DEFINING AND MEASURING FAIRNESS IN FINANCIAL CONTRIBUTION TO THE HEALTH SYSTEM 1

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1 DEFINING AND MEASURING FAIRNESS IN FINANCIAL CONTRIBUTION TO THE HEALTH SYSTEM 1 Chrstopher JL Murray Felca Knaul Phlp Musgrove Ke Xu Ke Kawabata GPE Dscusson Paper Seres : No.24 EIP/GPE/FAR World Health Organzaton 1 We would lke to acknowledge the support receved from the Natonal Insttute of Agng through an Inter-Agency Agreement wth WHO that was used to undertake a part of ths work. We would also lke to thank Davd Evans, Julo Frenk, Emmanuela Gakdou, Patrca Hernández and Jean Perre Pouller for comments, suggestons and nputs; Ana Mylena Agular, Juan Pablo Ortz and Paola Zuñga for outstandng research assstance; the team of researchers at WHO workng on the WHO-NHA calculatons; and Gabrella Covno and Nankhonde Kasonde for support n edtng and producton.

2 I. Introducton One of the challenges common to all socal systems s to acheve farness n the dstrbuton of the fnancng burden, and protecton from the rsk of fnancal loss. For health systems, ths goal s of partcular mportance and especally dffcult to acheve due to the catastrophc and unpredctable nature of some expendtures. Socetes have long demonstrated a specal concern about how health systems are fnanced.(behrman 1995;Londoño & Frenk 1997;World Health Organzaton 2000)Much of the publc dscourse n countres undertakng health sector reform s focused on the desgn of health system fnancng and ts farness.(londoño & Frenk 1997;Wagstaff A & Van Doorslaer E 1998) The purpose of ths paper s to present a defnton, a measure and an ndex of farness n fnancal contrbuton to the health system. Our noton of farness s not a concern about the extent to whch contrbutons to the cost of the health system across households redstrbute ncome. Startng from a socety s efforts to redstrbute ncome, there are, nevertheless, mportant consderatons of farness that we try to defne and quantfy. Three ssues are crtcal to ths concept of farness: avodng catastrophc payments by households, horzontal equty and (to some extent) progressvty of contrbuton. Further, our approach separates fnancng from utlsaton, so that farness n fnancal contrbuton s determned ndependently of the health status of the ndvdual or household or the use of health servces. Our defnton, measure and ndex of farness n fnancal contrbuton are desgned and developed to be applcable across and wthn countres wth varyng types of health systems and at dfferent stages of development and of the health transton. The ndex can be used as a tool to analyse changes over tme wthn countres such as the results of health reform, economc crses, or polces such as decentralsaton. Some emprcal applcatons consderng dfferences across countres and relatng these to the organsaton of health systems are dscussed n companon publcatons.(world Health Organzaton 2000;Xu et al. 2000) The paper s dvded nto eght sectons. The second secton descrbes the overall WHO Framework for Measurng Health System Performance, for whch the measure of far fnance was desgned. The thrd secton provdes some background nformaton on health system fnancng arrangements. The fourth secton s a bref revew of the lterature on equty n health fnance. Secton fve dscusses the conceptual and theoretcal aspects of our measure of farness of health fnancng. Secton sx explores the propertes of the measure and ndex usng smulaton analyss. The seventh secton gves detaled nformaton on the constructon of the measure. The fnal secton provdes a summary, conclusons and a dscusson of future applcatons. II. WHO Framework for Assessng Health System Performance The measure of farness of fnancng presented here s part of a framework beng appled by the World Health Organsaton to assst countres to assess the overall performance of ther health systems. The framework sets out three ntrnsc goals: mprovng health, enhancng the responsveness of the system to the legtmate expectatons of the populaton; and assurng farness n fnancal contrbuton. For the frst two goals, we are concerned both wth rasng ther level and mprovng ther dstrbuton.. Health and responsveness are addressed n more detal n other papers. (Murray CJL & Frenk J 1999;World Health Organzaton 2000)

3 For fnancng, we consder only the dstrbuton, not the level, as there s no consensus on what the level of health spendng should be. The ntrnsc goals of the WHO framework do not nclude ether ncreasng or decreasng the amount spent on health. Whle the level of health spendng s clearly an mportant determnant of the outcomes of a health system on all three ntrnsc goals, t s not an ntrnsc goal n and of tself. Socetes must choose the approprate level of fnancng for the health system. Gven a level of spendng, however, every socety wll want the greatest amount of the socally desred mx of health, responsveness and farness n fnancal contrbuton possble; ths s the concept of performance or effcency. The choce of the level of total fnancng s a very mportant polcy choce but unlke health, responsveness, and farness n fnancal contrbuton, more consumpton of healthcare s not unequvocally better. Farness n fnancal contrbuton s an ntrnsc goal of a health system because t s a desred outcome n and of tself. Farness n fnancal contrbuton may also mprove access to health care and health outcomes, but ths nstrumental role of far fnancng s a separate ssue. Consder two systems, both havng exactly the same level of health, the same dstrbuton of health, the same responsveness and the same dstrbuton of responsveness. But n one, many households pay catastrophc shares of ther effectve non-subsstence ncome for health and n the other no household makes catastrophc payments. Most would agree that the system that protects households from catastrophc payment s more far and to be preferred. The goal of farness n fnancal contrbuton s nested wthn a framework of overall health system performance n whch t s not the only ntrnsc goal. A system n whch all households contrbute 0% of ther ncome to health s farly fnanced, but would do very poorly n the goals of producng health and responsveness. Smlarly, a system fnanced entrely through out-of-pocket payments where the poor pay very lttle because healthcare s unaffordable may score relatvely well on fnancal farness but wll do poorly on the level and dstrbuton of health and responsveness. The ncluson of farness n fnancng as an ntrnsc goal s mrrored by general preferences regardng the goals of health systems. In a survey where respondents were asked to weght the relatve mportance of all fve aspects of health system performance, farness n fnancal contrbuton s consdered by respondents to be as mportant as achevng hgher levels of health and greater equalty n the dstrbuton of health. Each of these goals receved a weght of 20-25%.(Gakdou, Frenk, & Murray 2000) III. Dversty of Health Fnancng Systems The household s the basc unt of analyss for ths and many other studes of fnancng. Whle funds for health servces may flow from households, employers and governments, t s households or ndvduals who ultmately own the productve resources n a socety. (Fuchs V.R. 1988;Iglehart J.K. 1999)Funds for health servces are extracted from households through such means as payroll deductons, ncome taxes, value-added taxes ncorporated nto the purchase prce of goods and servces, out of pocket payments for health care, and prvate nsurance premums. As Fuchs (Fuchs V.R. 1988) wrtes: The most basc pont, often obscured n publc dscussons, s that the publc must pay for care under any system of fnance. the ultmate cost falls on famles and ndvduals even when the payment mechansm makes t appear that the blls are beng sent elsewhere.

