but did not reach i t s expected annual business levels until FY08. (See Figure 2). MIGA’s business volume f e l l by almost h a l f between FYOl and FY04, and during FY04 relied on one financial sector client for i t s business. Since FY05, business volume has increased but until F Y 0 8 MIGA has not reached the growth targets l a i d out in the strategy document, w h i c h called for a range of $1.6-1.8 billion. T h e change registered in F Y 0 8 m a y reflect the t i m e l a g from actions adopted by MIGA during the last 3 years, as examined in Section 4, including the change in the p r i c i n g model. Sustaining the recent business growth w i l l b e important f o r M I G A ’ s institutional sustainability in the future. 26 Figure 2. M I G A Guarantee Volume (FY90-OS) Ey08 figure i s actual business volume between July 1 and March 31,2008. 5.4. MIGA’s outstanding portfolio has remained constant. On a gross basis (i.e., before reinsurance) MIGA’s outstanding portfolio was $5.2 billion at the end of FY04 and $5.3. billion at the end of FY07, and net exposure (after reinsurance) showed a small decline from $3.3 b i l l i o n to $3.2 b i l l i o n over the same period. Both numbers have been remarkably stable since FYO1. 5.5. Table 1 presents some k e y characteristics of M I G A ’ s guarantee activities during FY05-08 and the previous strategy period. I t points to an increase over time in the average size of projects insured by MIGA, reflecting the rise of “mega-deals’’ in M I G A ’ s portfolio. Table 1: Key Characteristics of MIGA’s Guarantee Activities FY00-08 I FYOO-04 I FYO5-07 I FY08(Q3) I Average volume of guarantees issued per year, gross 1.455 1.296 1.874 ($ billion) Number of Projects Supported p.a. 40 35 18 Average Number of Contracts of Guarantee p.a. 58 58 30 Average Project Size (exposure per project, in $ 36.371 36.688 104.100 million) 5.6. MIGA’s share of the political risk industry has decreased in recent years, w h i l e Berne Union (BU) members have continued to increase their business even as MIGA’s business has remained flat. M I G A ’ s share in 2007 was approximately 4 percent of the relevant market, a decline f r o m 6 percent in 2004, during a period when the insurance market has recovered f r o m the conditions following the September 11 attacks and the fallout of the Argentine crisis.76 T h e relative decline for MIGA also reflects 76Based o n estimates provided by the Berne Union, the association of investment insurers and export credit agencies, but excludes some important insurers, such as Lloyd’s syndicates. Berne Union members report 27 increased supply o f political risk insurance, with capacity increasing as a result of new market entrants and expanding offerings b y existing providers. MIGA's share o f PRI in frontier countries has been volatile, falling from 10 percent (2005) to 4 percent in 2006 before i t rebounded to 9 percent (2007). 5.7. Despite the variety of risk-mitigation products available to investors, the demand for PRI products continues to be robust, as reflected in the rapid growth o f new business by Berne Union investment insurance members from 2005 through 2007. In 2001, the total new business b y BU members amounted to $16 billion; in 2007 these members generated $62 billion in new business as investors prepared for the resurgence o f traditional political risks, especially expropriation risk, which until early in this decade had been largely discounted. Recent episodes o f expropriations and nationalization in Bolivia, Ecuador, Venezuela, and Russia have underlined the continued need for traditional PRI. 5.8. MIGA's share in the PRI market has been eroded by private insurers offering a wide range of tailored guarantee and finance products and lower premiums. Private insurers offer tailor-made financial products that MIGA and some national insurers are unable to offer because of the limitations in their charters. In M I G A ' s case, i t can only insure eligible investments consisting o f equity or quasi-equity but its coverage o f debt i s limited to loans with a link to equity. Competition from private insurers has also pushed down the premiums for PRI coverage, many suppliers of which have a different cost structure than MIGA with its development mandate. Private insurers have also expanded their business into higher risk countries, especially in Africa. 5.9. Over the FY05-08 period;' M I G A has made important efforts to diversify the regional and sectoral distribution of the portfolio, following a sharp increase in portfolio concentration in the Europe and Central Asia (ECA) region and in the financial sector during FY04-05 (due to reliance on two financial sector clients in ECA). Significant improvements were achieved in FY06 and FY07 in terms of sectoral and regional diversification (Figures 3 to 6), yet partial results for F Y 0 8 indicate a return to high concentration levels. exposure for transfer restriction, expropriation, war and civil disturbance, breach o f contract, and non- honoring o f a sovereign guarantee; the latter i s not offered by MIGA and other public agencies. The statistics also reflect changing Berne Union membership, which added a new member in 2004, which accounted for 3.4 percent o f exposure during that year. 77 Business numbers include results for FY08 up to March 31,2008 (3" quarter). 28 Figure 3: Share of New M I G A Guarantees by Region and Sector (in Percent of Exposure) Yearly Average FY 2000-2004 Yearly Average FY 2005-2008 MENA Africa MENA Africa 1c? l h ECA 49% Figure 4: Share of New M I G A Guarantees by Region, by FY (in Percent of Exposure) 0 Asia 0 MENA LAC ECA 0 Africa 2000 2001 2002 2003 2004 2005 2006 2007 2008 (03) Figure 5: Share of New M I G A Guarantee Exposure by Business Sector Yearly Average FY 2000-2004 Yearly Average FY 2005-2008 Pgribusiness, Pgribusiness, Oil, Gas and Manufacturing Oil, Gas and Manufacturing Mining . 1U"/O and Services Mning and Services 16% 10% 29 Figure 6: Share of New M I G A Guarantee Exposure by Sector, by F Y (in Percent of Exposure) 0 Oil, Gas & Mining Infrastructure Financial 0 Agribusiness, Manufacturing and Services I 2ooo 2001 2002 2003 2004 2005 2006 2007 1 2008 I (Q3) 5.10. MIGA’s exposure tends to be concentrated in lower middle income countries (43 percent). MIGA also continues to meet demand for coverage in upper middle income countries, accounting for 35 percent of exposure. This i s consistent with trends in the FY00-04 period (see Figure 7). Figure 7: Share of New M I G A Guarantee Exposure Middle Income and Low Income Countries i Yearly Average N 2000-2004 Yearly Average PI 2005-2008 I Low Ircorne I Upper Middle Income 25% Low Income 30% Lower Middle Income Lower Middle 45% Income 43% 5.11. M I G A has pursued opportunities in each of its operational priority areas and i t s portfolio composition has shown continuity. MIGA has directed significant shares o f i t s new guarantees activities to priority areas. The portfolio composition shows a large degree o f continuity rather than changes in direction following approval of the new strategy, when compared to MIGA’s performance under the preceding strategy period (FY00-04). IEG reviewed shifts and trends in MIGA’s new guarantee issuance for FY05-07 (including FY08 where available) to assess how MIGA’s portfolio aligned with i t s strategic priorities. This i s shown in paras. 5.12 to 5.17 below. 30 5.12. In terms of MIGA’s support f o r frontier countries,78 about 3 9 percent of MIGA’s exposure (and more than h a l f of n e w projects) underwritten in F Y 0 5 - 0 8 went to countries that are characterized as either high risk or low income (see Figure 8). T h i s share has declined since FY05, and i s b e l o w the average achieved in FYOO-04 (44 percent). The relative decline m a y b e due to reclassifications of countries no longer considered frontier, and where MIGA has been active in both periods, such as Serbia or Ukraine.79 M I G A ’ s n e w exposure in frontier countries in FY05-08 decreased in A f r i c a and declined sharply in both the ECA and LAC regions, compared with the earlier strategy period. Figure 8: MIGA Guarantees in Frontier Countries and Africa (Annual new exposure by FY, USD millions) 350 350 303 300 700 600 250 250 500 200 200 403 150 150 303 200 100 100 100 50 50 0 0 0 zoo0 2001 2002 2 m 2004 2005 2006 2007 2008 Zoo0 2001 2CGZ 2003 2004 2005 2006 2007 2008 10 Frontier Countnes -Period Amrage 1 1 0 Africa -Penod Avaage 1 5.13. Within this group, however, MIGA has made substantial efforts to increase i t s activities in Sub-Saharan Africa, another focus area (see Figure S), from 15.4 percent of n e w exposure (FY00-04) to 16.8 percent (FY05-08). MIGA achieved an increase in business volume in A f r i c a from an average business volume o f $225 million p.a. (FYOO- 04) t o an annual average o f $265 m i l l i o n (FY05-07), although i t has not yet reached i t s target of quadrupling new business in A f r i c a by F Y 0 8 (from a base in FY04). Similarly, MIGA increased the share of projects supported in A f r i c a from just under 20 percent (FY00-04) to 3 3 percent (FY05-08). 