Mexico - Health System Reform Project (IMSS)

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P 7223-ME REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED HEALTH SYSTEM REFORM - IMSS ADJUSTMENT LOAN IN AN AMOUNT OF US$700 MILLION TO BANCO NACIONAL DE OBRAS Y SERVICIOS, S.N.C. WITH THE GUARANTEE OF THE UNITED MEXICAN STATES May 18, 1998 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit: Peso (P$) US$1.00 = P$8.4 Pesos (May 1998) FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS BANOBRAS Banco Nacional de -Obras y Servicios Publicos, S.N.C. APL Adjustable Program Loan CAS Country Assistance Strategy DDF Health Department of the Federal District DRGs Diagnosis-related groups EAP Economically Active Population FONASA Chilean National Health Insurance Fund FUNSALUD Mexican Health Foundation GDP Gross Domestic Product GOM Government of Mexico HMO HealtiL Maintenance Organization IDF Innovative Development Fund IMF International Monetary Fund IMSS Mexican Social Security Institute for Private Sector Employees IMSS/Solidaridad Special Basic Health Program for the Uninsured ISSFAM Institute of Social Security for the Armed Forces ISSSTE Social Security Institute for Public Employees IVRO Voluntary affiliation to IMSS insurance M&E Monitoring & Evaluation MAU Medical Area Unit MCO Managed Care Organization OECD Organization for Economic Cooperation and Development PCU Project Coordination Unit PEMEX National Mexico Petroleum Company RJP Regimen de Jubilaciones y Pensiones: Complementary pension plan for IMSS workers SECODAM Ministry of Comptrollership and Administrative Development SEyM IMSS Health and Maternity Insurance SH Specialty Hospitals SHCP Ministry of Finance SSA Secretariat of Health SSFAM Family Health Insurance Program SSHF Social Security Health Fund SSL Social Security Law TAL Technical Assistance Loan Vice President Shahid Javed Burki Director Olivier Lafourcade (LCC1C) Director Xavier Coll (LCSHD) IBRD Team Carmen Hamann, Jean-Jacques de St. Antoine (LCSHD, Team Leaders); James Cercone, (Consultant); Vinh Nguyen (LCSHD); Ferenc Molnar (LEGLA); Dov Chernichovsky. KPMG Consultants, Norma Leyva, Pablo Gottret (Consultants) Carren ViWlaril, Gizella Diaz, Maria Colchao, Patricia Romero-Casco (Task Assistants) Peer Reviewers Jeffrey Hammer (DECRG) and Robert Hecht (HDNVP)  FOR OFFICIAL USE ONLY MEXICO HEALTH SYSTEM REFORM - IMSS TABLE OF CONTENTS Page No. I. THE ECONOMIC SETTING .....................................................1 A. Macroeconomic Performance .....................................................1 B. Social Sector Expenditures .....................................................3 II. THE HEALTH SECTOR .....................................................4 A. Overview .....................................................4 Health Status .....................................................4 Health Financing And Expenditures .....................................................5 Organization, Coverage, And Delivery Of Health Services .....................................................6 III. THE GOVERNMENT'S HEALTH SYSTEM REFORM STRATEGY .............................................9 A. Achievements To Date - The Reform Framework .....................................................9 SSA Reform .................................................... 10 The 1995 Social Security Law - IMSS Reform .................................................... 10 B. The Social Security Law - Issues And Challenges .................................................... 13 Limiting the Fiscal Impact .................................................... 13 Extending Coverage .................................................... 15 Preparing IMSS for Competition .................................................... 16 Development of An Institutional and Regulatory Framework ................................................. 17 C. The Long-Term View Of Reform .................................................... 18 D. Reform Implementation - IMSS .................................................... 18 Developing The Regulatory Framework .................................................... 19 Institutional Strengthening of IMSS .................................................... 21 Next Phase of the Reform .................................................... 22 E. Bank Assistance .................................................... 22 Country Assistance Strategy (CAS) .................................................... 23 Rationale For Bank Involvement .................................................... 25 Justification for Adjustment Lending .................................................... 25 IV. THE PROPOSED LOAN .................................................... 