4 There are four man types of fnancng for health: government-rased (through general and specfc taxes); socal nsurance contrbutons (often leved through payroll and other taxes, as well as other contrbutons); prvate nsurance contrbutons; and outof-pocket payments. The frst three types of fnance are pre-pad, nvolve a substantal degree of rsk poolng and can protect both rch and poor from catastrophc and mpovershng health expendtures. Contrbutons are often a functon of ncome. It s mportant to emphasze that government-fnanced and socal nsurance schemes can, but do not necessarly, protect all ctzens. Partcular groups are often excluded such as the poor, recent mmgrants or nformal workers. Wthn the categores of government-rased and socal nsurance, there s also substantal varaton across countres. Most countres rely on a mx of value-added, ncome, excse and other taxes. The structure of each tax system reflects the preferences of each country for soldarty and progressvty, as well as the economc structure and wealth of the economy. Some countres rely heavly on general taxaton as compared to a socal nsurance or socal securty scheme. Further, countres vary n the proporton of the populaton covered by socal securty through payroll taxes, dependng on the sze of the formal labour market. Socal securty may be fnanced from general or payroll taxes, and there may be redstrbuton away from, or toward, those ndvduals that are nsured. In most cases, socal nsurance s pad for by dedcated payroll taxes where a fxed proporton goes to fnance health care for workers and ther famles. Some countres supplement ths wth funds collected through general taxes, whle others use funds from payroll collectons to fnance publc health programs that also cover the nformal populaton. Prvate payments are of two types: prvate nsurance premums and out-of-pocket payments. Prvate nsurance can protect ndvduals from catastrophc expendtures, but coverage, access and rsk poolng are often lmted. Prvate nsurance s typcally a good avalable only to the rch n poor countres, the healthy and those that lve n urban areas. Out of pocket payments are typcally made at pont-of-servce and the ndvdual consumers choose, as a functon of ncome, how much they are wllng and able to purchase. Catastrophc, and potentally mpovershng, expendtures arse because households wll sell assets and borrow from future potental earnngs n order to purchase care. The fnancng of out of pocket payments s, n fact, often severely constraned by the ndvdual or household access to credt and borrowng. Necessary care s forgone and expendtures are zero f the cost of care exceeds the ablty to pay at the tme of servce. Further, out of pocket payments are the most fragmented across ndvdual consumers, wth no possblty of poolng rsks. Out of pocket fnancng of health s the most lkely reason that would characterze unfar dstrbutons of health fnancng, and to generate severe fnancal losses and rsk of mpovershment for some famles. Ths s partcularly evdent n countres where other fnancng optons are restrcted to the rch, and out of pocket payments are the only opton for the poor.

5 By Source of Revenue % RAISED THROUGH GOVERNMENT TAXES A E D 20 0 PRIVATE SPENDING = 100% Adapted from: Van Doorslaer and Wagstaff, B F % RAISED THROUGH SOCIAL HEALTH INSURANCE C The health fnance mx tends to vary substantally across countres. The degree to whch governments rely on each of the four sources of funds government rased, socal health nsurance, prvate nsurance and out-of-pocket spendng -- vares substantally. A varety of combnatons are llustrated n Fgure 1. In ths dagram, the closer the pont s to the lne A-C, the less the relance on prvate spendng. A country that reled entrely on prvate out-of-pocket spendng would be found n the bottom left-hand corner (pont B). Systems fnanced (almost) entrely from one source-- such as at ponts A, B and C n Fgure 1 are rare. Most wealther and some developng countres rely on some combnaton of sources (pont D), wth certan countres leanng less heavly on out-of-pocket payments (Pont D as compared to Pont F). Many countres are close to ponts E or F wth a heavy relance on prvate fundng, most of whch s out of pocket n poor countres, to supplement publc and socal nsurance-based fnance. In only a few countres s prvate nsurance (pont G) mportant.(van Doorslaer E & Wagstaff A 1999) IV. Equty n Health Fnance Before presentng our framework on farness n fnancal contrbuton a useful startng pont s to revew the rch lterature on equty n health fnance.(wagstaff A & Van Doorslaer E 1998) Ths has grown out of the publc fnance lterature that analyzes the extent to whch the tax system acheves one of socety s goals, that of redstrbuton of ncome and wealth. In transferrng ths concept to the health system, equty n health fnance has been formulated as the extent to whch all forms of health payments (taxes, socal nsurance payments, prvate nsurance and out-of-pocket payments) contrbute to the redstrbuton of ncome. (Deaton A & Muellbauer J 1980) 2 Ths vew of equty n health fnance has been justfed usng two types of arguments. Frst, t s clamed that the health system should be consdered as one of many mechansms to redstrbute ncome and should thus be evaluated n terms of how well 2 There s good evdence that polcy-makers n the OECD countres are concerned about the effects of health care fnancng arrangements on the dstrbuton of ncome as well as on who receves health care (cf. E.g., OECD,1992).

