How are hospitals funded and which payment method is best?

Summary of a HEN network member’s report

The issue

European hospitals are financed largely through government budgets and statutory insurance funds. There are several ways to organize these payments, and by changing methods, payers can influence hospital behaviour. Specifically, well-managed payment policies can provide incentives for hospitals to deliver better and more cost-effective care.

Findings and discussion

Different payment mechanisms have differing impacts on hospital behaviour. The optimum funding mechanism will depend on policy priorities, as well as the ability of the health care and hospital systems to manage the chosen payment method effectively and affordably. There are six main approaches.

  1. Line-item budgets. This mechanism was typical of the Soviet Union but is now dying out. It specifies a detailed budget for staff, medicines, food and so on, often based on the previous year’s allocation. Line-item budgets are predictable and enable very strong central control. On the other hand, they are also inflexible, discouraging cutbacks and providing no incentives for efficiency or quality care.
  2. Payment per procedure. The fee-for-service model is normally based on a set list of charges for various procedures. Although easy to administer, this model requires specific and timely data. Fees-for-service reward productivity but they do not encourage efficiency, except when reimbursement rates are lower than costs. They can also encourage providers to deliver more services than needed.
  3. Payment per day. Paying an agreed fee per bed-day is straightforward, and data collection is quite simple. Day payments create an incentive, however, for hospitals to keep patients longer than strictly necessary, particularly as bed-days often cost less at the end of a stay.
  4. Payment per case. In its simplest form, one standard payment is made for every case or discharge, regardless of the actual cost of care. This basic model encourages increased admissions of less severe cases. Other models are adjusted for case mix, to reflect variations in hospital caseload. They are complex to run and demand a lot of data. Case-mix models do reward hospitals for keeping costs within payment limits – but they also encourage hospitals to upgrade the severity of cases, and to discharge patients early and readmit them often.
  5. Global budgeting. In this model, a hospital receives a lump sum to cover all specified services during a given period. At the end of the period, the hospital keeps any surpluses and covers any shortfalls. Agreeing on total expenditures in advance involves very complex calculations of activity, costs and case mix. If global budgets are strictly enforced, they encourage efficiency and allow managers real flexibility. Payers do lose control, though, and unless monitoring is introduced, quality may fall or rationing creep in.
  6. Capitation. In its most basic form, capitation reimburses a hospital for specified services to a defined population, paying a fixed amount for each person covered. Payers and providers must be completely clear about the services and population to be covered. Comprehensive data is essential, especially for the hospital, and adjustments to payment formulas can be very complex. Hospitals find this form of payment the most difficult to manage and the most risky.

Different elements of these approaches can also be combined. Adjustments are often made for the type of facility (general or specialist, urban or rural). Additional payments may help cover particular tests or exceptionally expensive cases, even empty beds. In some per-service, per-day or per-case systems, expenditure caps can limit total spending.

Changing the way hospitals are paid can promote efficiency and quality and make admissions more rational, yet the evidence of success in western Europe is mixed. In eastern Europe, many new models are overly complex and appear to raise provider activity and costs. Several unaddressed factors blunt the underlying incentives in the payment systems being developed:

  • a lack of mechanisms to fund capital investment;
  • contradictory incentives in government and health insurance funds;
  • an increasing reliance on patient out-of-pocket payments;
  • debt and deficit issues, including problems enforcing hospital budgets.


Hospital performance is a critical issue, and payment mechanisms offer some of the most promising ways to foster improvement. Yet no single payment model is obviously superior, and particular solutions must be considered in context. Ideally, a country’s approach to hospital payments should reflect societal priorities, including the relative importance of efficiency, quality and health outcomes. For maximum effectiveness, payment reforms should also be integrated with information system, management and monitoring reforms.

The views expressed in this summary are based on a publication of a HEN Network member agency and do not necessarily represent the decisions or stated policy of WHO/Europe.