5.14. MIGA has increased its guarantees volume in IDA o r IDA-eligible countries (see Figure 9). N e w exposure in IDA countries accounted for 29 percent during F Y 0 5 - 0 8 (compared with 19 percent in the earlier strategy period). Together with blend countries, MIGA commitments in I D A - e l i g i b l e countries rose to 3 6 percent from 3 0 percent earlier in the decade. In terms of the numbers of projects supported, a significant share (40 percent of n e w projects during FY05-08) were in IDA countries, compared with 23 percent during FY00-04. W h i l e guarantee volumes in both IBRD and blend countries declined in absolute and relative terms, MIGA increased i t s n e w guarantee exposure in IDA countries. T h e increase in exposure in IDA countries i s due to the increases in the A f r i c a and A s i a regions, w h i c h offset a sharp decline of exposure in L a t i n America. T h e MENA regions’ increase can b e attributed to one large project. 78 Using MIGA’s definition and list o f frontier countries. 79 The number of countries considered frontier declined from 98 ( W O O ) to 91 ( W 0 7 ) . 31 Figure 9: Composition of M I G A Guarantees in IDA, Blend, and IBRD Countries (Annual new exposure by FY, USD millions) Yearly Average FY 2000-2004 Yearly Average FY 2005-2008 Blend IDA 1 1% Blend 8% 70% 5.15. New exDosure in conflict-afflicted countries has remained constant. The share of M I G A ’ s h e w exposure in conflict-afflicted countries” has remained constant at around 20 percent of MIGA’s new exposure between FY00-04 and F Y 0 5 - 0 7 (see Figure 10). In this regard, the strategy had stated that MIGA would work on establishing a trust fund f o r underwriting guarantees in post-conflict countries in A f r i c a T h e initiative did not materialize. MIGA’s n e w exposure for conflict-afflicted countries declined in A f r i c a over the FY05-08 period compared with FY00-04, as did exposure in ECA, while exposure to conflict-afflicted countries in the LAC region decreased dramatically. Asia registered a moderate increase and the MENA region a significant improvement due to a mega-dea1. Figure 10: M I G A Guarantees in Conflict-Afflicted Countries (Annual new exposure by FY, USD millions) 450 400 350 300 250 200 150 100 50 0 2000 2001 2002 2003 2004 2005 2006 2007 0 Conflict Alfected - - P e d Average 5.16. MIGA has pursued a focus in infrastructure development, w h i c h was already a priority area during FY00-04, as evidenced by the large share (35 percent vs. 43 percent during FY00-04) of n e w guarantees volume in infrastructure projects (see Figure 11). W h e n considering the number of projects, the share o f infrastructure remained flat at 3 1 percent, for FY00-04 and FY05-08, respectively. Within this sector focus, the Agency has increasingly supported more complex projects in new subsectors, such as water and sanitation. As defined by IBRD: Quarterly Monitoring Report on Conflict-Affected Countries (various issues 1999- 2002) and Semiannual Monitoring Report on Conflict-Affected Countries (various issues 2003-2005). 32 Figure 11: M I G A Guarantees for Infrastructure Projects (Annual new exposure by FY, USD millions) - - -- I------ - 800 6M) 400 200 0 2oM) 2001 2002 2003 2004 20% 2w6 2007 2008 oInfrastNcture - P e n 4 Average 5.17. MIGA support for south-south investments has stayed constant between the two periods, with an upward trend registered since FY07. In this priority area, MIGA continues to support a share o f 19 percent of i t s guarantee volume to investors from MIGA Part I Icountries (see Figure 12).81 (The share o f projects originating in developing member countries increased from 21 percent to 34 percent.) However, when considering only investments among developing countries (excluding investments from MIGA Part I1 countries classified as high income, such as Cyprus, Israel, Singapore, Slovenia, and United Arab Emirates), the shares o f exposure drop to 15 percent (FYOO- 04) and 12 percent (FY05-08). In terms o f the origin o f insured investment flows, the recent strategy period involved for the first time MIGA guarantees for investments from emerging economies in Africa, the Middle East, and Asia. They also showed a relative decline o f insured investments originating in Latin America and E C A and from some traditional MIGA client countries such as Singapore, Mauritius, or Brazil. Figure 12: M I G A Guarantees for South-South Projects (Annual new exposure by FY, USD millions) t - - - ----- 4 500 400 300 300 200 200 100 100 0 0 2 W 2001 2002 2003 2004 2005 2C06 2007 2008 0 South-South Investments -Pen& Average 5.18. According to some country risk indicators, MIGA exposure i s increasingly concentrated in countries with low risk profiles. Changes in the risk profile o f MIGA’s exposure are an important indication o f MIGA’s added value in supporting investments in the most risky and underserved markets. IEG mapped the volume o f MIGA’s new exposure to a suitable risk indicator, the International Country Risk Guide,82 and classified countries in three categories as per this indicator: high risk, Investments from MIGA Part I1(developing) member countries into other developing countries. 82The ICRG rating comprises 22 variables in three subcategories of risk: political, financial, and economic, where the political risk index i s based on 100 points, and the financial and economic indices on 50 points 33 moderate risk, and low risk (see Figure 13). Many indicators approximating investment climate or country risk have shown an improving trend over the last 10 years.83 Parallel to this, MIGA’s exposure has become heavily concentrated in countries rated as low (including very low) risk (42 percent of exposure during FY05-08, compared with 23 percent during FY00-04). A relatively small share now goes to projects in high (including very high) risk countries (9 percent vs. 33 percent in the previous period). During FY05-08 most of MIGA’s portfolio in countries classified as high risk has been concentrated in Africa and MENA, whereas during FY00-04 the highest exposure in high risk countries was in the ECA region, followed by Africa. Most of MIGA’s low risk exposure i s concentrated in ECA, and medium risk i s dominated by the Latin America and Caribbean region. Figure 13 : Risk Profile of Countries with MIGA Exposure Yearly Average FY 2005-2008 (ICRG) High 9% Low 42% - 5.19. MIGA has been successful in supporting investments to underserved markets, rather than mirroring international FDI flows. Measured by the share of MIGA’s new exposure going to the top 10 developing country recipients of FDI, MIGA has well diversified i t s portfolio. The top 10 FDI recipients attracted 58 percent of FDI flows to developing countries84,but accounted for just 24 percent of MIGA exposure during FY05-08 (34 percent for FY00-04). MIGA i s notably more exposed to sub- Saharan Africa than the share of FDI this region i s receiving-it accounted for just over 7 percent of FDI to a l l developing countries during 2000-2005, while MIGA’s new business volume in Africa has averaged 17 percent of total new business during FY05-08. each. Composite country risk scores range from zero to 100 with scores between zero and 49.9 rated as “very high risk”, from 50.0 to 59.5 as “high risk”, from 60.0 to 69.5 as “moderate risk”, from 70.0 to 79.9 as “low risk”, and from 80.0 to 100.0 as “very low risk”. 83 See for example: World Bank. Improving Investment Climates. 2006, p. 66ff. 84 Based on FDI inflows during 2000 to 2005, top recipient countries are China, Brazil, Russian Federation, Poland, India, Chile, Hungary, Colombia, Turkey, and Romania. 