6 t acheves ths ntrnsc goal. The second argument s nstrumental: health systems that redstrbute ncome are lkely to gve more access to the poor and thus lead to better health outcomes. Ths latter vew leads naturally to a related set of analyses on the dstrbuton of the benefts of health servces. As Van Doorslaer, Wagstaff et al.(van Doorslaer E & Wagstaff A 1999) note, the most nclusve measure of equty n health fnance s the total effect of health fnancng contrbutons on the redstrbuton of ncome. One way to capture ths net effect s to compare the Gn coeffcent of household ncome pror to health system payments wth the Gn coeffcent of household ncome after health system contrbutons. The total re-dstrbutve effect can be conceptually and quanttatvely dvded nto the contrbutons of vertcal equty and horzontal equty. 3 Vertcal equty s the extent to whch the rch pay more for the health system than the poor. Horzontal equty s the extent to whch households wth the same ncome pay the same amount to the health system. The extent to whch health system contrbutons redstrbute ncome s domnated by the progressvty of the contrbutons, wth the progressvty of each mode of fnancng weghted by ts mportance relatve to other sources. 4 Several authors have appled the well-developed methods for evaluatng the progressvty of tax payments to payments for health care.(aronson JR, Johnson P, & Lambert PJ 1994;Kakwan K 1977;Kakwan K, Wagstaff A, & Van Doorslaer E 1997;Kakwan N. 1997;Rasell E, Bernsten J, & Tang K 1994;Wagstaff A & Van Doorslaer E 1992;Wagstaff A & Van Doorslaer E 1993;Wagstaff A & Van Doorslaer E 1999;Wagstaff A., Van Doorslaer E, & Pac P 1989;Aronson JR, Johnson P, & Lambert PJ 1994;Aronson JR, Johnson P, & Lambert PJ 1994;Aronson JR, Johnson P, & Lambert PJ 1994;Aronson JR, Johnson P, & Lambert PJ 1994;Aronson JR, Johnson P, & Lambert PJ 1994) Many of these studes have used the Kakwan ndex, whch consders the degree to whch a payment (for tax or health care) departs from proportonalty, where proportonalty s measured aganst the dstrbuton of pre-payment ncome n the populaton. The method nvolves plottng ranked pre-payment ncome aganst the cumulatve proporton of health care payments. The area between the two dstrbutons provdes a measure of the extent of regressvty or progressvty n health care payments relatve to that of ncome (Fgure 2). 5 When health system contrbutons are progressve the Kakwan ndex wll be postve and when health system contrbutons are regressve the Kakwan ndex wll be negatve. 3 Unequal treatment of households wth the same ncome by the tax system or the health system can be further dvded nto two components: the extent to whch the rankng of households by ncome changes after payments for the health system, and the extent to whch there s nequalty n payments to the health system when households are ranked wthn bands of smlar post-payment ncome. For most purposes ths dstncton may not be that nformatve. 4 A progressve system of payments means that rcher households pay a larger share of ther ncome than poorer households. In a regressve system, the rcher households pay a smaller share of ncome than poorer households. 5 The Kakwan ndex s formulated as the dfference between the Gn coeffcent for prepayment ncome, and the concentraton ndex for health care payments.

7 100 Fgure 2: Kakwan Index of Progressvty Health contrbuton concentraton curve Lorenz Curve of ncome* pre health contrbuton Cumulatve percent of ncome* and of health payments 0 0 Cumulatve percent of populaton Adapted from: Van Doorslaer and Wagstaff, *May be ncome, expendture, or some other measure of capacty to pay. The analyss of progressvty usng the Kakwan ndex has been appled to a number of OECD countres.(rasell E, Bernsten J, & Tang K 1994;Wagstaff A & Van Doorslaer E 1993;Wagstaff A & Van Doorslaer E 1999;Wagstaff A., Van Doorslaer E, & Pac P 1989;Wagstaff A., Van Doorslaer E, & Pac P 1989) These studes fnd that drect taxes are progressve n all developed countres, whle ndrect taxes are generally regressve. Socal nsurance s progressve n countres where coverage s unversal, and regressve n those that exclude the hgher ncome groups. Prvate nsurance s regressve n countres such as the Unted States and Swtzerland, because premums are not related to ncome but are constant or related to rsks. For those who purchase t, prvate nsurance s often the sole source of coverage. Even when the poor do not buy nsurance, the dstrbuton can be regressve among those who do buy, because of the large dfferences n ncome. A common fndng of these studes s that out-of-pocket payment s regressve. It s partcularly so n countres where pre-pad health care does not cover the low-ncome groups. The overall fndngs show that n countres where health fnancng s predomnantly prvate, ether va nsurance or out-of-pocket payments, the system s most regressve. Socal nsurance-based countres are mxed, dependng on whether the hgher ncome groups are permtted to opt out of the system. Tax-fnanced systems are proportonal or mldly progressve. Several authors have analysed changes over tme, the mpact of reforms or proposed changes n health fnancng wthn countres such as the Unted States, the Netherlands and Australa. These studes have measured the extent to whch changes n fnancng have generated or would generate more or less progressve health fnancng regmes.(holahan J & Zedlewsk S 2000;Larson DR, Hndson P, & Hauqutz A 1995;Wagstaff A & Van Doorslaer E 1998)

