Health Financing Systems
Health financing provides the resources and economic incentives for the operation of health systems and is a key determinant of health system performance in terms of equity, efficiency, and health outcomes.
Health Financing Functions
Health financing involves the basic functions of revenue collection, pooling of resources, and purchase of interventions.
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Revenue collection is how health systems raise money from households, businesses, and external sources.
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Pooling deals with the accumulation and management of revenues so that members of the pool share collective health risks, thereby protecting individual pool members from large, unpredictable health expenditures. Prepayment allows pool members to pay for average expected costs in advance, relieves them of uncertainty, and ensures compensation should a loss occur. Pooling coupled with prepayment enables the establishment of insurance and the redistribution of health spending between high- and low-risk individuals and high- and low-income individuals.
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Purchasing refers to the mechanisms used to purchase services from public and private providers. Figure 12.1 illustrates these functions and their interactions.
[Figure 12.1]
In terms of health policy at the country level, these three financing functions translate into the following:
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raising sufficient and sustainable revenues in an efficient and equitable manner to provide individuals with both a basic package of essential services and financial protection against unpredictable catastrophic financial losses caused by illness or injury.
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managing these revenues to equitably and efficiently pool health risks; and,
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ensuring the purchase of health services in an allocatively and technically efficient manner.
These financing functions are generally embodied in the following three stylized health financing models:
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national health service (NHS): compulsory universal coverage, national general revenue financing, and national ownership of health sector inputs
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social insurance: compulsory universal coverage under a social security (publicly mandated) system financed by employee and employer contributions to nonprofit insurance funds with public and private ownership of sector inputs
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private insurance: employer-based or individual purchase of private health insurance and private ownership of health sector inputs.
Although these models provide a general framework for classifying health systems and financing functions, they are not useful from a micropolicy perspective because all health systems embody features of the different models. The key health policy issues are not whether a government uses general revenues or payroll taxes, but the amounts of revenues raised and the extent to which they are raised in an efficient, equitable, and sustainable manner. Similarly, nothing is intrinsically good or bad about public versus private ownership and provision. The important issue is whether the systems in place ensure access, equity, and efficiency.
Revenue Collection
Governments use a variety of financial and nonfinancial mechanisms to carry out their functions, including directly providing services; financing, regulating, and mandating service provision; and providing information (Musgrove 1996). A substantial literature is devoted to the various sources for financing health services and the economic and institutional effects of using these sources in terms of efficiency, equity, revenue-raising potential, revenue administration, and sustainability (Schieber 1997; Tait 2001; Tanzi and Zee 2000; WHO 2004b; World Bank 1993). An additional source of revenue receiving increasing attention is efficiency gains (Hensher 2001). LICs rarely use tax credits as a financing source (Tanzi and Zee 2000).
The key fiscal issue for LMICs is for their financing systems, both public and private, to mobilize enough resources to finance expenditures for basic public and personal health services without resorting to excessive public sector borrowing (and creation of excessive external debt); to raise revenues equitably and efficiently; and to conform with international standards (Tanzi and Zee 2000). Institutional constraints are particularly important, including a country's economic structure—for example, large rural populations and limited formal sector employment; ineffective tax administration; and lack of data, all of which tend to preclude LMICs from using the most efficient and equitable revenue-raising instruments (Schieber and Maeda 1997; Tait 2001). The high level of inequality in most LMICs means that governments face the difficult situation of needing to tax the politically powerful and wealthy elites to raise significant revenues in an equitable manner but of being unable to do so easily. As Tanzi and Zee (2000, 4) point out, "tax policy is often the art of the possible rather than the pursuit of the optimal."
Another area of health financing that continues to generate heated debate is user fees (that is, charges to individuals for publicly provided services). The need to significantly scale up resources to meet the MDGs in LICs has pushed the user fee issue to the forefront of this debate. Arhin-Tenkorang (2000) and Palmer and others (2004) suggest that the overall effect is negative: use decreases, particularly among the poor, and frequently, administrative costs of collecting the fees are higher than the revenue generated. Further, Kivumbi and Kintu (2002) suggest that granting waivers and exemptions for the poor is difficult, if not impossible. Given those findings, many have called for the abolition of user fees, including the United Nations Millennium Project (2005) and the Commission for Africa (2005).
