How health care is funded

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Part of How should the NHS be funded?

The NHS is experiencing the longest and most severe slowdown in funding in its history. This has raised questions about the sustainability of its funding model.

The way that health care is funded varies between different countries. Here we explain the main models used to finance health care: taxation, private health insurance and social health insurance. We outline how each model works in its purest form, while recognising that most countries typically pay for health care using a combination of methods.

We also cover user charges. Although no European or OECD (Organisation for Economic Co-operation and Development) country relies on user charges as a primary source of health care funding, all countries incorporate at least some element of user charging into the funding mix.

We do not consider how social care is funded; in England, health and social care are funded separately, while the definition of social care varies between countries, making comparisons difficult.

Taxation

Diagram illustrating the taxation funding model

What is it?

Tax revenues are collected to fund health care.

How does it work in principle?

Tax-funded models typically seek to pool risk across large populations and make health services available on a universal basis.

Taxes vary according to:

  • how they are levied: direct taxes are levied on individuals, households and companies by the government (eg, Income Tax, Corporation Tax), whereas indirect taxes are applied on the manufacture or sale of goods and services (eg, Value Added Tax, import/export taxes)
  • who is raising them: taxes raised by central government may be used to finance national spending on health care; taxes raised by local government may be used for spending on health care in a specific region or local area
  • whether they are raised for general purposes or earmarked for a specific use – the latter is known as a hypothecated or earmarked tax (see box).

How is this model applied in practice?

Australia, Canada, New Zealand and the Nordic countries are some of the other countries that rely mainly on general taxation to fund health care. However, no country relies on general taxation alone; they may also have user charges or elements of private insurance. For example, in Canada, about 70 per cent of health spending is publicly funded though taxation, with the remaining 30 per cent largely accounted for by out-of-pocket spending (costs borne directly by patients) (14.6 per cent) and private health insurance (12.2 per cent) (Canadian Institute for Health Information 2016).1

Methods of levying tax vary considerably between different countries, particularly whether they are raised by central or local government. In Sweden, for example, public funding for health care comes from both central and local taxation. In 2013, local taxes accounted for 68 per cent of county councils’ total revenues, 18 per cent came from subsidies and national government grants financed by national income taxes and indirect taxes (Mossialos et al 2016).

  • 1. Canada’s out-of-pocket and private health insurance spending is high in comparison to other OECD countries (Canadian Institute for Health Information 2011). This is because universal Medicare coverage is limited to medically necessary hospital and physician services. So, for example, there is almost no public coverage for dental care.

Arguments for and against taxation

The pros and cons of this model vary depending on the taxes used to raise funding, but some general implications are as follows.

For

  • It is generally considered to be equitable: where general taxation is drawn from the whole population, regardless of health status, income or occupation, it pools both financial and health risks, ie, the sick do not pay more than the well. Exactly how equitable these models are depends on whether the wider tax system is progressive or regressive (see box).
  • General taxes are an efficient way of raising money, with low administration costs relative to the amount of money they raise.
  • There are strong incentives in tax-funded models to control spending. This is because in these systems, the process by which the spending level is determined is a political one that forces governments to weigh trade-offs between health and other areas of public spend. The ability to control spending in this way brings with it both benefits and disadvantages. For example, complaints of underfunding are common in tax-funded systems (Savedoff 2004).

Against

  • As spending on health care tends to rise over time, health services can consume an increasing proportion of public spending. To pay for this, governments can either divert funds away from other areas of public spending or raise taxes, which can be unpopular, and particularly difficult during an economic downturn.
  • Some argue that these decisions politicise the process and can make health budgets less predictable from year to year, although others see this as an advantage as it introduces a degree of accountability not present in other models.

Glossary

  • Regressive: A regressive tax on incomes is one in which the average rate of tax falls as income rises – ie, the percentage of your income taken in tax falls as you become richer
  • Progressive: A progressive tax on incomes is one in which the average rate of tax rises as income rises – ie, the percentage of your income taken in tax rises as you become richer

Private health insurance (PHI)

Diagram illustrating the public health insurance funding model

What is it?

Individuals (or employers on their behalf) take out health care insurance policies from private organisations.