8 Informaton on vertcal equty n developng countres s scarce. Several studes have shown that n some countres, all famles, ncludng the poor, spend a hgh share of ther budget on out of pocket health spendng.(hotchkss DR et al. 1998) In Thaland and Mexco, the poor spend a hgher proporton of ther ncome on out-of-pocket health spendng than the rch. Further, the regressvty of out-of-pocket spendng s related to the degree to whch populatons are covered by pre-pad nsurance schemes. (Frenk J, Lozano R, & González Block MA. 1994;Pannarunotha & Mlls 1997)A study of Jamaca, Ghana, Côte d Ivore, Peru and Bolva usng Lvng Standard Measurement Surveys, concluded that health fnancng channelled through the publc sector dd lttle to amelorate nequaltes n spendng and access to health care.(baker JL & van der Gaag J 1993) Efforts are under-way to extend the work on the progressvty of health fnancng n OECD countres to the developng world, partcularly to Latn Amerca and the Carbbean. Some early results from these studes have shown a heavy relance on out-of-pocket payment that vares from 30 to 60% of health fnance. Further, out-of-pocket payments are regressve n a number of countres, and exacerbate the exstng nequaltes n the dstrbuton of ncome. (Gonzalez Per E & Parker S 1999;Lasprlla E, ObandoC, & Encalad E Lasprlla C 1999;Suarez RM 1999;Valladares R & Barllas E 1999)A recent study of health fnancng n Mexco usng Kakwan ndces found that overall the system s close to neutral, out of pocket spendng s regressve and other sources of fnance tend to be somewhat progressve.(gonzalez Per E & Parker S 1999) When health system payments dffer for households wth the same ncome, the mpact on ncome redstrbuton s less than f households of the same ncome pad the same amount. Ths s a central ssue n studes of horzontal equty wthn the context of the total re-dstrbutve effect. Emprcal studes of ths effect n OECD countres show t to be relatvely small. There are few studes of the effect of horzontal equty on ncome redstrbuton n developng countres. Although not part of the equty n health fnance lterature, another type of study that s relevant to farness of fnancal contrbuton attempts to quantfy the extent of catastrophc or mpovershng payments for healthcare.(frenk J, Lozano R, & González Block MA. 1994) Whle few such studes exst, mpovershment has been recognzed as a crtcal dmenson for polcy. In summary, work to date relevant to evaluatng the farness of fnancal contrbuton has proceeded n three man drectons. Frst, the domnant conceptual framework s to analyze equty of the health fnancng system by ts contrbuton to ncome redstrbuton. In practce, ths means a focus on progressvty. Ths work has clearly been mportant, useful and nfluental, but the concept of farness s much broader than ths concern for ncome redstrbuton. For example, most would agree that when households face catastrophc payments to purchase needed healthcare that ths s undesrable and unfar. Yet, catastrophc payments for rch households mght actually mprove the dstrbuton of ncome and catastrophc payments for a small number of poor households would have a neglgble effect on overall ncome dstrbuton. Second, most of the emprcal work has been on developed country systems. Thrd, the recent trend n the lterature s to lnk analyses of payments to the health system to the analyss of the dstrbuton of the benefts of the health system. In the WHO Framework for Health Systems Performance Assessment, the ultmate mpact of the dstrbuton of healthcare resources should be captured n the

9 measure of farness n fnancal contrbuton. V. Concepts and Theory In ths secton, we defne our concept of farness, operatonalze ths defnton and propose a summary measure or ndex to compare the farness of fnancal contrbuton n two dfferent populatons. A. Conceptual Framework Let us explore the concept of a far dstrbuton of contrbutons to the health system across households wth a completely dfferent pont of reference. Socetes do not purchase health systems n order to redstrbute ncome. Socetes may have a very mportant socal goal to redstrbute ncome through government tax polcy but ths can be acheved through many mechansms unrelated to the overall fnancng of the health system. A parsmonous lst of goals for the health system to acheve s not lkely to nclude ncome redstrbuton as one of the man goals. Rather, gven ncome redstrbuton efforts n socety, there are stll ways to fnance the health system that are more far than others. We begn ths dscusson of the conceptual bass for measurng farness of fnancal contrbuton wth the queston: what s a maxmally far dstrbuton of fnancal contrbuton to the health system? Ths normatve dscusson s a useful bass for makng sure that any measure captures the crtcal dmensons of farness and provdes some bass for establshng meanngful endponts for any scale. Ultmately, the measure of farness may be used only to descrbe the state of affars n dfferent populatons. Nevertheless, startng from some explct normatve dscusson wll help clarfy the meanng of the measurements. The followng dscusson wll lead us to a more nclusve formulaton of farness than has been the focus of much of the lterature n developed countres revewed above. To explore notons of farness n fnancal contrbuton, we can start by dentfyng what s unfar. Almost everyone would agree that catastrophc payments are undesrable and unfar. Imagne two systems, one n whch health, health nequalty, responsveness and responsveness nequalty are dentcal but n one system two percent of households make catastrophc payments and n the other zero percent. Most would prefer the zero percent. Unequal payments by equvalent households are also unfar. The concern that should be gven equal consderaton s a powerful nfluence on the formulaton of socal systems. For example, wdely dfferent shares of ncome gong to pay for health nsurance n dfferent German sckness funds was broadly seen as unfar, leadng to the rsk equalzaton reforms of the 1990s.(Wagstaff A & Van Doorslaer E 1998) Fnally, many thnk that farness should nclude some noton that the rch contrbute more for the health system than the poor on a per capta bass. Ths concern can be dstnct from a general consderaton of ncome redstrbuton. Ths specal concern for how the health system s fnanced may stem from the specal nature of health tself as an ngredent to opportunty and the pursut of the good lfe.