Others have argued, however, that absent resources to fund drug purchases, provide facilities with some discretionary funding, and motivate providers, use of primary health care by the poor will remain low because of both poor quality and lack of drugs, and the poor will purchase these essential services on the private market. The Bamako Initiative shows that user fees may be an important revenue source where institutions are weak, resources are limited, and the choice is between having drugs or not having them (World Bank 2003, 76-77). Furthermore, studies indicate that user fees can improve benefit incidence if user fee and waiver policies have been well designed and implemented and if providers are compensated for forgone revenues. Indeed, proponents of user fees argue that as long as the fees are set below private market levels, this "savings" may result in a net reduction in overall out-of-pocket spending for the poor (Bitran and Giedion 2003). These diverse experiences demonstrate the difficultly involved in making blanket statements regarding user fees. As the World Bank (2003, 71) points out, "user fees, as with other public policy decisions, must balance protection of the poor, efficiency in allocation, and the ability to guarantee that services can be implemented and sustained."
Risk Pooling and Financial Protection
Preventing individuals from falling into poverty because of catastrophic medical expenses and protecting and improving the health status of individuals and populations by ensuring financial access to essential public and personal health services provide a strong basis for public intervention in financing health systems. Public intervention may be needed because of market failures in private financing and provision (for instance, information asymmetries) and instabilities in insurance markets (such as favorable risk selection by insurers and moral hazard). Indeed, in virtually all Organisation for Economic Cooperation and Development (OECD) countries except the United States, governments have decided to publicly finance or require private financing of the bulk of health services. However, given both low income levels and limits on possibilities for domestic resource mobilization in LICs and some MICs, these countries face severe challenges in publicly financing essential public and personal health services. They also often confront difficult tradeoffs with respect to financing these basic essential services and providing financial protection against the costs of catastrophic illness.
Ensuring Financial Protection
Ensuring financial protection means that no household spends so much on health that it falls into and cannot overcome poverty (ILO and STEP 2002b). Achieving adequate levels of financial protection requires maximizing prepayment for insurable health risks; achieving the largest possible pooling of health risks within a population, thereby facilitating redistribution among high- and low-risk individuals; ensuring equity through prepayment mechanisms that redistribute costs from low- to high-income individuals; and developing purchasing arrangements that promote efficient delivery of good-quality services.
Meeting those requirements depends on how health systems arrange the three key health financing functions of revenue collection, risk pooling, and purchasing. Although all health financing functions play an important role in ensuring financial protection, risk pooling and prepayment—whether through taxes or individual premiums—play the central and often the most poorly understood roles.
Risk pooling refers to the collection and management of financial resources so that large individual and unpredictable financial risks become predictable and are distributed among all members of the pool. The pooling of financial risks is at the core of traditional insurance mechanisms. Whereas pooling ensures predictability and the potential for redistribution across individual health risk categories, prepayment provides various options for financing those risks equitably and efficiently across high-and low-income pool members. The health financing models described earlier embody different means for creating risk pools and financing such pools through prepaid contributions.
In most LMICs, multiple public and limited private arrangements coexist, making system fragmentation the norm rather than the exception. This situation increases administrative costs; creates potential equity and risk selection problems, for example, when the wealthy are all in one pool; and limits pool sizes. Moreover, health care risks change over the life cycle of an individual or household, but because generally little correlation exists between life cycle needs and capacity to pay, subsidies are often necessary and are facilitated by risk pooling.
Risk pooling and prepayment functions are central to the creation of cross-subsidies between high-risk and low-risk (that is, a risk subsidy) and rich and poor (that is, an equity subsidy) individuals. The larger the pool, the greater the potential for spreading risks and the greater the accuracy in predicting average and total pool costs. Placing all participants in a single pool and requiring contributions according to capacity to pay rather than individual or average pool risk facilitates cross-subsidization and, depending on the level of pooled resources, can significantly increase financial protection.
However, spreading risks through insurance schemes is not enough to ensure financial protection, because it can result in low-risk, low-income individuals subsidizing high-income, high-risk individuals. Furthermore, significant portions of the population may not be able to afford insurance. For this reason, most health care systems aim not only at spreading risk, but also at ensuring equity in financing of health care services through subsidies from high- to low-income individuals. Equity subsidies are the result of such redistribution policies.
At least four alternative organizational arrangements exist for risk pooling and prepayment: ministries of health (MOHs) or NHSs, social security organizations (SSOs), voluntary private health insurance, and community-based health insurance (CBHI). Each of these is linked to distinctive instruments for revenue collection (for example, general revenues, payroll taxes, risk-rated premiums, and voluntary contributions) and for purchase of health services.