34 Figure 14 :FDI Flows vs. M I G A ’ s New Exposure in Sub-Saharan Africa FDI to Sub-Saharan Phica as MlGAEqosure in Sub- MlGAEqosure in Sub. % of Total FDI to Developing Saharan Nrica as %of Total Saharan Plrica as Yo of Total Countries (2000-2005) (2000-2004) (2005-2008) 5.20. MIGA’s client concentration has been a concern. In the period FYOO-04 four financial sector clients accounted for 30 percent (31 n e w projects) of M I G A ’ s n e w gross exposure. Client concentration increased in the period FY05-08 as two financial sector clients accounted for 35 percent of n e w exposure and the top four clients accounted for 49 percent of n e w guarantees issued in the same period (18 new projects). W h i l e client concentration has thus remained high, the composition of the top ranked clients has changed. MIGA has reduced i t s reliance o n one financial sector client from FY04 and FY05 (accounting for 43 percent and 54 percent o f gross exposure, respectively) to (10 percent in FY07). Also, the year-to-year trend shows that the proportion o f n e w guarantee volumes of the two clients with the largest yearly exposure went up from 17 percent in FYOO to 62 percent in FY05 and then declined to 25 percent and 43 percent in the next two years. B. Financial Results and Sustainability 5.21. A s noted in para. 3.9, MIGA’s strategic directions did not incorporate financial objectives and targets, or reflect explicitly the need for MIGA to pursue a balanced portfolio to ensure i t s financial sustainability and manage r i s k s prudently. 5.22. MIGA has a strong capital base, but its income side i s much less solid. MIGA’s capital base gives clients comfort in M I G A ’ s ability to pay out claims, one of the comparative advantages as identified through client surveys. However, i t s income side i s less healthy. MIGA has had a positive net income each year. As a result, net premium income peaked in FY04 and has since declined; in FY07 i t was 11.3 percent lower than in FY04. At the same time, administrative costs are relatively high, after having grown by 54.9 percent between FYOO and FY04 in nominal terms, and then, (as noted in para. 4.29), staying flat since FY06. However, the ratio of actual administrative cost to net premium income was 80 percent in FY07, up from 61 percent in FYOO and 68 percent in FY04.85 If this trend should continue, M I G A ’ s cost c o u l d exceed i t s net guarantee income in the m e d i u m term. MIGA’s earlier increases in administrative cost are relatively w e l l understood and partly reflect M I G A ’ s development mandate and i t s ’’MIGA Financial Statements. Multiple years. 35 role as a member o f the World Bank Group, but MIGA needs to manage better the dynamics on i t s revenue side in order to reach a more healthy relationship between costs and revenues. (See Table 2.) 5.23. MIGA’s net premium income depends on (i) the effective premium rate, and the (ii)average size o f i t s portfolio (including the size o f reinsurance). As noted above, MIGA’s total portfolio remained relatively flat throughout FY07. I t i s determined by new guarantees issued, but also by the run-off from the portfolio (cancellations, reductions, and expiries). Cancellations play a particularly important role, accounting for between 11.8 percent to 19.2 percent p.a. o f outstanding portfolio (FY04 and FY07, respectively). The reasons for contract cancellations differ and may be consistent with MIGA’s development mandate and value added in fostering investment. However, a high share of cancellations affects MIGA’s revenues. 5.24. Effective premium rates declined during FY05-07 compared to earlier this decade.86 This seems consistent with a (much more dramatic) overall decline in premium rates for other Berne U n i o n member^.^' The recent PRI study for MIGA’s upcoming strategy found MIGA to be among the PRI providers with the highest premium rates.88 The downward trend in effective premium rates f o r MIGA may well reflect market pressures given a “soft” insurance market (see para. 0 f.). There has been a general improvement of risk and business environment indicators over the past few years, which can also explain the lower average effective rates. The decline in MIGA’s premium income may also reflect an increasing share of financial sector projects with fewer r i s k coverages per project and projects exiting f r o m the portfolio that were underwritten when MIGA’s average premium rates were higher. 5.25. Premium: As noted in para. 4.25 f., MIGA’s pricing model has recently been modified to incorporate more rigorous assumptions, which should improve i t s ability to accurately reflect in premium rates a systematic recovery o f administrative cost on a portfolio level. IEG has analyzed the consistency o f MIGA’s pricing practice since implementation in January 2004 o f the current pricing model and through FY07, comparing non-binding indications generated by the model with actual pricing in the contracts. A consistent pricing would indicate that MIGA systematically attempted to recover administrative cost, a risk premium, and return on capital through i t s new business. The analysis did not find a consistent trend over the FY05-07 period, However, overall there appeared to be a modest net underpricing (affecting 5 percent gross exposure) compared with the benchmark rate generated by the pricing model (used as a proxy for full cost recovery). Some patterns have emerged in apparent underpricing in mining and infrastructure, and overpricing in the financial sector and o i l and gas, but w i l l need to be examined further. The results for mining were determined by t w o large projects for which pricing was below the benchmark rate. IEG observed that projects are priced consistent with model benchmarks up to a certain hurdle (estimated at $200,000 in 86 Average premium rates per $ insured peaked at the end of FY02 (1.17 percent) and declined to a low of 0.98 percent in FY07. 87 Average premium rates charged by Berne Union members declined from 0.89 percent (2002) to 0.62 ercent (2005), or more than 30 percent. ” MIGA. Political Risk Insurance Study. PriceWaterhouseCoopers,2008, p. 45. 36 gross annual premium), but as they increase in size, the over and underpricing increases significantly. 5.26. MIGA has little flexibility in changing i t s pricing over the m e d i u m term since i t s p r i c i n g model i s based o n recovery of administrative cost (on a portfolio basis) plus a risk component. Changes in expected and outstanding business volume can drive changes in pricing. As a development institution, MIGA has a mandate o f “complementing” private insurance companies and export credit agencies rather than competing with them for business. However, if MIGA’s pricing should diverge significantly from that of other providers, it c o u l d erode i t s comparative advantage and business volume or, alternatively, c r o w d out other PRI providers in certain market segments. MIGA can further c l a r i f y i t s p r i c i n g strategy vis-a-vis insurance business cycles and market prices. As prices largely reflect administrative costs and i t s cost drivers are derived from expected volume of new and outstanding business, premiums would tend to decrease when the expected and outstanding business volume rises, and w o u l d tend to increase when expected demand for MIGA’s product falls. This aspect would require further attention in future p r i c i n g model adjustments, to ensure alignment between p r i c i n g and MIGA’s strategic objectives. Table 2: MIGA’s Guarantee Activities FY00-07 and M I G A Financials (in US$ Thousands) Outstanding Portfolio (as of June 30th) 2000 2001 2002 2003 2004 2005 2006 2007 Guarantess Issued (MAL) 1,605,398 1,999.780 1,194,256 1,351,977 1,054,738 1,206,631 1299.764 1,355,377 Number uf Contracts (issued) 67 58 59 56 63 66 __ 45 59 Gross OutstandingGuarantee Portfolio 4,364.812 5,179,040 5,256,599 , 5,082,778 5,186,017 5,094,443 5,362,405 5,301,190 Reinsurance 1,548,856 2,022,603 2,055,148 1,878,789 1,927,255 1,956,147 2,052,228 2,091,776 Net Outstanding Guarantee Portfolio 2,815.956 3,156,437 3,201,451 3,203.989 3,258,762 3,138,296 3,310,177 3,209,414 MIGA Financials FYOO FYo1 FY02 FY03 FYo4 FY05 FY06 FY07 Premium Income 37,443 46,341 57,043 53,878 57,947 57,140 52,879 48,960 Premium Ceded (13,037) (18,078) (24,376) (21,371) (23,225) (23,864) (20,488) (17,289) Fees and Commissions 5,128 8,203 7,700 6,990 6,194 6,354 4,772 4,617 Premium Income 29,534 36,466 40,367 39,497 40,916 39,630 37,163 36,266 Income from Investments 23,473 30,356 28,708 25,298 14,241 16.842 11,352 42,747 Others (Translationgains + income from staft retirement plan) 2,717 2,999 2,187 16 4 2,673 8,848 Total Other Income 26,190 33,355 30,895 25,314 14,245 16,642 14,025 51,595 Total Income 55,724 69,621 71,262 64,811 55,161 56,472 51,166 67,683 (Release of) provisionsfrom clams 26,625 29.734 43,891 (20,672) (62,440) (106,849) (3,374) (3,726) Release of provisions due to withdrawal of c l a i m (837) Administrative Expenses 18,065 19,772 21,939 25,523 27,985 30,330 30,846 29,103 Other Expenses 130 745 943 1,144 1,612 1,995 484 995 Total Expenses 44,820 50,251 66,773 5,995 (32,843) (74,524) 27,956 25,535 37 5.27. Claims and pre-claims: MIGA has had an excellent claims record over 19 years of operation. M I G A ’ s net income and financial sustainability i s also dependent o n i t s claims record. In the nearly 19 years since i t s inception, MIGA has accepted and p a i d only three claims for a total of $5.2 million (net, i.e., after reinsured amounts); one c l a i m p a i d was subsequently recovered from the host country government. Two claims were brought under expropriation and one under a war and c i v i l disturbance coverage. The latest two claims were paid in F Y 0 5 . 