How does it work in principle?

Policy-holders contribute on a regular basis. The level of contribution is based on their risk of requiring health care, which can be assessed in several ways:

  • individual risk, which may take into account age, family history and the existence of pre-existing medical conditions
  • community risk, for example, where contributions are estimated as an average across a geographically defined area and all members of the community pay the same premium
  • group risk, typically estimated across employees of a single firm or occasionally a single industry; again, all members of the group pay the same premium (Mossialos et al 2002).

Contributions are collected by private insurers. The benefits package may vary between insurers, enabling people to choose according to their means, needs and preferences.

How is this model applied in practice?

The use of private insurance varies greatly. Broadly speaking, there are five different ways in which private insurance can be used: as the dominant form of cover; as duplicate cover; as complementary cover; as supplementary cover; and as substitutive cover.

Dominant or primary cover

In the United States, PHI is the dominant form of health cover for most of the population. In some countries (eg, Switzerland) PHI is mandatory. However, as with tax-funded models and social health insurance, countries that use PHI as a dominant form also rely on other sources of funding (for example, see box on US).

Duplicate – or ‘double’ cover

In other countries (eg, in the UK, Portugal, Spain), PHI is largely taken out by individuals in higher income groups, to allow quicker access to services or increased choice of provider. This form of PHI does not exempt people from paying into the publicly funded health system. Arguments that the privately insured are ‘paying twice’ and are making less use of public services can lead to advocacy for tax relief for PHI (see box).

Complementary – or ‘additional’ cover

In some countries, PHI is used to complement government/social insurance schemes by covering the costs of publicly funded services that incur user charges. For example, in France complementary insurance is held by approximately 85 per cent of the population to cover the cost of statutory user charges.

Supplementary cover

This form of PHI provides coverage for health services that are excluded from government/social insurance schemes. In Canada, for example, private supplementary health insurance provides coverage for the cost of prescription drugs (only medication administered in hospital is covered by public funding), dental care, optical care and other goods and services not covered by the public system.

Substitutive – or ‘alternative’ cover

Finally, in some countries, people are permitted to opt out of government health coverage or statutory social insurance schemes and purchase PHI as an alternative. In Germany, for instance, people who earn over a certain amount can choose to purchase private health insurance instead of social health insurance. However, this type of opt-out needs to be carefully managed to ensure the statutory scheme remains equitable and financially viable.

Arguments for and against using private health insurance as the primary source of financing

For

  • Proponents of private health insurance argue that it promotes choice for users, encourages competition and drives up standards of care. Competition can in theory also drive down premium prices between competing insurance companies; however, Switzerland and the US, which both use PHI as the primary source of financing, spend more on health than the UK.
  • It is also often argued that private health insurance reduces the burden on public finances by taking some people out of the state system.

Against

  • A pure (unregulated) private health insurance market is inequitable as it is based on risk selection. This means that insurers can deny cover (or charge very high premiums) to those who are deemed more likely to use health care services, such as those with pre-existing medical conditions or older people, leaving a proportion of the population uninsured (and therefore forced to pay for their own care).
  • There are a variety of failures in health care insurance markets (such as asymmetric information and market power), so when private health insurance is used as a primary source of funding it tends to be heavily regulated.
  • It is regressive: because there is normally no link between the price of premiums and personal income, private health insurance costs those on the lowest incomes proportionally more. As those on low incomes tend to have a higher need for health care, they are also more likely to have higher premiums, which may act as a further barrier to access (Van Doorslaer et al 1993).
  • This model tends to incur high management and administrative costs due to the resource required to assess risk, set premiums, design benefit packages and assess claims.
  • Employer-based PHI schemes can make employees with higher health risks less likely to move to new employers and less able to work as self-employed or in smaller firms, leading some to argue that it makes countries less competitive in a global market.

Social health insurance (SHI)

Diagram illustrating the social health insurance funding model

What is it?

Typically, employees and employers pay contributions to cover a defined package of services (Wagstaff 2010). This system was introduced under Chancellor Bismarck in 19th century Germany.

How does it work in principle?