Within these organizational structures, three alternatives often coexist for generating revenues and financing equity subsidies: subsidies within a risk pool, subsidies across different risk pools, and direct public subsidies through transfers from the government. Although medical savings accounts (with or without public subsidization) are also sometimes referred to as a risk pooling mechanism, they do not pool risks over groups and, therefore, are far more limited in terms of predictability and equity subsidization. They are simply intertemporal mechanisms for smoothing health risks over an individual's or household's life cycle.
Subsidies within a risk pool, whether financed through general revenues or payroll taxes, are prerequisites for pooling risks in traditional NHSs and SSOs. The goal of collecting revenues through an income-related or general revenue-based contribution (in contrast to a risk-related contribution, as is generally the case with private insurance) is to generate subsidies from high- to low-income individuals. These systems are effective when payroll contributions are feasible, when the general revenue base is sufficient and a large proportion of the population participates in the same risk pool, or when both conditions exist. Moreover, in a system with multiple, competing, public and private insurers and a fragmented risk pool, payroll contributions may increase incentives for risk selection. In the case of a NHS or SSO, financial resources might be insufficient or inappropriate for spreading the financial risks or for creating an equity subsidy, particularly if the general revenue or payroll contribution base is regressive.
Subsidies across different risk pools involve the creation of funds, often called solidarity or equalization funds, financed by a portion of contributions to each risk pool. This mechanism is found in systems with multiple insurers in, for example, Argentina, Colombia, Germany, and the Netherlands. A key element of this mechanism's success is the implementation of adequate systems of compensation among different risk and income groups.
Finally, in many OECD countries, direct public transfers funded through general taxation are made to insurers for subsidizing health care for certain groups or for the entire population. They are also used in some LMICs, although at a limited level because of low revenue collection capacity.
In most LMICs, risk pool fragmentation significantly impedes effective risk pooling, while limited revenue-raising capacity precludes the use of broad public subsidies as the main source of finance. Therefore, targeting scarce public subsidies across different risk pooling schemes is probably the most feasible way to finance equity subsidies for the poor and those outside formal pooling arrangements. However, this method has important transaction costs. Because a significant portion of the population is excluded from the formal sector, using this mechanism for ensuring universal financial protection is limited, particularly in LICs. Even if significant subsidies are available from general taxation, the lack of insurance portability restricts its usefulness as a subsidization mechanism among risk pools because individuals may lose their coverage when they change jobs. LICs and certain MICs will be challenged both to publicly finance essential public and personal health services and to ensure financial protection through equity subsidies. Thus, LMICs should strive to achieve the best value for publicly financed health services in terms of health outcomes and equity and should try to facilitate effective risk pooling for privately financed services. Providing public financing for cost-effective interventions is one critical aspect of determining which services to finance publicly.
Distributing and Sourcing Health Expenditures
As table 12.1 shows, health spending is derived from three broad sources: public sector (expenditures financed out of general revenues and social insurance contributions), private sector (expenditures financed out of pocket and by private insurance), and external sources (grants or loans from international funding agencies). In 2001, high-income countries spent an average of 7.7 percent of their GDP on health (country weighted), MICs spent 5.8 percent, and LICs spent 4.7 percent.
[Table .]
Even though a clear upward trend between a country's income level and the level of public and total health spending is apparent in terms of both absolute spending and share of GDP, spending for any given income level varies a great deal, particularly at lower income levels (Musgrove, Zeramdini, and Carrin 2002). The composition of health spending also exhibits major differences. As incomes increase, both private and out-of-pocket shares of total health spending decrease. In LICs, private and out-of-pocket spending and external assistance account for the bulk of all health spending. As countries move up the income scale, public spending predominates and both out-of-pocket spending and external assistance decrease drastically.
LMICs with high levels of out-of-pocket spending have limited opportunities for risk pooling, which hinders allocative efficiency and financial protection efforts.1 Moreover, low overall spending levels in many LICs and some MICs result in limited access to essential services and limited financial protection, particularly for the poor. As Musgrove (personal communication with G. Schieber, April 2004) indicates, if GDP is adjusted for basic subsistence needs, poor households in LICs appear to be spending a substantial share of their postsubsistence income on health, reinforcing much of the discussion that follows on the need for additional funds from external financing sources.