5.28. Between F Y 0 3 and FY07, 21 MIGA projects i n v o l v e d claims or pre-claims. Infrastructure projects accounted for the largest share among t h e m (57 percent), somewhat higher than the share of infrastructure projects in M I G A ’ s portfolio. Agribusiness, manufacturing, and services projects accounted for 19 percent, whereas relatively few financial sector projects encountered disputes. Sixteen projects involved either Public Private Partnerships (PPPs) or a project with a concession. Based on the l o w number of investment disputes in i t s portfolio that resulted in the payout of a claim, MIGA has had a good track record in helping resolve such disputes. 5.29. In sum with respect to financial performance and sustainability, MIGA’s strategy lacked a full discussion of the interdependencies between growth, financial, and development objectives. MIGA has a strong capital base for underwriting guarantees, but i t s net p r e m i u m i s declining and the ratio of administrative cost to p r e m i u m income i s high. D u e to several factors, including market trends, MIGA has seen i t s effective p r e m i u m rates decrease over recent years. At the same time, MIGA has maintained a strong record in mitigating investment disputes, resulting in a very low incidence claims paid. C. Expected Development Results 5.30. I t i s too early to assess development outcomes of MIGA projects supported during the FY05-08 period. However, IEG-MIGA evaluated a sample of 12 projects that reached maturity during the strategy period (i.e., projects underwritten by MIGA between FY96 and FY02), the results of w h i c h are presented in this section. Prior I E G - MIGA evaluations have found an association between work quality and development outcome.89 (This i s a finding that has been confirmed by IEG-IFC evaluations of IFC investment projects.) M I G A ’ s performance in projects prior to i t s current strategy period i s used as a benchmark against w h i c h to assess progress during FY05-08, using IEG- MIGA’s more recent assessment of the quality at entry of the population of MIGA guarantees underwritten between January 1, 2005 and June 30, 2006. These findings are complemented by an IEG project profiling of a l l new MIGA projects during FY06 and FY07 (see Box 2). 5.3 1. Findings from Ex-post Evaluations of Projects Preceding the Current Strategy:” Figure 15 shows an association between M I G A ’ s work quality and development outcomes for this sample of 12 projects. Three-fifths of evaluated projects had high ratings for development outcomes, while the rest were rated partially 89 MIGNR2006-0025: IEG-MIGA 2006 Annual Report. 90 Based on IEG evaluations of 12 MIGA projects that were underwritten in the period FY97-02. 38 unsatisfactory. H a l f of the projects were rated as high for MIGA’s effectiveness9* (consisting of three components: strategic relevance, MIGA’s role and contribution, and MIGA’s assessment, underwriting and monitoring), with a l l projects rated high f o r their strategic relevance and a l l but one rated high for M I G A ’ s role and contribution. However, only 33 percent of projects rated high for M I G A ’ s work quality (assessment, underwriting, and monitoring; see Figure 16). Figure 15: Development Outcome and MIGA’s Effectiveness (Sample of 12 Most Recent Projects Evaluated) (=6 7%) (=33%) Low High MIGA’s Work Quality Strategic Relevance MIGA’s Role and Contribution M I G A ’ s Assessment, Underwriting, and Monitoring 5.32. IEG identified the following issues in this cohort’s adequacy of project assessment, underwriting, and monitoring, w h i c h preceded guidelines and processes of the current strategy period: 0 MIGA’s analysis of projects’ financial viability h a d shortcomings. D u e t o a strong reliance on investor’s representations, MIGA did not verify assumptions on information provided by the guarantee holders. 0 M I G A ’ s analysis of development impact was not satisfactory. In m a n y cases ex- ante project impacts were not adequately discussed by MIGA in the underwriting documents and were based on overly optimistic assumptions and incomplete analysis. 91 Ratings o f Excellent and Satisfactory correspond to “high”, whereas partially satisfactory and unsatisfactory correspond to “low” for the purposes o f showing associations in the graph. 39 0 Although the agency h a d scaled up the environmental and social supervision of i t s projects since 2004, adequate monitoring arrangements associated to compliance with environmental and social policies and safeguards were s t i l l not in place at the t i m e of evaluation. Some o f these problems were associated to M I G A ’ s practice of not requiring monitoring reports for Category B projects. 5.33. IEG Quality at Entry Assessments o f Projects Underwritten during Current Strategy Period: M I G A ’ s work quality to ensure strategic alignment, ex-ante assessment, and due diligence of guarantees has improved for recent projects reviewed by IEG. T h e IEG-MIGA 2007 Annual Report assessed 23 n e w regular projects to determine improvements in M I G A ’ s work quality. These guarantees were issued by MIGA during the period January 2005 to June 2006.92 T h e results are summarized in paras. 5.34-5.38. below. 5.34. M I G A ’ s strategic relevance and value added: Nearly a l l of the MIGA projects were aligned with the host country, WBG, and MIGA’s strategic priorities. T h e quality at entry assessment confirmed that M I G A ’ s collaboration with the World B a n k and IFC had increased since 2004. 5.35. Assessment of expected business performance: Since 2004, MIGA has strengthened analysis of the projects’ ex-ante financial performance, a k e y determinant of expected development outcome. T h e business objectives and scope of these projects are also better defined, w h i c h previous IEG reports found often laclung in earlier MIGA projects.93 However, the underlying assumptions and risks affecting a project’s financial viability are not always p r ~ v i d e d . ’ ~ Relevant sector issues are now taken into consideration more systematically, especially for financial sector projects. 5.36. Assessment of Expected Contribution to Economic Sustainability: MIGA h a d made progress in determining the economic soundness of projects through the application o f a cost-benefit approach, but this method h a d not yet been mainstreamed and requires further attention by MIGA. In 200495IEG h a d not found any projects that presented an ERR96 or a full cost-benefit analysis to aid MIGA’s decision on whether a project would b e beneficial to society or not.97 In contrast, in the latest analysis, f i v e out of the 18 real sector projects for w h i c h cost-benefit analysis was applicable presented a full cost-benefit analysis in the decision documents. Projects with concessions have to indicate “positive social return” because of their potential to affect a range of 92 IEG also reviewed 13 new projects under the Small Investment Program (SIP) but these projects have different requirements and procedures and thus excluded from the analysis below. 93 This improvement was facilitated b y the recent inclusion o f Clause 2 in MIGA’s contract o f guarantee, requiring a legal description o f the investment project. 94 Only a third o f the projects specified FRR assumptions in a manner consistent with the project’s business lan and the sector context while a third o f the projects discussed commercial risks adequately. Results included in MIGfdR2004-0055.2004 Review o f Development Effectiveness in M I G A . August 19, 2004. 96 Paragraph 3.06 o f MIGA’s Operational Regulations i s explicit in i t s requirement that a reasonable ‘’ economic rate o f return should be established based on the projects costs and benefits regardless o f any distortions due to trade, tax, pricing and other concessions offered by or have been agreed with the host overnment. Guidelines on Assessing the Development Impact o f Operations Supported by M I G A Guarantees. December 30, 2004. Frank. J. Lysy, MIGA Chief Economist. Paragraph 6. 