10 All three of these concerns, avodng catastrophc payments, equal payment by equvalent households and some element of progressvty, can be related to the core concept of farness. Farness n the phlosophcal lterature s often assocated wth the concept of mpartalty. One way to thnk about mpartalty s usng the devce of the orgnal poston. If you do not know who you are n socety, what would be a far way to organze the fnancng of the health system? We argue that from such an mpartal pont of vew, we want households or ndvduals to contrbute equal shares of ther capacty to pay for the health system. The debate about defnng farness n fnancal contrbuton then becomes a debate over the meanng of capacty to pay. Is a household s capacty to pay smply ts ncome? Households face unavodable costs to mantan subsstence, such as expendtures requred for food, mnmal clothng and shelter. Surely a household s capacty to pay should exclude expendture requred for these basc needs. Capacty to pay could then be defned as to equal a household s ncome mnus subsstence expendture. But a household s capacty to pay may not smply be a functon of current ncome. Households may have assets, and they may also have access to ther future earnngs through formal and nformal fnancal mechansms. Current ncome, assets and future earnngs may all contrbute to the effectve ncome of a household. We beleve that capacty to pay needs to be defned n terms of effectve ncome (see below for a more formal defnton) rather than current ncome. Effectve ncome may be hgher or lower than current ncome; t can be consdered as the ncome that households would behave as f they have when makng consumpton decsons. In that respect t s akn to permanent ncome (Fredman M 1957), but wth at least one mportant dfferences. Permanent ncome s a postve theory of consumer behavour whch wll reflect among other factors the dscount rate that ndvduals use n decson-makng. For a normatve concept to compare to health expendture, effectve ncome must be defned ndependent of varaton n ndvduals subjectve dscount rate. Ths s dscussed more fully below. Although we do not argue that emprcal ethcs s the soluton to all normatve choces 6, measurements of populaton preferences can be nformatve. WHO undertook a survey of 1007 respondents of ther preferences for health systems, ncludng preferences for the fnancng arrangements n the health system. The sample was a convenence sample of health professonals and those wth a specal nterest n health from over 100 countres, but was not a representatve sample. Ths survey was dstrbuted to the world-wde staff of WHO and then placed on the WHO web ste n order to elct responses from a broad range of nterested ndvduals. The results of the survey strongly ndcate preferences for a system n whch everyone contrbutes an equal share of capacty to pay nto a health system (Table 1A). For ease of explanaton, n the survey dsposable ncome was defned to be equal to capacty to pay. More than 70% of the WHO staff and more than 60% of nternet respondents voted for ths opton as ther preferred method for achevng a far system of health fnancng. 6 Well-known problems wth abhorrent preferences lmt the scope for usng emprcal ethcs (Hausman Danel M 2000). Perhaps even more problematc s that many of these choces requre consderable delberaton, the tme for whch s rarely avalable n surveys.

11 Table 1: Preferences for Farness of Health Fnancng based on the WHO Survey of Preferences on Health System Performance Assessment (percentages of respondents) Table 1A: Preferred fnancng mechansm for a health system WHO staff Internet respondents All respondents Everyone pays the same amount Everyone pays for what they receve Everyone pays an equal share of ther ncome Everyone pays an equal share of ther dsposable ncome The rchest 10% pay for everyone Table 1B: Choce between one household payng 50% of dsposable ncome and two households each payng 25% of dsposable ncome WHO staff Internet respondents All respondents One household more far Two households more far Equally far Don t know Table 1C: Choce between one household payng 100% of dsposable ncome and two households each payng 50% of dsposable ncome WHO staff Internet respondents All respondents One household more far Two households more far Equally far Don t know Table 1D: Choce between one household payng 200% of dsposable ncome and two households each payng 100% of dsposable ncome WHO staff Internet respondents All respondents One household more far Two households more far Equally far Don t know

12 To summarze, we make the normatve clam that: A health system s farly fnanced f the rato of total health system contrbuton of each household through all payment mechansms to that households capacty to pay (effectve non-subsstence ncome) s dentcal for all households, ndependent of the households health status or use of the health system. Ths s a plausble normatve clam that may appeal to many. Nevertheless, we recognze that there may be a long and lvely debate as to the deal concepton of farness of fnancng for the health system. Not everyone wll agree wth ths normatve clam, but the measure derved from lookng at the share of non-subsstence effectve ncome that goes for the health system across households can be stll be used for comparsons, just as the Gn coeffcent can be used wthout endorsng complete equalty of ncome across households as a socal goal. In practce, those who prefer want a health fnancng system that s even more progressve than that mpled by ths measure should not be concerned, as no country we have studed comes even close to equal shares of nonsubsstence permanent ncome. We expect and hope that ths approach to examnng the farness of health system fnancng through shares of household non-subsstence effectve ncome wll spark debate. But we beleve t captures the three key ssues: a specal concern of for those households facng catastrophc spendng for health, for unequal contrbutons for equvalent households and for the overall progressvty of the system. B. Operatonalzaton of HFC The defnton of farness developed above s an equal dstrbuton of shares of capacty to pay across households. Capacty to pay for a household has been defned as effectve ncome mnus subsstence expendture. We begn by formulatng the quantty of nterest at the household level as the health fnancng contrbuton (HFC): HE (1) HFC = ENSY where HFC s the health system fnancng contrbuton of the household, HE s the per capta expendture on health of household, and ENSY s the per capta effectve ncome mnus subsstence expendture of household. HFC s deally defned over a perod of one year for a household. One year has been chosen because for most households t s a natural unt of tme that encompasses many predctable fluctuatons n ncome and expendture. It s also the nterval over whch the World Health Organzaton ntends regularly to evaluate health systems. 7 In practce, HFC has been estmated usng shorter perod data, typcally referrng to one month, because survey data seldom refers to an entre year. 7 The perod of evaluaton of health expendture and permanent non-subsstence ncome s mportant. Dependng on the avalablty of varous formal and nformal mechansms to borrow and save, households may behave as f they average ther ncome over longer perods. In the extreme, the lfe cycle consumpton hypothess argues that households smooth consumpton over the stream of all future ncome. (Ando A & Modglan F 1963)In practce, n dfferent socetes the perod over whch permanent ncome s defned wll vary, beng generally longer at hgher ncomes.