27 A. Loan Description .................................................... 27 B. Loan Size and Tranche Conditionalities .................................................... 27 Health Finance and Regulatory Framework .................................................... 27 Institutional Strengthening of IMSS .................................................... 30 C. Technical Assistance .................................................... 32 D. Disbursement and Auditing .................................................... 32 E. Lessons Learned .................................................... 33 F. Monitoring And Reporting .................................................... 33 G. Program Objective Categories .................................................... 34 H. Impact, Benefits And Risks .................................................... 34 V. RECOMMENDATION .................................................... 35 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  ANNEXES 1. Letter of lMSS Health Insurance Development Policy 2. Conceptual Framework and Linkages With TAL 3. Matrix of Policy Actions 4. Health System Reform - The Long-Term View 5. Social Security Health Fund 6. Corporeate Restructuring of IMSS 7. Innovative Development Fund 8. Technical Assistance 9. Financial Projections Model 10. Glossary 11. Documents in the Project File 12. Econormic Indicators 13. Status of Bank Group Operations in Mexico ii  MEXICO HEALTH SYSTEM REFORM - IMSS LOAN SUMMARY Borrower: Banco Nacional de Obras y Servicios Publicos, S.N.C. (BANOBRAS) Guarantor: United Mexican States Implementing Agency: Mexican Social Security Institute (IMSS) Amount: US$700 million Terms: The loan is proposed to be fixed rate single currency loan in US dollars with a maturity of up to fifteen years. Objectives: The proposed loan would support the ongoing implementation of the Government's health system reform, focusing on the modernization of IMSS, designed to: (a) improve the financial management of the health insurance system to ensure financial transparency; (b) introduce new resource allocation and financial mechanisms to improve efficiency and limit the fiscal impact of the proposed reforms; (c) strengthen the institutional and regulatory framework for health insurance to extend coverage to the self-employed and informal sector workers; (d) ensure greater transparency and accountability among providers; (e) develop measures for quality assurance and user rights, and to facilitate user choice; and (f) improve the quality and efficiency of the IMSS health delivery system by supporting the decentralization of decision making, restructuring of the health care delivery network around a population-based system, and the introduction of performance-based incentives for providers. Description: The reform program for the period 1998-2000 to be supported by the loan would follow a two-pronged approach: (a) developing and implementing health insurance financing reforms and the necessary regulatory framework through (i) separating financing from provision of services, increasing user choice and extending coverage, and (ii) developing and implementing purchasing mechanisms; and (b) institutional strengthening of IMSS through (i) changing its corporate structure for health services administration and (ii) strengthening its health care delivery network. Benefits: The reform would contribute to the economy and society by: (a) limiting the fiscal burden of the current health system and its concomitant potential distortions, while improving its financial sustainability; (b) improving the system's efficiency and quality of care; and (c) increasing its contribution to equity. It would ultimately iii  contribute to greater welfare and productivity, based on improved extension of coverage and health status. These benefits would be attained through improved financing and allocation mechanisms, improved service delivery, and the creation of internal markets, all of which should lead to greater accountability within the system. Risks: The greatest risk to the proposed operation is backsliding in political commitment. While the current Government supports the reform of the health insurance system, such support need[s to remain strong, active and visible to overcome resistance that will inevitably arise in the course of the reform process, particularly at the time of second tranche release. High-level officials in both IMSS and the Ministry of Finance have participated in preparing the reform program and give political support to the process. It will be necessary to continue to internalize the reform within IMSS in order to ensure that personnel at all levels understand the reform objectives and