40 stakeholders but only three out of 14 complied.9* Most projects involving concessions were s t i l l not assessed adequately, particularly their implications for consumers affected by the projects, especially the poor. Among the four financial sector projects only one had an economic return on invested capital (EROIC) as required by M I G A ’ s guidelines. 5.37. Assessment o f Environmental and Social Issues: MIGA’s assessment of environmental, health, and safety (EHS) and social issues showed strong improvement as most (86 percent) of the assessed projects, including SIP, adhered to MIGA’s requirements for addressing environmental and social issues. MIGA adequately addressed EHS issues of Category A and C projects but there were shortcomings in four Category B projects, three of w h i c h were S I P projects. T h e shortcomings related to the use of outdated environmental audits, E I A s not covering the full scope of the project, absence of environmental and social assessments prepared by guarantee holders, and lack of investors’ environmental management system^.'^ Notable improvements have been achieved in the w a y MIGA ensures that relevant specific safeguard policies are addressed, with the greatest improvement in social safeguard policies. MIGA has also made better use of i t s contracts of guarantee to reference appropriate safeguards and guidelines’00 since 2004, consistent with an earlier IEG recommendation, although i t also needs to include E H S reporting requirements. Modest progress has also been made in adapting IEG’s earlier recommendation to k e y reporting requirements for E H S monitoring in the contract of guarantee for relevant projects. However, upstream attention to setting up Environmental Management Systems (EMS) has remained insufficient. 5.38. IEG’s r i s k profiling of recent MIGA projects confirms a strengthening of underwriting quality (see Box 2). 98Ten projects had concessions and four projects had the government as i t s direct client. 99IEG-MIGA FY07 Annual Report. looContracts of guarantee were used in 54 percent o f the projects to explicitly reference relevant MIGA safeguards. 41 IEG has profiled recent MIGA projects underwritten during FY06 (32 projects) and FY07 (20 projects) to determine their risk factors against success drivers IEG-MIGA adapted from IEG-FC evaluation findings.'" A total o f 52 projects were profiled, excluding contracts linked to modifications o f prior projects. The review was based o n information contained in MIGA's underwriting papers, President's Reports, and using independent indicators (such as for business environment). This exercise covered: (i) changes in the quality o f a country's business climate following project approval; (ii) type o f industry sector in which the investment i s made; (iii) quality o f the project sponsor; (iv) level o f product market, client company and project type risks; and (v) work quality (in this case by MIGA).lo2 Absence o f a success driver means higher risk. , based on these findings, MIGA appears to have made further progress in the depth o f i t s underwriting. For FY07, 45 percent o f projects contained information on concessions or Public- 1 Private Partnerships. Of these projects, more than half contained references t o competitive bidding. MIGA also strengthened i t s analysis o f sector issues in i t s underwriting: M o r e than half the projects referred t o sector reforms, restructurings, or policy changes. Of the 20 projects, 12 analyzed whether there was a presence o f market distortions or circumstances impeding competition, which may affect the economic viability o f projects. Eight o f these projects affirmed the presence o f such distortions. 60 percent o f projects where this information was referenced in MIGA's documents involved sectors with claims or disputes in the host country. Conclusions: 5.39. MIGA's strategy anticipated business growth targets and an expectation of an increased focus in the four operational priority areas. There has been a consistent increase in business volume since the nadir o f FY04, following a steep decline o f MIGA business and high portfolio concentration. But MIGA did not reach until FY08 the business volumes expected for the FY05-08 period. At the same time the political risk insurance has experienced significant growth, due to the entrance o f new market participants and expansions of offerings from existing PRI providers. 5.40. MIGA has been successful in pursuing opportunities in each o f i t s operational priority areas: frontier countries, conflict-afflicted countries, infrastructure, and south- south investments. I t s operational results for business volume in each o f these areas show some continuity with the patterns observed during the previous strategy period. MIGA has improved i t s focus on Africa and in IDA countries. 5.41. MIGA's exposure continues to be concentrated in lower middle income countries and analysis also suggests MIGA i s increasingly active in countries with low risk. lo'IEG-IFC has for a number of years used i t s large annual samples of IFC's Expanded Project Supervision Reports (XPSRs) to identify key results drivers for the quality of development outcome and IFC's investment outcome, and the identified drivers have been shown to be quite robust across sectors and regions. IEG-MIGA does not yet have a corresponding data base for MIGA projects, but i t seems likely that findings for IFC projects will be at least reasonably valid also for MIGA projects, and IEG-MIGA has also in the past been able to identify some similar associations for the quality of MIGA project outcomes. lo'See IEG Annual Review of FY2005 EvaluationFindings in IFC. April 13,2006, p. 9ff. and IEG Independent Evaluation of IFC's Development Results 2008, p. 8f. 42 5.42. MIGA has a strong capital base, but net premium income has declined due to a largely flat outstanding portfolio, market pressures, and changes in MIGA’s portfolio composition-although MIGA’s premiums remain above industry averages. The ratio o f administrative cost to net guarantee income has increased. Overall, MIGA i s recovering i t s administrative cost through premium income but instances o f under- and overpricing have had an impact on guarantee income. 5.43. I t i s too early to assess the development outcomes o f MIGA projects approved during the FY05-08 period, but findings from IEG ex-post evaluations and quality at entry assessments suggest a strengthening in many aspects o f MIGA’s effectiveness, ensuring the strategic relevance and MIGA’s value added, and improving MIGA underwriting and, to a lesser extent, monitoring. In particular, MIGA improved attention to the financial viability o f i t s projects, an important predictor o f development outcome; made progress in assessing the economic soundness o f projects; and scaled up the assessment and supervision o f environmental, health, safety and social issues. 5.44. IEG evaluations point to an important role MIGA has played for a sample o f ex-post evaluated projects, ranging from MIGA’s support being critical for the investment to go forward, i t s environmental and social requirements providing comfort to investors dealing with local communities, and to investors entering a new country. MIGA role was considered especially important for investments in post-conflict countries. There is, however, a need to address more systematically MIGA’s additionality in i t s projects. 