13 The numerator (HE ) ncludes all fnancal contrbutons to the health system attrbutable to the household through taxes, socal securty contrbutons, prvate nsurance, and drect, out-of-pocket payments. These nclude fnancal outlays that the household tself s not necessarly aware of payng, such as the share of sales or valueadded taxes that governments then devote to health. For taxes that are not earmarked and for socal securty contrbutons, total household payments must be multpled by the share of these revenues that ultmately goes to fnance the health system. 8 To operatonalze the denomnator of HFC, we need to defne effectve ncome and subsstence expendture. Our noton of effectve ncome s meant to reflect household tendences to smooth consumpton over tme, takng account of expected varatons n ncome over the course of the year, ther assets (allowng for savng or non-savng) and ther future earnngs potental. There s a rch lterature n economcs offerng dfferent theores of how households make consumpton decsons. For example, n the lfe cycle ncome hypothess, households are assumed to smooth ther consumpton over the lfe cycle, such that expected consumpton s equal n all subsequent tme perods. One formulsaton of ths theory of consumpton behavour that s adapted to the crcumstances of health s: (2) C Y + A t= 1 0 = l t 1+ Pδ t= 1 l t t Y Pδ Where C 0 s the consumpton of a household at tme t = 0, gven complete access to mechansms to smooth consumpton and consume assets, Y t s the ncome at tme t > 0, P t s the probablty of beng alve n each future year, Ao s the net value of assets (savngs or debts) at tme t = 0, and δ s 1/(1+r), where r s the market nterest or dscount rate, equal for all households. The lfe cycle hypothess s a postve theory of consumer behavour. In ths context, the dscount rate must be the dscount rate of the ndvdual or household. However, for the purposes of defnng the capacty to pay of a household, we do not want to use the subjectve present value of future consumpton, but rather the fnancal present value. In other words, the dscount rate should be the market rate of nterest. The lfe cycle ncome hypothess s partcularly mportant for three sets of crcumstances: when households face predctable fluctuatons n ncome durng the course of the year, when ther ncome n future years s expected to change and when they have postve assets or negatve assets (debts). A household s lkely to consume n a year, more or less, than t earns, n all of these crcumstances. t t 8 Two potentally mportant sources of fnance for the health system n some countres, donor assstance and government non-tax revenue through the sale of assets such as ol, need further dscusson. Donor assstance s pad for by households n other countres through voluntary contrbutons or taxes; therefore, we do not nclude donor assstance n the defnton of household health expendture n the recpent country. Ol revenue or the sale of any other natonal asset s a more dffcult ssue. One argument holds that natonal assets are owned equally by all households. Thus government revenues from ther sale should be attrbuted n equal amounts to all households. Such fnancng would appear to be extremely regressve because the same dollar value of sales for a poor household would be a much larger share of ncome than for a rch household. Alternatvely, t can be argued that sale of assets should be treated n the same way as donor assstance and not attrbuted to households n the analyss of farness n fnancal contrbuton, so that t has no effect on the measure. A thrd possblty s to attrbute n proporton to the capacty to pay, so the effect s neutral.

14 For households to succeed n smoothng consumpton over long perods of tme, effectve formal or nformal mechansms must exst to allow borrowng on the bass of the present value of ther future earnngs or savng earnngs n a form of assets that can be subsequently sold as needed. If households possess assets, n most settngs these can be sold and converted nto effectve ncome although temporary problems may exst that mpede the sale of assets and create lqudty problems for households. A more mportant problem s that n many countres mechansms may not be avalable to allow households to ncrease consumpton by borrowng on the bass of future earnngs. Because of the mperfectons of formal and nformal mechansms to smooth consumpton, the ncome that a household s able to consume and would seek to consume accordngly gven ts current ncome, assets and access to future earnngs could dffer from that predcted by the lfe cycle hypothess. Where no mechansms exst to borrow or save, effectve ncome equals ncome at that tme; where mperfect mechansms exst, consumpton would be somewhere between current ncome and expresson 2.(Behrman 1995) One of the many ways to model the effects of the lmted access of mechansms to borrow s: (3) C0 Y = Mn o + A 1+ + t= 1 L 0 t= 1 L t t Y Pδ t t Pδ t, Y o + A F L t= 1 t Y P F δ t t t Where F t s a measure of the access a household has currently to future earnngs at tme t. The Mn expresson means that a household would lke to consume at the level suggested by the lfe cycle hypothess, but when ts access to borrowng s less than what s requred t s forced to consume less. When all F t are zero, but F 0 > 0, households cannot draw on future ncome, but are lmted n ther consumpton to current ncome and current assets.

15 At frst pass, the noton of consumpton smoothng may be confusng. Fgure 3 shows a smple llustratve example. Annual ncome for the household shown s expected to ncrease rregularly for the next 15 years and then steadly decrease. If the household has access to mechansms to smooth consumpton, then we would expect the household to consume the amounts shown by the pnk lne. In the absence of effectve mechansms to smooth consumpton, consumpton may be as shown n the dashed lne Fgure 3: 1500 $ Y PY EY Year Consderatons of farness n fnancal contrbuton are normatve and the denomnator n HFC needs to be defned n terms of some meanngful comparable standard across households. Reflectng the desre of households to smooth consumpton over tme and the lmtatons to consumpton smoothng n many envronments, we defne effectve ncome as the level of consumpton that a household would seek and s able to consume, based on a lfe cycle perspectve assumng that all households share a standard dscount rate. To avod all ambguty, we are argue that effectve ncome s as defned n equaton 3 wth the added constrant that all households use the market nterest rate as the dscount rate. Because we defne capacty to pay n terms of effectve ncome, t leads naturally to certan conclusons about what should be ncluded n the denomnator. For example, subsdes rase a household s net ncome and therefore ts effectve ncome. Lkewse, tax payments generally lower ncome and effectve ncome. 9 Because F t cannot be easly observed, estmatng effectve ncome presents a number of challenges that are addressed n the secton on mplementaton. 9 Medcal savngs accounts are an nterestng llustraton of how the measure depends on the nature of an asset. In Sngapore, Medsave s a mandatory savngs account of a certan percentage of ncome that can only be used to pay for health servces. When a household pays for healthcare from a medcal savngs account, the expendture s clearly to be ncluded n HE, the numerator of HFC. But how does the medcal savngs account affect effectve ncome? Because a medcal savngs account can only be used to pay for health care, t has a dfferent effect on effectve ncome than regular assets. When t s used, t ncreases effectve ncome by the same amount that s used n the numerator.