support it. To reduce opposition to change, competition in the market will be introduced gradually and will be accompanied by substantial financial and technical assistance to IMSS. To mitigate political risks, an accompanying Technical Assistance Loan will support a major campaign to disseminate information on program actions and their benefits to IMSS employees and beneficiaries. A second risk is the sheer technical complexity of the reform, which dictates that many complementary activities be executed satisfactorily and in a highly coordinated fashion. Again, the Technical Assistance Loan is designed to provide IMSS with important technical input to support the implementation of the reform, such as the design of regulations, design of enrollment database system, and direct technical assistance for institutional reform within IMSS. Poverty Category: Not Applicable Estimated The proposed loan for US$700 million will be disbursed in two Disbursement: tranches of US$350 million each. Tranche releases will take place assuming the Government meets effectiveness conditions and the conditionalities related to reform of the IMSS health insurance system, as described in the Letter of IMSS Health Insurance Development Policy (Annex 1) and Matrix of Policy Actions (Annex 3). iv  REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED HEALTH SYSTEM REFORM - IMSS ADJUSTMENT LOAN TO BANCO NACIONAL DE OBRAS Y SERVICIOS PUBLICOS, S.N.C. WITH THE GUARANTEE OF THE UNITED MEXICAN STATES 1. I submit for your approval the following Report and Recommendation on a proposed Loan to Banco Nacional de Obras y Servicios Publicos, S.N.C. (BANOBRAS) with the guarantee of the United Mexican States, in the amount of US$700 million to support regulatory, financial and corporate reforms of the Mexican Social Security Institute (IMSS), as part of Mexico's continuing process of health system reform. The loan would be a single currency loan at the Bank's standard fixed rate, with a maturity of up to 15 years, and would be disbursed in two tranches of US$350 million each. It would further be supported by a parallel US$25 million Technical Assistance Loan. 1. THE ECONOMIC SETTING A. Macroeconomic Performance 2. The Mexican economy rebounded in 1996-97 following the financial crisis at the end of 1994 and the severe recession of 1995 when GDP fell by 6.2 percent and domestic investment dropped by over 30 percent. In 1996, real GDP rose by 5.1 percent, reflecting continued export expansion and a strong recovery in investment. The implementation of tight monetary policies led to a near halving of inflation, a significant lowering of nominal interest rates, and greater stability of the peso. Investor sentiment improved, leading to a substantial rise in foreign direct investment, a marked improvement in Mexico's access to international capital markets, and a substantial increase in international reserves. The economic recovery was consolidated in 1997, and inflation continued to decline. Real GDP growth reached 7 percent in the year with another healthy expansion of investment in excess of 20 percent. Through September 1997, formal sector employment increased by a record 10 percent. 3. As with other emerging market economies, Mexico also was jolted by the events in Southeast Asia in the second half of the year. But contagion effects remained relatively small when compared to the impact on other emerging market economies, such as Argentina and Brazil. Market sentiment toward Mexico remains cautious and the expectation is that, given continued positive performance in the United States' economy and in its stock market in particular, Mexican equities will regain their loss in value, reflecting the strength of the economic recovery since 1995. 1  2. As shown in the adjacent Mexico: Exports Imports and FDI chart, Mexico's external accounts 110 USS$iXbn 12 have experienced a marked D05i / improvement since 1994. Exports , 10 boomed in 1995, prompted by the large change in the exchange rate and by the contraction in domestic demand. These same forces had the 85.t opposite impact on imports. 80 However, imports recovered rapidly 75 Evorts 4 with the expansion in domestic 70 Note: Epots and irrort otgoods output and consumption. Even 65 and servces; bd hand scale. t 2 though the real exchange rate 60 remains about 12 percent more a depreciated than in November 1994, it appreciated significantly since 1995, mainly on account of the resumption of capital flows (in the 3rd qua:rter of 1996 alone, portfolio inflows summed to nearly US$10 billion). The combination of an appreciating real exchange rate and growing domestic absorption have produced a trend reversal in the current account, which has shown a negative balance since the 3rd quarter of 1996. In 1997, the deficit in the current account was US$7.3 billion, and is expected to continue expanding in 1998. Nevertheless, on balance, the levels of the deficit (at about 2-3 pe-rcent of GDP) and of external borrowing, are prudent and consistent with a solid long-term creditworthiness position. 