In classic social insurance models, members (normally employees) contribute a proportion of their salary, with the level of contribution related to income rather than risk of illness. Employee contributions are typically matched by employers. For example, in Germany, the basic flat social health insurance contribution rate in 2016 amounts to 14.6 per cent of an employee’s gross income (with an annual upper limit of €52,200), shared equally between employer and employee. Those earning above €57,600 per year can opt out of the social health insurance system and purchase private insurance instead (Federal Ministry of Labour and Social Affairs 2016).

Contributions are often collected by independent bodies, usually known as insurers or ‘sickness funds’, which are responsible for paying providers of health and care services.

There may be a single fund or several funds covering different sectors of the population and these are usually publicly run. In some countries, privately run insurers can compete; where this happens, mechanisms may exist to pool risks and costs between funds. Members may or may not have a choice of which fund they join. The defined package of health benefits may also vary between funds, but there is usually a standard regulated basic package.

How is this model applied in practice?

The way that social health insurance schemes operate varies widely from one country to another.

In most countries, the statutory scheme does not raise sufficient funds and is subsidised by other means (see below). In France, for example, additional funds are raised via general taxation (income tax) and ‘sin taxes’ on alcohol and tobacco. France also requires co-payments at the point of access that are capped. Co-payments also apply in Germany – eg, for each day of an inpatient stay – and are capped at 2 per cent of household income, or less for certain groups that meet the criteria (Robertson et al 2014).

As social health insurance is often based on employment, countries operating this model have to find ways (including general taxation and other sources such as statutory pension funds) to provide cover for those not in employment. For example, the Japanese health insurance scheme has several options to ensure universal cover is provided: employees of large firms are required to sign up to SHI; employees at smaller firms are given cover through the Japan Health Insurance Association; those who are not covered by either of these are covered by a government scheme.

Arguments for and against social health insurance (SHI)

For

  • Ensuring equity and universal access based on clinical need is a principal objective of SHI systems, and a major benefit is that payment is not related to risk. This means it does not discriminate against those who are older or have pre-existing medical conditions. Properly designed, SHI can provide comprehensive cover to all, in a similar way to tax-funded systems.
  • Compared to private insurance, SHI is generally considered to be more efficient as it allows pooling of resources and risk across a group of people.
  • Social insurance funds can be kept separate from other government-mandated taxes and charges, so like hypothecated tax models (see box on hypothecated taxes), they potentially give more transparency and provide increased certainty about funding levels for health in the medium term.
  • Because SHI contributions are raised purely for health, beneficiaries may be more willing to contribute the rates needed to provide comprehensive coverage.

Against

  • SHI schemes usually result in higher taxes on wages; employers and employees both contribute, leading some organisations to argue that this makes them less competitive in a global market when compared to those in countries that fund health care through general taxation.
  • If there are many insurers and people can switch between them, administrative costs can be high (Wanless 2001).

User charges as an additional source of financing

What is it?

User charging involves individuals paying for some or all of their medical care out of their own pocket.

How do user charges work in principle?

In their purest form, user charges rely on patients paying the cost of care. In most European and OECD countries, these charges make up only a small proportion of expenditure. However, user charges often form a large part of the way health care is financed in developing countries (Gottret et al 2006). In India, for example, more than 70 per cent of total health expenditure is accounted for by user fees (Mossialos et al 2016).

How are user charges applied in practice?

Health care costs can be catastrophically expensive for people with severe or long-term illness, so very few countries rely solely on user charges to cover health care costs, instead developing alternative financing models that allow risks and costs to be pooled across large groups of people.

However, most countries rely on user charges to some extent. An OECD survey of 29 member states in 2010 found that all had some form of co-payment or charge for pharmaceuticals and 20 had some form of payment for a GP visit and half had some form of charge for hospital treatment (Paris et al 2010). Some countries allow charges for non-clinical services that do not affect health outcomes. For example, the NHS in England allows hospitals to charge inpatients for use of bedside entertainment systems.

User charges also apply where individuals seek private care for services or treatments not covered by a national scheme or insurer, or where access may be limited (eg, paying privately for an operation to avoid having to wait).