16 The second step n defnng capacty to pay s to defne expendture requred for subsstence. There s an extensve lterature on basc needs whch addresses ths queston.(sen A 1981;Sen A 1984;Sen A 1985;Streeten P et al. 1981)Clearly, subsstence expendture for the purposes of defnng HFC should not nclude expendture on health even f t s seen as essental. Subsstence mnmally ncludes expendture on food, basc shelter and mnmal clothng. Implementaton of the defnton of subsstence wll address the mportant problem of usng defntons that are comparable across populatons. Household composton wll have an mportant effect on total subsstence expendture. The capacty to pay and thus HFC wll, therefore, reflect dfferences across households n ther composton. In prncple, t wll be mportant to develop estmates of actual subsstence requrements for dfferent households that reflect the composton of households and ther crcumstances. Expendture requred for subsstence can vary wth local events. For example, durng a famne the fracton of ncome requred to purchase subsstence needs may ncrease dramatcally. The conceptualzaton of HFC as effectve non-subsstence ncome (ENSY) captures these effects. C. Summarzng the dstrbuton of HFC We have formally defned HFC so that for each country one could wth the approprate nformaton on health expendture, effectve ncome and subsstence expendture, estmate the household dstrbuton of HFC. Fgure 4 shows the dstrbuton for two countres (the Russan Federaton and the Unted Republc of Tanzana) based on the analyss of household survey data. Fgure 4: Russa: The Dstrbuton of Health Fnancng Contrbuton Tanzana: The Dstrbuton of Health Fnancng Contrbuton Fracton.6.4 Fracton Health fnancng contrbuton Health fnancng contrbuton The dstrbuton of HFC n the Russan Federaton s much broader than for the Unted Republc of Tanzana; there are more households contrbutng catastrophc shares of ther capacty to pay to the health system than n the Unted Republc of Tanzana. Even n the lower ranges of capacty to pay, there s much more nequalty n the Russan Federaton than n the Unted Republc of Tanzana.

17 Cumulatve Dstrbuton of Households Health Fnancal Contrbuton Fracton of Households Russa Contrbuton Fracton of Households Tanzana Contrbuton Dstrbutons of Households Accordng to Health Expendture as a Fracton of Effectve Non-Subsstence Income Russa Tanzana % 10-30% 30-50% % % 10-30% 30-50% % Fgure 4 also shows the nformaton contaned n the dstrbuton of HFC n two other ways: a pe chart emphaszng the percentage of households wth very hgh shares of ther capacty to pay spent on health and a lne chart representng the cumulatve dstrbuton across households of HFC. Such graphcal representatons of the dstrbuton of HFC are all nformatve n dfferent ways. But when we want to compare many such dstrbutons across countres, t s necessary to develop an ndex that can summarze the extent of nequalty n the dstrbuton of HFC. Ths s analogous to the problem of comparng dstrbutons of ncome where measures such as the Gn coeffcent are commonly used to represent dstrbutons as a sngle ndex.

18 Whle there s a vast lterature on ndexes of nequalty to summarze dstrbutons, the development of ths ndex should take nto account the specal concern we have about catastrophc spendng. Ths means that the rght hand tal of the dstrbuton should be heavly weghted. Preference measurement through the survey of health systems preferences dscussed above s also nformatve. When faced wth a choce between dstrbutng the burden of health fnance among two households as opposed to concentratng the burden n a sngle household, more than 70% of respondents favoured dstrbutng the burden across the households (Tables 1B, 1C, 1D). Ths preference for a shared burden s robust to varyng the magntude of the fnancng burden from 25 to 100 percent of household dsposable ncome. Ths s consstent wth a strong preference for protectng ndvdual households from catastrophc expendtures and for sharng the burden of health fnancng across households. One famly of nequalty measures that can be desgned to gve specal weght to the tal of the dstrbuton, compares the quantty of nterest, n ths case each ndvdual s fnancal contrbuton, to the mean of the populaton. The general form of such ndvdual-mean dfference (IMD) measures s: (4) IMD( α, β ) n = = 1 HFC µ nµ where HFC s the fnancal contrbuton of household, µ s the mean fnancal contrbuton of the populaton, and n s the number of households n the populaton. The choce of the parameter α determnes the sgnfcance attached to dfferences n the health fnancal contrbuton observed at the tals of the dstrbuton, compared to dfferences observed close to the mean of the dstrbuton. The parameter β determnes the extent to whch the measure s relatve to the mean as opposed to measurng absolute dfferences. If β =1, the measure s strctly relatve and when β =0 the measure s restrcted to absolute devatons from the mean. β can take any value between 0 or 1, reflectng some mx of concern for relatve and absolute ndvdualmean dfferences. Varance s a measure of ndvdual-mean dfference where α = 2 and β =0, and the coeffcent of varaton corresponds to α = 2 and β =1. We argue that to gve approprate emphass to households spendng catastrophc shares of ther capacty to pay, α should be greater than 2. We have selected a value of 3 for smplcty. So that the ndex s not affected by the level of spendng we have set β equal to zero. Ths means that the ndex has translaton ndependence, namely that a fxed quantty added to every household wll not affect the extent of nequalty. Fnally n constructng an ndex of Farness of Fnancal Contrbutons to Health (IFFC), we have rescaled the measure so that t has unt value when all households pay the same fracton of ther capacty to pay; n other words, 1.0 means complete equalty of HFC. A constant has been added to the ndex so that the mnmum value represents a maxmum dstrbuton of nequalty that s not exceeded n any emprcal example studed: β α