3. Underlying the strong performance of the external accounts and of private sector growth has been the supportive role of the Government. The operations of the public sector resulted in an increase in the primary surplus from 2.2 percent of GDP in 1994 to 3.8 percent in 1995-1996, in a context of overall fiscal balance which is expected to prolong into 1997. Despite declines in government expenditures reflected in transfers to public enterprises, lower spending on wages and salaries, and a rephasing of some capital projects, expenditure on social programs was safeguarded. Monetary po]Licy has supported the fiscal stance and has focused primarily oCL disinflation. Monthly rates of inflation have been on a declining trend since end- 1995 and, as a result, the annual rate of inflation has fallen from 51 percent in 1995 to 28 percent in 1996 and to less than 16 percent in 1997. 4. The short- and medium-term prognosis for the conduct of macroeconomic policy, and for the economy as a whole, is positive. I:n 1998, real growth is expected to slow down to 4.8 percent, in part on account of negative inputs arriving from the Asian issues. The public sector balance is expected to deteriorate for structural and policy-induced reasons, even as the fiscal authorities come under increasing political pressure for authorizing expenditure increases and/or revenue reductions. 5. Mexico's health system reform program is part of a continuum of reforms addressing public contingent liabilities while promoting measures !to improve the quality of public services. Most importantly, the Government, with the support of the World Bank, has implemented a major reform in the pension system covering workers in the private sector. The near-term fiscal cost of this measure is somewhere in the range of 1-2 percent of GDP. The specific measures relating to the pubLic health system addressed through this loan will impose an additional fiscal cost of approximately 0.75 to 1 percent of GDP. Furthermore, other quasi- 2  fiscal losses and contingent liabilities were allowed to expand and will require additional fiscal outlays in the near future. These losses arise mainly from the successive bailouts and/or rescheduling of the debts held by private banks, firms, households (mortgages and credit card debt), tollways operators, etc., in the wake of the 1995 financial crisis. The total cost of the financial sector rescue programs are now estimated at 12 percent of GDP, or a near term pressure on public finances of another 0.5 percent of GDP. 6. On the macroeconomic side, the success of its recent performance and the credibility of its policies have earned Mexico access to international financial markets and thus, the country does not technically face a short-term funding constraint for its balance of payments requirements. Nevertheless, with a foreign debt stock of US$163 billion and gross servicing requirements estimated at US$36 billion in 1998 and US$41 billion in 1999, Mexico has a complex debt management challenge. In the current internationally volatile environment, securing reliable long-term debt instruments is an essential part of any viable medium-term debt management strategy. And Mexico does face restrictions in its access to longer term debt and/or internationally placed bonds. In this regard, World Bank balance of payments support is critical especially when, at the margin, the macroeconomic impact of the reforms this loan is supporting is to expand domestic absorption. Mexico faces a seriously binding fiscal constraint. Although the Government has carefully measured and balanced its access to domestic capital markets, domestic interest rates are high in real terms and this complicates the management of short-term capital inflows. The structure of foreign financing is sub-optimally inclined to shorter-term funding. The current program of health insurance reforms would exacerbate the difficulties to be faced by the Government in abiding to the fiscal constraint and, hence, in managing short-term capital inflows. World Bank balance of payments support would allow the authorities more room to maneuver while helping safeguard the limits of domestic borrowing and improve the overall quality of the medium-term fiscal response. B. Social Sector Expenditures 9. The recovery of the Mexican economy has allowed the Government to Social Expenditure as % of GDP continue its efforts to increase