FISCAL DECENTRALIZATION AND HEALTH SECTOR FINANCING FORMULAE

By: Jean-Marc Lepain

Public Finance Specialist

Intergovernmental Fiscal Advisor, Ministry of Finance

Date: June 8th, 2009

This paper is intended to be used as a basis for discussion between the Ministry of Health and the

Ministry of Finance for the selection of a budget norm formula for the financing of the health sector

within the framework of the forthcoming fiscal decentralization reform. It is an interim report and it

does not reflect necessarily the project final conclusions.

This report does not take into consideration needs that might arise as a result of the reform of the

health insurance system. This will be done at a latter stage of the Expenditure Need Assessment.

After reviewing the literature available on the subject1, it appears that the health sector funding

approach the most adapted to Lao PDR seems to be a formula based on area-based capitation

adjusted to take into consideration variations in costs and needs. Typically, capitation methods takes

a measure of the size and characteristics of local population, for example in the form of risk factors

and costs such as levels of disease, poverty, population structure and geography, and infers the

expected level of local service expenditure without reference to actual local health service use.

However it does not appear that the health financing formula can be based hundred percent on

capitation because of the heterogeneity of services provided across the territory of the Lao PDR and

the need to provide incentives for increasing the number of patients visiting health facilities. We

might consider disaggregating the capitation amount by broad types of services in order to avoid

allocating funds for services which are not provided. We might also consider the possibility of ex

post adjustments for adjusting the funding made available to local performance, such as number of

patients treated or number of visits to villages.

Following the various discussions we had with people in the MoH and with a number of experts

(World Bank, WHO and Swiss Red Cross), five possible approaches have been identified. Making a

choice between these different approaches should be put in the wider perspective of the health

sector financing strategy based on a national health policy framework that still need to be prepared.

MoH can decide either to adopt an interim solution based on budget norms and applicable only for

one or two budget cycles or undertake immediately the design of a health financing formula.

1 I have paid special consideration to Formula Funding for Health Services ; Learning from Experience in some

Developed Countries, WHO Discussion Paper No 1 2008 by Peter C. Smith and Achieving Universal Health Coverage: Developing the Health Financing System, WHO Technical Brief for Policy Makers No 1 2005, by G. Carrin, C. James and D. Evans.

A. Selection of a formula

1) Approach based on salaries

Based on the observation that salaries are the main expenditure in the health sector and one of the

only reliable indicators of service, we try to equalize the number of health workers and provide

incentive for remote and difficult districts. Then non-wage recurrent expenditures can be expressed

as a percentage of salaries or can be based on other indicators.

Strength of the approach:

We are using data which are easily available

We can disaggregate the staff numbers by categories and facilities (provincial hospital,

district hospital, health centres)

The formula can ensure that sufficient funding is available for non-wage recurring

expenditures

Weakness of the approach:

Increasing the number of civil servants is difficult in Lao DPR and requires a long process

The equalisation impact will be very limited. There is a risk of freezing the existing situation.

Staffing is not a good indicator of needs and the formula does not provide any mechanism

for correcting under spending

2) Approach based on number of health workers

This approach is very similar to the previous one. It substitute to salaries the number of health

workers to avoid the problem of variable elements in salary compensation. There is no objective of

equalization of the number of health workers. This will require the desegregation of the number of

health workers into a few categories such as: general practitioners, specialized doctors, nurses,

paramedics , etc.

Strength of the approach:

The number of health worker is known and cannot be questioned

This is a better approach than the number of beds because beds can be unoccupied

This approach can be a good step in the direction of a heath financing formula or block grants

Weakness of the approach:

This approach works well for the equalisation of non-wage expenditure but does not give a

solution for the equalization of wage

The equalization impact is very limited

3) Approach based on capitation and case payments

A number of countries use formulae that combine capitation with case payments. A health facility

can be financed 60% by capitation and 40% by case payments.

Strength of the approach:

It provides a strong incentive for increasing service outreach

The equalization impact remains strong

Weakness of the approach:

This approach works well only when case payments are reimbursed according the diagnosis

and treatment of the patients. It implies knowing precisely the cost of each treatment;

something that does not appear feasible in Lao PDR.

The method requires a system able to check on the validity of the local data and the

appropriateness of the services being delivered. Either it requires a large investment in it or a

strong administrative structure. Without such system data can be easily manipulated and

audit requirements will become costly and administratively demanding.