19 (5) IFFC = 1 4 n = 1 HFC 0.125n HFC 3 We have compared results for a number of countres usng some alternatve values of α. For example, there s lttle mpact of changng α from 2 to 3. We expect to contnue work n ths area n order to explore the propertes of other ndexes to summarze the dstrbuton of HFC. We also ntend to nvestgate ndvdual preferences further as a bass for gudng the selecton of the parameters and rescalng of the ndex. D. Other aspects of the dstrbuton of HFC As wth any measure, there are some ssues that are not captured n the dstrbuton of HFC or n the IFFC. It s mportant to note that the dstrbuton of HFC wll not show f a poor household chooses not to purchase healthcare because t s unaffordable. In ths sense, a far dstrbuton of HFC may mask a stuaton where poor households have opted out of the system and are not recevng needed health servces. Ths lack of fnancal access to needed servces wll reduce overall health of the populaton and ncrease health nequalty. It s also lkely to reduce responsveness and ncrease responsveness nequalty. Ths smply emphaszes the mportance of judgng the overall equty of a health system n terms of the dstrbuton of health, responsveness and fnancal contrbuton. The relaton between the dstrbuton of HFC and the extent of fnancal rsk protecton n a populaton s mportant. Measures of fnancal rsk protecton such as the coverage of nsurance are dffcult to nterpret because the benefts packages, copayments and premums for nsurance vary so much wthn and across populatons. The ex post dstrbuton of health expendture across households s a good estmator of the average ex ante dstrbuton of fnancal rsk n the populaton. In other words, n a very large sample, the dstrbuton of health expendture last year (the ex post dstrbuton) wll equal the average ex ante dstrbuton of fnancal rsk across households. Because health expendture s n the numerator of HFC, changes n the ex ante dstrbuton of fnancal rsk wll be reflected n changes n the dstrbuton of HFC. Nevertheless, t s mportant to recognze that the dstrbuton of HFC may not capture all the nequalty n the dstrbuton of ex ante fnancal rsk protecton. However, f average ex ante fnancal rsk s correlated wth effectve ncome or subsstence payments then the dstrbuton of HFC wll reflect these dfferences. We conclude that because the ex post dstrbuton of expendture can be measured through household surveys and the ex ante dstrbuton of fnancal rsk s extremely dffcult to measure, the dstrbuton of HFC s a convenent and feasble measure of farness n fnancal contrbuton and of ex ante fnancal rsk protecton. VI. Measurement Propertes of the IFFC In ths secton, we wll use a hypothetcal populaton to llustrate the propertes of the IFFC: the dstrbutons of ncome per capta, ex ante health expendture rsk, and food expendture per capta are based on real populatons. We use smulatons that are explaned n more detal below to show how the dstrbuton of HFC across households would change as prepayment mechansms are ntroduced n a populaton

20 and as the progressvty of the fees or prepayments s ncreased. These smulatons also allow us to explore the phenomenon of optng out and to contrast the measurement propertes of the IFFC and the wdely used measure of vertcal equty, the Kakwan ndex. To calculate the dstrbuton of HFC across households n a populaton, we need nformaton on ncome, subsstence expendture, and the rsk of health expendture. Health expendture rsk s a functon of the avalable technology and ts cost and the rsk of llness. We have developed the smulatons for a populaton of 2000 households, whch can be consdered equvalent to montorng farness of fnancal contrbuton n a larger populaton usng a random sample survey of 2000 households. The assumed dstrbutons of the key quanttes have been developed from averaged results from selected households surveys to make sure they are realstc. 10, 11 One mportant phenomenon that we want to present n these smulatons s that households may need to borrow n order to pay for healthcare, because health expendture exceeds the capacty of a household to pay. In the smulatons, we have assumed that households faced wth a health expendture that s three tmes greater than capacty to pay wll choose to not pay and not to receve care. Table 2 summarzes the base case when there s no prepayment to allow rsk poolng. In the base case, 5.7% of households are spendng more than 50% of ther capacty to pay for health. Four households n a thousand (0.4%) are choosng not to purchase care because t s unaffordable. The IFFC s and the Kakwan ndex s 0.3, showng how out-of-pocket payment s hghly regressve. The fgure of 5.7% of households facng catastrophc payment s hgh, but lower than that found n a number of countres n real survey results.(xu et al. 2000) 10 Per capta ncome s smulated usng a log normal dstrbuton wth quartles at $US 562, 838 (medan) and 1251, correspondng to a mean of $US1000 and a standard devaton of $US650. The subsstence share s a decreasng share of total household expendture and the parameters are drawn from the household survey data mentoned above. The formula for subsstence expendture (percentage spent on food) s : (6) pctfd = exp( α + β * ln( ncome ) Where α== 2.24 and β== -0.5 Health expendture rsk s smulated usng a log normal dstrbuton wth quartles at $US 14, 25 (medan) and 67, correspondng to a mean of $US60 and a standard devaton of $US100. The mean corresponds to an average of 6% health expendture across countres. Agan, the dstrbuton s parametersed usng survey data for out of pocket expendture. Usng realsed expendture as a proxy for ex ante health expendture rsk has certan caveats. These two varables wll tend to concde, at least ex post, when there s rsk poolng. Stll, usng the realsed expendture from survey data does not provde nformaton on the rsk from health needs, but only the dstrbuton of those needs that actually resulted n expendture. The rsk assocated wth actual health need may be ether less or more that realsed expendture. In the absence of ndependent data on medcal needs, we draw a dstrbuton from the survey data 11 In ths smulaton, we assume that the dstrbuton of ex ante health expendture rsk s the same for all households. In fact, the dstrbuton may be shfted to the rght for poorer households because they have worse health status. Ths covarance between the ex ante dstrbuton of health expendture rsk and ncome per capta s not ncluded n ths llustraton.

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