social sector spending, with particular emphasis 10 on protecting the poor. Between 1990 and Other social exenditure -- 1994, public expenditures in the social 8 sectors increased by more than 55 percent ; 6= in real terms. As a result, social . expenditures increased from 6 percent of 4o GDP in 1990 to 9 percent in 1994 and from1 2 38 percent of total public sector budgeted expenditures to 52 percent. The 1994- o _ crisis implied a short-term shock to social expenditures, reducing them by 12 percent in real terms in 1995. However, the share of total budgeted public expenditures allocated to the social sectors continued to increase -from 52 percent in 1994 to 53 percent in 1995, reflecting the Govermnent's firm commitment to increasing social sector spending. Expenditures continued to increase in real terms in 1995 and 1996, reaching 8.4 percent of GDP in 1996 and almost fully recovering to the 1993 levels. For 1997, social 3  expenditures; are budgeted to continue increasing to 8.8 percent of GDP and 59 percent of the total public sector budgeted expenditures - the highest historical share (see chart). 10. Public expenditures in the social sector allocated to education and health in 1996 are 43 percent and 42 percent, respectively. Expenditures in the health and social security sector mirrored the changes in social sector expenditures. The 1997 budget signals an increase in health and social security expenditures of 16 percent in real terms, partly resulting from the new social security legislation. This inicrease would allow health and social security expenditures, (4 percent of GDP and 44 percent of the total public expenditures in the social sectors) to surpass, for the first time, the corresponding expenditures in the education sector. Having secured adequate levels of public funding for the social sectors, the Government has now turned the focus to improving the efficiency of public spending, while introducing reforms that aim to improve the quality of public services. The proposed loan would complement Government strategy to increase the efficiency and quality of public services to obtain greater value with public resources. II. THE HIEALTH SECTOR A. Overview Health Status 11. Mexico's health indicators have improved markedly over the last 50 years. Life expectancy at birth increased by 30 years between 1940 and 1990, and in 1994 had reached 75 years for women and 69 for men. Mortality rates for children under five years of age fell by more than 3,7 percent over the last decade, and mortality from pneumonia and diarrhea fell by more than 65 percent. Vaccine-preventable diseases have declined drastically, with no cases of polio or diphtheria reported since 1993. Maternal mortality rates were reduced by 44 percent between 1981) and 1992. Average fertility feli from 4.1 children per women aged 15-44 in 1984 to just 2.9 in 1994. The population growth rate, which peaked at 3.2 percent in the 1970s, had fallen to 2.1 percent in 1990, and is expected to reach 1.7 percent in the year 2000. 12. The Mexican population is also aging rapidly. In 1970, 47 percent of Mexicans were under 15; in 1990 the figure was 39 percent and, in the year 2000, it is expected to be 35 percent. Over the same period, the proportion of Mexicans over 60 is expected to have risen from 5 percent to 7 percent and, by the year 2020, to reach 12 percent. While this is a fairly universal phenomenon, it has important implications for health delivery, expenditures and insurance- based financing. 13. Due to strong economic and regional inequalities, Mexico combines two epidemiological situations: while some areas have health indicators similar to OECD countries, urban slums, rural areas and some states are still subject to a pattern of common infectious diseases and malnutrition typical of low-income countries. For example, life expectancy stands at 53 years among the poor versus 73 yea,rs among the wealthy. Similarly, infant mortality ranges from under 20 per 1,000 in the northern states to 50 per 1,000 in the poorer southern states. 14. Mexico's many achievements in the health sector over the past several decades have led to significant improvements in the health status of the population, a broadening of access to basic services, and support of important public health measures. Nevertheless, its health sector faces major structural problems, as measured by financial access to health care, efficiency and, 4  increasingly, total cost. The following sections provide a brief overview of the organization and financing of the health sector, followed by a description of the Government's reform efforts to reduce the structural problems in the sector and to ensure continued improvements in the health status of the population. Health Financing And Expenditures 15. Over the past ten years, the Government has made steady progress in increasing public health and social security expenditures. In 1996, Mexicans spent between US$16-18 billion on health care, or 4.7 to 5.3 percent of GDP. On the basis of a population of 93 million in 1996, this yields an estimated per capita expenditure of US$172194,1 placing Mexico well below its fellow OECD countries, but in the middle of the range for Latin America. 