In practice, many European countries use exemptions to ensure that individuals less able to pay are not discouraged (or prevented) from seeking care when they need it. Often these exemptions apply to people on lower incomes, children or older people, or people with long-term conditions or a disability. Introducing these exemptions makes the administration of schemes more complex, and will limit the money such charges can raise.

In Italy, out-of-pocket spending accounted for 18 per cent of total health spending in 2013 – comprising spending on services not covered by the public system and co-payments for some services, including pharmaceuticals, specialist visits and some diagnostic testing (Mossialos et al 2016). Various exemptions are in place: for pregnant women (for treatment related to pregnancy), prisoners, people with severe disability or long-term conditions, and those over the age of 65 and under the age of 6 who live in households with a gross income below a nationally defined threshold (Mossialos et al 2016).

In Norway – where co-payments are used for GP and specialist visits, physiotherapy visits, prescription drugs and some diagnostics – annual caps for out-of-pocket expenditure are set nationally. Above this, fees are waived, and exemptions are also in place. In New Zealand, co-payments are required for most GP services and some nursing services provided in GP clinics. The average co-payment for a GP consultation ranges from NZD15-45 (around £8-25), although this is capped at NZD17.50 (around £10) per visit for people living in low-income areas (Mossialos et al 2016).

A variant of having users pay for their own healthcare is Medical Savings Accounts. Usually mandatory, individuals (and in some cases, their employers) make regular savings into funds which they then use to pay for care when they or their family members need it. The most widely known example is Singapore, although even here it is only one of a number of payment systems. Other funding streams used to supplement it in Singapore include direct subsidies to hospitals, voluntary back-up insurance to cover high health care costs and a government-funded safety net for low-income people (McKee 2013).

Arguments for and against using user charges as an additional source of financing

For

  • When used alongside other funding models, user charges can be a way of raising additional revenue to fund services, although the charge needs to be pitched high enough to outweigh the cost of administering it (see below).
  • Proponents of user charges often argue that charging can act as a deterrent to overuse of health care, encouraging people to use health services more responsibly and to engage in less risky behaviour. However, this argument is not straightforward (see below).

Against

  • User charging can discourage people from seeking care. One of the most important studies on the impact of charging – the RAND Health Insurance Experiment in the 1970s – found that user charges reduced demand across all types of health care irrespective of whether the service was more or less effective. User charges also had adverse impacts on health in some cases, particularly among the poorest, sickest people (Newhouse 1993).
  • This deterrent effect can mean that people delay seeing a GP about a genuine health need; this can lead to a deterioration in the patient’s health and a requirement for hospital admission, which is more expensive.
  • The cost of the systems needed to administer and collect user charges reduces the net contribution charges can make. Setting up exemption arrangements can add to the complexity of administration and further reduce the financial benefit.

Conclusion

No country (the UK included) relies on a single source of funding for health care. Countries typically use one of the three main funding models as the principal way of paying for health care alongside elements of the others. All countries make use of user charges to pay for a proportion of overall costs.

The precise combination of funding sources in use develops over time based on a country’s context, history and social values. Whatever model is used, debates about its effectiveness and efficiency are inevitable.

However, there is no evidence that one funding model or particular mix of funding mechanisms is inherently superior to others. As the OECD concluded, ‘There is no health care system that performs systematically better in delivering cost-effective health care’ (OECD 2010). This, plus the high costs associated with any transition, means that developed countries rarely make major changes to their established primary way of paying for health care.

Regardless of how health care is funded, all countries face similar challenges – namely, how to meet rising demand for services and transform care in response to an ageing population and changing patterns of disease. This is leading to increased pressures on services and funding challenges in countries around the world.

For the sake of simplicity, we have limited this analysis to health care; however, it is important to note that most countries face similar challenges in funding social care. As we have argued elsewhere, any debate about how to fund the NHS in future must go hand in hand with discussion about how to pay for social care, with the aim of creating a single ringfenced budget for health and social care (Commission on the Future of Health and Social Care in England 2014a).

Our thanks to Loraine Hawkins (Health Systems, Finance and Governance Consultant​, and Visiting Fellow at The King's Fund) for her contribution to this report alongside the authors.

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