43 6. OUTLOOK: MIGA'S ROLE AND THE POTENTIAL FOR MIGA GUARANTEESlo3 6.1. The challenge facing M I G A in the next five years i s to take advantage of the demand for political risk insurance given i t s strengths and to find solutions to constraints hindering i t s ability to adapt to a rapidly changing global investment environment. Notwithstanding the array o f risk mitigation products offered to investors and the number o f investors opting to self-insure, demand for PRI had been strong since 2O04.lo4 The resurgence o f expropriation and nationalization risks and the increasing incidence of non-honoring o f sovereign guarantees has revived awareness o f political risks. Demand for PRI products continues to be robust indicated b y the rapid growth in the new business o f the Berne Union investment insurance (BU) members from 2004 through 2007. A June 2007 global survey o f 602 executives b y the Economist Intelligence Unit affirmed the positive outlook for PRI in the next five years, noting that companies with better political risk assessment capabilities experienced fewer cases o f expropriation, government payment default, or currency transfer restriction compared to those without PRI ~ o v e r a g e . " ~ MZGA 's strengths: 6.2. M I G A i s known in the PRI market for offering long-term tenors, i t s excellent claims record, ability to provide coverage to difficult projects in high risk countries, large underwriting capacity, and, as part of the WBG, it has good relationship with host governments. MIGA i s also a trusted party in resolving investment disputes. I t s comparative advantage vis-&vis other market players has been consistent and reaffirmed by the 2008 and past client studies commissioned b y MIGA. The 2005 conceptual framework presented in the strategy document capitalizes on these strengths which identified the two areas where MIGA can deploy i t s resources for maximum development impact: (1) countries that are relatively low risk but s t i l l underserved b y private insurers due to country capacity limits; and (2) high-risk, frontier markets and conflict-affected countries for maximum value-added and development impact.'06 These identified segments remain relevant at the present time as confirmed b y the 2008 PwC client study. However, MIGA has faced increasing competition from private insurers even in high r i s k countries in the last four years. In 2005, Berne Union private insurers accounted for 50 percent o f new PRI business in Africa, which has most o f the high-risk, frontier countries. In 2007, i t s share has increased to 70 percent. Private insurers are also offering long-term tenors (10 to 15 years) for their PRI. 6.3. M I G A has the most mainstreamed, flexible, well-defined and tested guarantee product within the WBG. MIGA has the most unbundled and narrowly lo3 IEG: Catalyzing Private Investment for Development: Evaluation o f the Use of World Bank Group Guarantee Instruments, 1990-2007 (forthcoming, 2008). I O 4 See Berne Union statistics. Reported new exposure has increased from $18 billion to $62 billion between 2004 and 2007. 105 Economist Intelligence Unit. "World Investment to 201 1. Foreign Direct Investment and the Challenge of Political Risk. 2007." IO6 MIGA: M I G A 2005 Review for FY00-04 and Strategic Directions for FYO5-08, pp. 27-28. 44 defined product within the WBG, thus allowing clients to purchase exactly what they need. There i s clear demand for this flexibility. M I G A ’ s insurance i s also the least disruptive to a project’s financing structure, compared with other risk mitigation tools offered by the WBG. MIGA has been able to enhance i t s capacity despite limitations imposed by i t s Convention. MIGA’s product i s also the most standardized among WBG guarantees, w h i c h allows for quick deployment. Thus i t appears that M I G A ’ s comparative advantages over other WBG instruments i s in situations where (i) certain political r i s k s can clearly b e identified, isolated, and managed; (ii) the project i s at an advanced stage of development and possible funding has been identified; and ( iii) the client wants specific, narrowly defined risk m i t i g a t i ~ n . ” ~ MIGA ’s Constraints: 6.4. M I G A faces challenges in i t s business environment due to a proliferation of political risk mitigation instruments offered by private insurers, which M I G A i s unable to match due to limitations in its Convention. The business environment for MIGA has become more difficult because i t can only provide coverage against four types of ‘traditional’ political risks. I t can cover loans (non-shareholder loans) if these are equity-linked and the guarantee coverage must b e related to n e w investments. Private insurers, such as AIG, Chubb, Lloyds, and Zurich do not have these constraints and can insure stand-alone debt and provide coverage to n e w and existing investments. Business growth also came from tailor-made guarantee products and by offering a wider range of guarantee products including comprehensive coverage. Their PRI products include coverage against non-honoring of sovereign guarantees, trade credit insurance, terrorism cover, a l l of w h i c h are ineligible under the MIGA Convention and Operational Regulations. 6.5. The soft PRI market since 2004 has pushed premium rates of private insurers lower than MIGA’s prices, making MIGA’s product less competitive, partly due to different cost structures. Among the 73 survey respondents of companies from Part Icountries for the 2008 PwC client study, price considerations ranked top among the f i v e most important factors for selecting a PRI provider, f o l l o w e d by the scopeherms of coverage, size of project and country limit, the financial strength of the provider, and insurer reputation.”* Part I1 investors had similar responses.109 A s discussed in Para. 5.8, MIGA’s cost structure reflects i t s mandate as a development institution and i t s policies, processes, and procedures w h i c h are aligned more with the W B G ’ s than with the PRI industry. Average administrative cost represented 80 percent of average net p r e m i u m income during FY07. W h i l e MIGA has made efforts to improve i t s cost-efficiency, i t bears higher costs associated with fulfilling i t s role as a development institution, as w e l l as related to the provision of complementary services mandated by i t s Convention (such as disseminating information on FDI and PRI, technical assistance and mediation activities). ~ IEG: lo7 Catalyzing Private Investment for Development. PriceWaterhouseCoopers. MIGA Political Risk Insurance Market lo* Study. Appendix C2-14. IO9 PriceWaterhouseCoopers. MIGA Political Risk Insurance Market Study. Appendix C3-14. 45 6.6. Alignment, coordination, and collaboration with the WBG has benefits for MIGA but i s also associated with transaction costs. The strategic direction for FY05- 08 clearly stated that “MIGA’s mission i s to promote foreign direct investment (FDI) into developing countries, to promote economic growth, reduce poverty, and improve people’s lives.” MIGA’s underwriting requirements reflect this development mission and partly explain i t s low claims record but these requirements also prolong the due diligence process. MIGA’s deterrence effect, which i s valued b y investors, comes from i t s close alignment with WBG’s policies, process and procedures but alignment, coordination and collaboration with the WBG have also increased transaction costs for MIGA and the client in recent years. Underwriters and some r i s k management officers were concerned that such collaboration undermines MIGA’s competitiveness.’ lo MIGA ’s Potential: 6.7. M I G A has supported several innovative projects but must ensure that these are replicated to grow business and for development impact. An example i s the FY05 biomass project seeking carbon credits in El Salvador, which MIGA could build upon b y offering to assist investors to tap carbon credit offsets for their renewable energy projects. In FY2005, MIGA insured i t s first private placement in support o f a toll-road project in the Dominican Republic, which allowed the project to obtain a single notch rating above the sovereign risk. The bond offering was reportedly over-subscribed due to MIGA’s PRI and i t s “AAA” insurer strength rating would make MIGA’s participation in infrastructure projects attractive to investors and lenders.”’ These are particularly suitable for PPP structures in high risk countries where the project rating needs enhancement to obtain a higher project rating than sovereign risk. I t had more success in replicating support for projects involving securitization o f mortgage-backed securities (MBS) and accounts receivables. MIGA’s eligibility requirement for an equity-linkage also posed a problem for investors in asset-backed securities (ABS). I t s experience with the providing coverage under Shariah Laws for the Djibouti port facility i s another first for MIGA which i t could build on to support projects with Islamic financing. 6.8. Within its eligibility criteria, there i s some room for M I G A to grow by taking advantage of the space allowed b y i t s Convention and Operational Regulations. While the Convention and the Operational Regulations specify the eligibility requirements, these documents allow for a range of risks and underlying assets that MIGA could cover (e.g., any tangible or intangible assets with monetary value such as machinery, patents, processes, technical services, trademarks, etc). Other types o f investments can also be covered provided that the Board approves b y a special majority under Article 12(b) and MIGA’s Operational Regulations Section 1.08. Article 13(c) IEG-MIGA interviews of underwriters and risk management officers for the IEG-MIGA FY2007 ”’ Annual Report. FitchRatings uses the rating of the insurance company’s insurer financial strength as a first step in the process of rating a structured finance with PRI coverage. For example, if OPIC or MIGA provides the PRI, an “AAA” insurer financial strength i s assumed by Fitch since OPIC i s a U S government agency and MIGA i s a member of the World Bank Group. Refer to “FitchRatings. “Political Risk Insurance and Structured Finance.” December 22,2005. Provision of PRI for structured finance i s not new. OPIC provided i t s first capital markets transaction PRI coverage (transfer restriction and inconvertibility) in 1999. 