1. 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.

2. 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:

3.  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

4. 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.

5. 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.

6. 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.

7.  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.

8. 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.