4) Approach based on needs and cost

This is the simplest solution and the one that was envisaged when the Budget Norm Policy

Framework was prepared. We start from a notional level of spending per capita that we adjust in

every province to take into consideration needs and costs. For example: 20,000 kip per capita + 10%

to 20% based on a need indicator + 5% to 25% based on a cost indicator. As in the previous approach,

we ensure that a correct ratio wage/non-wage applies.

Suggested need indicators are life expectancy, infant mortality, nutrition, percentage of

population under the poverty line, etc.

Suggested cost indicators are ethnic structure of the population, population density, altitude,

etc.

Strength of this approach

The equalization effect will be maximum

It meets all the requirements of the budget law and would get easily political support

The formula can ensure that sufficient funding is available for non-wage recurring

expenditures

Weakness of this approach

Suggested needs indicators (life expectancy, infant mortality) appear to be all questionable

The equalization effect might be too fast resulting in allocation of funds that cannot be

properly used. The increase of the local budget should be limited over time or based on the

submission of an implementation plan.

5) Approach based on cost of infrastructures and programmes

This approach combines the two previous one. It distinguishes the cost of infrastructure from the

cost of other programmes.

Infrastructure cost is calculated by “bed” with a minimum allocation by bed that includes

salary cost and Goods & Services and by block grant for health centres. A substitute for beds

could be the number of qualified doctors.

Like in the previous formula, the allocation to other programmes is calculated on the based

of a minimum allocation per capita adjusted for cost and needs. However this time are

calculated by programme on the basis of a 10% (or more) increase in their coverage.

Strength of this approach:

This is the most equitable approach in terms of a balance between needs and costs

This approach solves the problem of insufficient funding for district hospital and health

centres. District hospital could be financed by a block grant calculated on that basis.

It is consistent with programme budgeting which is the direction toward MoH wants to move

Weakness of this approach

The formula become more complex

Experience shows that at the district level the bed occupancy rate is very low. One can

question the financing of bed if they are not used

It might be difficult to distinguish between infrastructure cost (expenditure per bed) and

other health services provided from the same health facilities.

6) Approach based on cost and service delivery

This approach build on the previous one but includes some adjustments in order to take in

consideration the quantitative aspect of services provided and to offer incentives for better use of

facilities and more services provided.

The cost of beds and other infrastructure is financed only to a certain level (between 60% and 80%).

The difference is covered by a payment made on the basis of the number of patients treated (case

payments).

Other incentives are introduced in other programmes. In the case of Lao PDR we can include lump

sum payments for each visit to a village in a priority district or even modulate the lump sum by village

types.

Strength of this approach:

It combines the advantages of the approach based on cost of infrastructure and programmes

with a strong incentive to increase service delivery.

The system is fairer and avoids financing facilities which are not efficiently used.

Weakness of this approach:

The formula can become too complex and difficult to calculate.

Data on use of services might be difficult to collect or manipulated.

B. Conclusion of the formula selection

Approach No 1 does not bring the equalization effect required and in fact exacerbate horizontal

imbalance for non-wage expenditures. According to a test run with the macro fiscal model when

wage expenditure fluctuate between 13,000 kips and 23,000 kips (if we exclude Vientiane Capital and

Attapeu which are special cases), non wage expenditures fluctuate between 7% and 94% of wage

expenditures.

The conclusion that we should draw from the test is that we might consider limiting the capitation to

non-wage expenditure. Equalization of salaries and compensation is impossible in the short term and

should be considered as a long term goal that requires a proper mechanism.

Approach No 2 is the one MoF’s Budget Department favors the more because it does not raise the

issue of salaries and the equalization of wage expenditure. A formula limited to non-wage

expenditures should take in consideration the staff structure of the health sector, the deployment of

programmes in a given province, specific need factors and factors that affect cost of service delivery.

Approach No 3 appears to be impracticable in Lao PDR.

Approach 4 and 5 appear as good candidate for the interim formula if we accept that the final health

financing formula should be developed over one or two years. A financing based on the number of

beds does not appear as a good approach due to the very low occupancy rate. That leaves the

number of qualified doctors as the only indicator of need.

Approach 6 can be considered, but look more like a basis for a more elaborated health financing

formula.

So far the best approach seems to be Approach No 2 seen as a transition formula toward a Health

Financing Formula developed on the basis of approach No 4 with a strong incentive component

and a clear objective of increasing the utilisation of heath facilities.