46 also allows the Board, through a special majority, to extend eligibility to a national of the host country or to a company which i s incorporated in that country."* Although fraught with high procedural hurdles, the Convention and the Operational Regulations also allow the Board, by special majority, to add any other non-commercial risks, including acts of terrorism or kidnapping specifically directed against the guarantee holder to be eligible for coverage except for currency depreciation or events that occurred before contract signing.' l3The 2008 PwC market study identified expanding MIGA eligible investments to include the entire portfolio, intellectual property, qualifying MIGA's PRI coverage for favorable regulatory capital treatment under Base1 I1 requirements, sovereign non- honoring guarantee -- which may require only amendments to the Operational Regulations. 6.9. Updating M I G A ' s Convention to reflect changes in the global investment environment would improve the Agency's ability to achieve i t s objective of helping foster the flow of FDI to developing countries. Investment insurance trends and market feedback indicates demand for stand-alone debt coverage, comprehensive non-payment coverage, coverage o f existing equity and acquisitions which all requires changes in the Convention. Flexibility in the guarantee contracts' terms and conditions was also identified in the 2008 PwC market study as a constraint, which requires a change in the Operational Regulations or the Convention. In the long run, MIGA's business growth and relevance would depend in part on amending the Convention to provide i t with more flexibility to react to the demand for coverages in support of projects where the Agency can add value.'14 6.10. The emergence of new investors from developing countries (south-south investors) provides M I G A with an opportunity to increase its activities in this growing market segment. FDI flows among developing countries are now growing more rapidly than investments from developed countries. While MIGA has made strides in supporting south-south investments (Para.5.17), there are several member countries whose nationals have not taken advantage of what the Agency can offer. A business development or shareholder relationship plan that cultivates the business links with MIGA shareholders in part 2 countries, who could be potential new clients given the lack o f national insurance agencies in many o f these countries. 6.11. MIGA has the potential to play an important role and provide additionality in its projects. In 2006 IEG evaluated a sample o f 21 mature MIGA projects'" to assess MZGA 's additionality as an insurer, i t s role in leveraging and complementing partners, as well as i t s contribution to i t s clients, and found that in the majority o f projects (18 out o f 21) MIGA made important contributions. The high ratings reflect investors' perceptions that MIGA's involvement in many cases was critical for the investments to proceed, or provided comfort to clients entering new markets or new sectors (especially private provision o f public infrastructure). MIGA's insurance was particularly crucial for ' I 2 MIGA Convention, Article 13(c) includes a proviso that the assets invested must be transferred from outside the host country and that the investor and the host country must jointly apply for Board approval. 'I3MIGA Convention, Article 1l(b) and MIGA Operational Regulations. Paragraphs 1.53 to 1.57. 'I4Catalyzing Private Investment for Development: Evaluation of the Use of World Bank Group Guarantee Instruments, 1990-2007 (forthcoming). ' I 5 MIGNR2006-0025: Independent Evaluation Group - MIGA 2006 Annual Report. 47 investors in post-conflict countries. In one evaluated project, MIGA provided a tailored product that was not available from private insurers for the term required by the investors, and in six cases, MIGA coverage was a condition for lenders to provide funds. However, MIGA does not always explicitly define the value i t adds to a given project. An IEG review o f the quality of underwriting o f new projects (FY05-FY06) showed that in more than half o f the cases MIGA did not define the particular value i t brings to the project which would distinguish i t from other possible insurance providers. Conclusions 6.12. There continues to be a role and demand for MIGA’s political risk insurance. MIGA’s main strength lies in i t s ability to underwrite difficult projects in difficult markets, and there i s continued demand for traditional PRI as offered b y MIGA. However, i t s business model, product range, and processes need updating, and i t needs to address i t s shortcomings in communicating with clients and more general manage client relationships. There are indications that the potential for MIGA guarantees may increase, given that political r i s k s may increase in the medium term, and due to the emergence o f south-south investors. 48 7. SUMMARY OF FINDINGS AND RECOMMENDATIONS 7.1. MIGA was established to offer political risk insurance and was created with a specific role and narrowly defined product. MIGA has the most mainstreamed, flexible, well-defined and tested guarantee product within the WBG. I t s product i s the most unbundled of the guarantee instruments within the WBG, a l l o w i n g clients to purchase exactly what they need. MIGA has been able to enhance i t s capacity despite limitations imposed by i t s Convention. MIGA’s product i s also the most standardized among WBG guarantees, w h i c h allows for q u i c k deployment. At a time of an important juncture for MIGA to review i t s role and strategy, this report evaluated k e y aspects of the design and implementation of MIGA’s FY05-08 Strategic Directions, and results to date. 7.2. The Strategy Design: T h e 2005 Strategic Directions were MIGA’s first comprehensive exercise to develop a strategic framework and to firmly articulate the Agency’s mission as a development institution. T h e strategy also emphasized MIGA’ s role as a member of the W o r l d B a n k Group and i t s implications for increased alignment and collaboration among the institutions. I t s four priorities aligned with WBG strategies. 7.3. The FY05-08 strategy incorporated development, business, and risk management aspects. However, the strategy h a d weak l i n k s between i t s overall objectives and operational priorities, and planned initiatives, and i t did not explicitly link objectives and outcomes with performance measures or resource needs. 7.4. Implementation: During implementation MIGA has emphasized several aspects of the strategy. There has been a significant departure from i t s past business m o d e l and practice in coordinating and collaborating with the WBG on both the strategy and operational (project) levels to ensure consistency across the WBG, and MIGA has supported more projects jointly with the WB and F C . W h i l e consultations with B a n k sector or country staff have been systematic, the relationship with IFC has not shown such a degree of interaction. Coordination i s an important w a y for MIGA to manage risks and to leverage i t s role in projects, but has also increased the cost to underwrite projects. 7.5. MIGA has improved i t s risk and finance analytics, and has m o d i f i e d i t s p r i c i n g m o d e l to better reflect i t s current cost structure in pricing. There have also been improvements in the way the Agency assesses the development impact and environmental and social aspects of i t s projects. Despite considerable progress in project-based adaptation of i t s product, i t has made little progress in more general product development, a focus on the 2005 strategy. MIGA also made improvements in i t s client relationship management. I t has not yet instituted a business development plan, and clear responsibilities and performance incentives for business origination. M o r e efforts are needed to improve performance management, internal reporting, and monitoring to add value to MIGA’s development mandate. 