As also discussed by Hecht and Shah in this book (chapter 13), external funds—development assistance for health—have become an increasingly importance source of health financing in LICs, supporting some 20 percent of LIC spending. Specifically, DAH from governments, multilateral and bilateral agencies, and private foundations increased from an average of US$6.7 billion between 1997 and 1999 to US$9.3 billion in 2002. Sub-Saharan Africa received 36 percent of DAH funds in 2002, and in 13 extremely poor countries, DAH accounted for more than 30 percent of health spending (WHO 2004b).
The relationship between health expenditures and health outcomes is not always clear. Higher spending does not necessarily translate to better health outcomes. Although the evidence tenuously demonstrates a positive relationship between public spending on health and selected health indicators, it falls far short of a definitive statement (Bidani and Ravallion 1997; Filmer and Pritchett 1999; Gupta, Verhoeven, and Tiongson 2001; World Bank 1993; World Bank 2003). Health outcomes also vary across income groups, with the poor generally receiving fewer services and having worse health outcomes. As in the case of health services and health outcomes, health spending is often not pro-poor (Gwatkin and others 2003). The quality of a country's institutions also plays a key role in determining the effectiveness of health spending (Devarajan, Swaroop, and Heng-Fu 1996; Rajkumar and Swaroop 2002; Wagstaff and Claeson 2004; World Bank 1993).
Mobilizing Government Revenues
Governments of LICs have recognized the need for greater domestic investments in health. In the 2001 Abuja Declaration on HIV/AIDS, Tuberculosis, and Other Related Infectious Diseases, African leaders pledged to increase health spending to 15 percent of their government's budgets (Haines and Cassels 2004; UNECA 2001). Yet LICs' ability to raise enough revenue to meet needs and demands for publicly financed health services is highly constrained (Gupta and others 2004; Schieber and Maeda 1997). Even though revenue mobilization is directly correlated with income, wide cross-country variation in revenue mobilization within income groups is apparent. For example, Myanmar's tax revenues amounted to only 4 percent of its GDP, whereas Lesotho's were 36 percent (WHO 2002).
As table 12.2 shows, during the early 2000s, LICs collected the equivalent of about 18 percent of their GDP as revenues, whereas high-income countries collected almost 32 percent. Given projected future economic growth on the order of 4 percent for LMICs during 2006-15, they will face difficulties in mobilizing additional domestic revenues (World Bank 2004b). In other words, even though economic growth is a necessary condition for progress, it is unlikely to provide the financing base needed to deal with the HIV/AIDS pandemic or to achieve the health MDGs.
[Table .]
Trends in Health System Financing
As countries move to different stages of the income spectrum, their health financing profiles transition as well. The following discussion compares countries at different stages of the income spectrum. Given health systems' variability across time periods, countries, and income levels, the analysis provides only a snapshot. Figure 12.2 illustrates transitions in general health systems as countries move from low- to middle- to high-income status.
[Figure
12.2]
In LICs, almost half of health spending is private, virtually all out of pocket, and usually in the form of payments for privately provided health services and pharmaceuticals. The government, through the MOH, generally operates like a NHS. It provides basic public health and other services, including some tertiary-level hospital care, generally in major urban areas, to the entire population within an extremely limited budget. In general, because of the small size of formal sector employment, social insurance is limited, except perhaps for government employees. Community-based health insurance may be available to varying degrees but is unlikely to play a major role. Private health insurance, if any, is extremely limited because of people's inability to pay and institutional constraints to the industry's development, including the lack of well-developed financial markets and regulatory environments.
As countries' economies improve, government revenues tend to increase because of the expansion of the more readily taxable formal sector. Other institutions, such as financial markets, legal systems, and regulatory capabilities, are able to develop. Although private spending still accounts for some 40 percent of all health spending in MICs, the out-of-pocket share declines as private health insurance markets develop. The MOH generally continues to provide basic public health services and to serve as the insurer of last resort for the poor or for the entire population for specific chronic conditions as social health insurance mechanisms develop.
Countries move into the high-income group with improved institutions, more efficient governments, and greater revenue-raising capacity and spend a relatively small share on basic public health. With few exceptions, publicly financed universal coverage—or, in some cases, publicly mandated private coverage—becomes the goal. MOHs maintain responsibility for public health and surveillance and for the general regulatory environment but generally do not directly provide services. Risks are pooled either through a NHS, as in Italy and the United Kingdom, or through single or multiple insurance mechanisms, as in France and Germany. The Netherlands requires wealthier individuals to be insured through a private system. Private spending declines to 30 percent, and out-of-pocket spending represents about 20 percent of total health spending. Although health financing systems are highly country specific, available information on sources of health spending and government revenues supports these stylized models.