C. Analysis of cost drivers

The main cost drivers in Lao PDR seem to be geography and population structure. Reaching

minorities in high lands is more expensive than reaching Lao Loums in Mekong plain. Probably the

best approach would be classifying provinces and districts in four or five broad categories associated

with different cost levels based on some characteristics such percentage of minorities, percentage of

urban population, population density, etc.

D. Decisions that need to be made

We need to decide the scope of the financing formula. Certain health services might be

excluded from the formula and financed by ad hoc grants. It might be the case of specialized

hospitals. The formula should be linked to a health package available on a national basis.

At the moment it looks more likely that budget norms for the health sector will be

introduced in different stages. The different stages could be (a) a formula for non-wage

expenditure, (b) a formula for intergovernmental transfers giving an indication on the broas

size of the general budget in the provinces, (c) a complete health financing formula

MoH needs to look at the process for rationalizing the number of health workers in provinces

by developing staffing norms.

Do we take a full-fledge capitation approach based on a minimum spending per capita

(approach 1 and 2) or do we want to disaggregate the formula in a number of service type?

Do we want to use the health financing formula to provide incentive for heath delivery?

E. Conclusion and Recommendations

Designing a complete health financing formula is a complex task that cannot be rushed. It can be

done only when a number of health policy issues have been clarified such has the content of the

health package, the new universal insurance scheme, user fee policy, incentive policy, and hospital

management autonomy. We expect that these issues will be clarified within a year when a Health

Policy Paper will be published as part of PRSO triggers.

From the previous analysis we are able to make a few recommendations:

An interim budget norm formula applying for one or two budget cycles seems to be the best

approach. A full-fledge health formula can de develop in parallel in one or two stages an

introduced for the preparation of 2010/11 budget.

The interim formula should prefigure the health financing formula in order to avoid any

disruption.

Health facilities, activities and programmes outside the scope of the formula should be

identified immediately and will be financed through ad hoc grants.

The selection of the formula should be based on its equalization effect and on its capacity to

ensure that sufficient funding is available for non-wage recurring expenditures.

At this stage there is no guarantee that an increase in non-wage recurrent budget will cause

a reduction of user fees. This objective can only be achieved if proper instructions are given

to health facilities. Work on user fee policy and instructions (or regulation) should start in

parallel with the design of the budget norm formula.

Additional components of the formula such as incentive, program financing desegregation

and availability of funds at the district level will be reviewed in the next forth coming weeks

and it will be decided if they become part of the interim formula or not.

If the option of an interim formula is chosen, it is important to create a dynamic with time

constrains that will ensure that the final outcome (the complete heath financing formula) is

not postponed indefinitely. Objectives of the health financing formula should be defined in

the Health Policy Paper under preparation.

A satisfactory health financing formula requires better data than exist presently in Lao DPR.

For that reason we believe that the health financing formula should de developed in several

stages. Meanwhile other actions must be taken:

o A database must be created for the systematic collection of health

management data;

o A statistical model for analysing spending variations amongst health

facilities, programmes, provinces and districts must be developed ;

o The Medium-Term Expenditure Framework (MTEF) must be

completed;

o The MTEF should be used to create a link between investment

decisions and recurrent costs. No investment should be approved

unless there is sufficient additional funding for its operation and

maintenance.

o A more detailed heath budget must be produced and consideration

should be given to the introduction of programme budgeting;

o The health budget should include user fees and user fees should be

reflected in the national budget;

o Accounting rules should be revised in order to provide better

information on central/local expenditures, recurrent/investment

expenditures and the used of donors’ funding.

o A reporting mechanism on budget execution should be put in place

between Provincial Health Offices and MoH. This reporting

mechanism should provide data by district, by programme and by

health facility

o User fees should be fully reflected in health facilities’ accounting and

proper regulation must ensure that user fees are always linked to a

traceable service.

o For the sake of reporting, transparency and effective public finance

management, an agreement should be reached with the Treasury

for they management through the Single Treasury Account while

ensuring that the fund collected remain fully available at the local

level.

o In accordance with good public finance management practices, user

fees should be included as resource of the Health Budget.

F. Way forward

In the first stage this paper will be used as a basis for discussion in an informal way. The objective

will be to eliminate impracticable approaches, identified other possible options and refine the

strategy. When a consensus will have emerged we might consider organizing a round table to reach a

final decision.