7.6. Results of the strategy: T h e business volume of n e w guarantees has increased steadily, but did not reach until FY08 overall targets for the FY05-08 strategy period. During this time, MIGA’s market position in the PRI industry declined. T h e portfolio has been concentrated on areas stated in the strategy, and has in particular increased i t s 49 focus on Africa and IDA countries within i t s frontier markets priority area. There has been continuity in patterns o f business volumes among the operational priorities compared with the previous strategy period. 7.7. The Agency has a strong capital base with a solid claims record. However, net premium income from guarantees has declined and although administrative costs have been contained in recent years, the ratio of cost to net income has increased. 7.8. While i t i s too early to assess the development outcomes o f MIGA projects underwritten during the strategy period, the Agency has strengthened the work quality in i t s projects, such as ensuring better alignment of projects with WBG strategies and policies, and improving project assessments and due diligence during underwriting, which have been found to be associated with outcomes. 7.9. There i s a role and demand for MIGA’s political risk insurance product, based on key strengths such as i t s ability to insure difficult projects in difficult markets. MIGA faces some challenges in i t s operating environment and constraints in i t s Convention and regulations. I t needs to take advantage o f the growing demand for risk mitigation instruments and find solutions to address institutional constraints. The Agency has the potential to play an important development role. Recommendations In order to i)consolidate i t s long term viability; ii)ensure the sustainability o f recent operational results; and iii)strengthen i t s development results, MIGA needs to: 1. On MIGA ’s long-term viability: a) Develop a new strategic directions framework that carefully considers the external and internal context in which MIGA i s involved, the proposed performance dimensions and the linkages between the latter, the expected value to its customers, the necessary changes in internal processes, and the human capital and technological demands of the strategy. Aspects to be considered include: the potential demand and appetite for r i s k mitigation products, the agency’s market position vis-&vis other providers of political risk mitigation tools, the changing international market conditions, the effectiveness of delivering guarantee instruments and potential synergies across the World Bank Group, remedies to address institutional and external restrictions imposed by MIGA’s Convention, i t s competitive advantage, potential areas o f growth and high development impact, and factors affecting the achievement o f the objectives o f the FY05-08 strategy. I t would need to address the weaknesses o f the current strategy b y linking objectives, resource allocation, processes, and expected development results. As part o f this strategic exercise MIGA management would need to consider: 0 Tackling the issue o f administrative costs, as reflected b y the increasing ratio administrative costs to net premium income; 0 Improving the effectiveness o f i t s business development and client relationship functions: and 50 0 Continuing enhancing the value added and the efficiency o f business processes and decision malung to ensure impact and cost-efficiency in underwriting. b) Ensure that the new strategic directions make explicit the link between risk levels, pricing, and financial, operational, and development impact objectives. The strategy should include a portfolio perspective that would consider net guarantee income across risk, financial performance, and development objectives to facilitate decision malung and performance monitoring o f indicators such as expected income, costs, risk, and development impact. Similarly, MIGA should obtain more accurate unit cost data for underwriting individual guarantees. Finally, it could clarify further i t s pricing relative to market pricing throughout the insurance business cycle. c) Ensure that the new strategy identifies the set o f performance indicators to track progress in implementation. The strategic exercise needs to include the development o f a framework o f strategy metrics as well as the further improvements in internal systems for performance measurement, reporting, and monitoring. 2. On sustainability of MIGA’s recent growth: a) Strengthen systematic support to innovative projects and improve product innovation and internal processes to meet investors’ changing risk mitigation needs. The Agency needs to strengthen innovation through systematic support to innovative projects and for new product development and innovation. I t should address changes to i t s eligibility requirements not demanding amendments to the Convention. In the medium term, ensuring MIGA’s innovation capability, vital for i t s relevance and sustainability, may require changes to the Convention. b) Build on recent developments to improve tracking and management o f progress during implementation. MIGA should systematize i t s recent efforts to develop metrics to monitor progress for improving management decision malung, allocating resources to the desired areas o f growth and impact, and communicating results to the Board and other stakeholders. 3. On strengthening development results: M a k e significant progress in implementing initiatives related to development impact assessment and monitoring, recommended in previous evaluations of the Agency b y IEG, including the development o f self-evaluation. i) The test o f a sounder strategic and implementation framework w i l l be in the accomplishment o f development results in supporting inclusive and environmentally sustainable growth. In this respect, to ensure that the projects MIGA supports are economically sound and have positive and sustainable development impact, the consistent application o f MIGA’s development impact assessment guidelines i s crucial: i t w i l l underscore the Agency’s unique role. ii)Likewise, the Agency should give high priority to continuing the steps i t i s initiating to implement a monitoring and self-evaluation system that would allow i t to gauge, understand, manage, and report the development impact o f i t s interventions. 51 Annexes 52 Annex 1: A n Illustrative Strategy M a p MIGA's strategy can be mapped to four different perspectives: Financial and Development Perspective: At the highest level, the strategy would depict MIGA's dual mandate as a development institution, and as an insurance agency. MIGA's strategy highlighted a need to enhance i t s development impact and strengthen i t s financial sustainability as described in paragraph 2.5.[quality of interventions and quantity o f FDI]. Customer Perspective: This perspective would describe components of MIGA's customer value proposition that differentiate i t from other providers. In MICA'Scase i t s focus i s on product leadership.'16 MIGA's strategy defined i t s customer segments as i t s private sector clients and member country governments. The strategy defined some o f the value proposition components for each customer segment by operational priority. Internal Perspective: The strategy would describe internal capabilities and initiatives needed to deliver MIGA's customer value proposition, and consequently i t s financial and development impact performance. MIGA's strategy identified initiatives such as product development, coordination and collaboration within the WBG, and improved marketing and business development. Kaplan and Norton use Treacy and Wiersema's research (1995) to describe three distinct types of customer value propositions: product leadership, operational effectiveness and customer intimacy. While most organizations do some o f all three, strategically, the customer value proposition i s focused on delivering only one. 53 Human Capital and Infrastructure Perspective: This layer reflects how MIGA would use i t s resources to enable delivery of the other components of the strategy. T h i s would include capabilities and skills, additional staff, and technology applications to support information tracking, analysis and reporting. MIGA’s strategy included a section on ‘scaling up the business’ w h i c h addressed some of these needs. IEG considers this to b e a useful approach to analyze and logically structure a strategy. 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