16. Overall, the two major social security Public and Private Health Expenditure in Mexico institutions, IMSS and the Social Security Source offinance Institute for Public Employees (ISSSTE), account for nearly 75 percent of public health P-W21-- expenditure, the Secretariat of Health (SSA) 21 percent, and the Armed Forces (ISSFAM) and J. parastatals such as PEMEX the remaining 4 percent. However, the adjacent chart shows that the relatively high private sector spending (45 percent) lowers the share of social security 4l% spending to 43 percent. Other public spending S. SSA. R NSAL.Id W-ld 11-k Ert-- from SSA, IMSS-Solidaridad (Special Basic Health Program for the Uninsured) and others account for around 13 percent of total spending. )istribution qfEixpendnure byprov,der 1994 In terms of the sources of finance, the vast majority of health spending is funded through 4Y1, individual contributions, either through out-of- pocket payments or social security PIS contributions. The remaining health sector revenues are generated from employers (28 U Nbh. S_ percent), the federal government (20 percent) 1(A. _ and the state governments (3 percent). S-urc SSA -cd FI.NSAI UD) 17. The fragmented system of financiers, payers and providers and the lack of adequate risk-pooling mechanisms have led to considerable differences in the level of spending per capita among the SSA, IMSS, ISSSTE and other social security systems. In 1996, annual expenditure per covered person ran from US$21 in IMSS-Solidaridad to US$448 in PEMEX (see table next page). The table also shows the considerable differences between the health expenditure levels in the social security system (US$213 average per member) and the public health system for the uninsured population (US$23 average per person). In 1996, IMSS health care spending reached US$4.2 billion, or US$114 per beneficiary and US$173 per user. Total 1 World Bank calculations based on IMSS, FUNSALUD data and SHCP Public Accounts for 1996. 2 The calculations are based on a 1996 total insured population of 34.3 million and registered user population of 24.6 million. 5  IMSS health care spending has increased only 5 percent since 1991, dampened by the effect of the 1995 crisis when spending fell by 13 percent. The table below shows the total revenue and expenditure for IMSS from 1991 to 1996, including spending per enrolled beneficiary (including direct insured and their family members). 19. The deficit of IMSS health Expenditure per potential and user population, 1996 insurance was a deciding factor behind the change in the health Expenditure per Expenditure insurance financing system Institution potential per user promulgated by the 1995 Social population population Security Laiw (SSL, see paras. 37-43). Social Searit Funds (in100 U da ( US dollars) The table also shows that the IMSS 114 173 program's administrative ]SSSTE 58 91 expenditures accounted for roughly ISSFAM 216 216 12 percent of total spending, far PEMEX 448, 448 above the average of around 2 UinEMi X4red F percentfor administration of Chile's SSA 19 51 national health insurance fund DDF 28 38 (FONASA), and above the average Source: FUNSALUD. El Observatorio de la Salud, 1997 of 11.9 percent for private insurers in the U.S.3 As a share of total public sector health spending, IMSS health insurance spending accounts for nearly 33 percent (1.3 percent of GDP). Annex 9 contains a more detailed analysis of IMSS' current financial situation as a result of the changes in health insurance financing. IMSS Revenues and Expenditures, 1991 to 1996 (1996 US$ million) Year Employer- Govt. Other Total Health Other Admin. Other Total Deficit/ pdn employee Care benefits Surplus efi 1991 3,615 244 113 3,971 3,122 234 382 317 4,054 (83) 104 1992 3,949 270 126 4,345 3,395 243 577 327 4,542 (197) 4121 1993 4,334 286 127 4,747 3,712 267 616 357 4,952 (205) 135 1994 4,993 318 171 5,482 3,954 288 653 397 5,292 190 145 1995 4,031 261 193 4,485 3,323 236 556 437 4,553 (68) 133 1996 3,725 218 162 4,105 3,163 201 458 433 4,256 (151) 114 Source: Inforue de Gestion, IMSS (1997) Organization, Coverage, And Delivery Of Health Services 20. Many of the problems of financial access highlighted in the previous section are partly the result of the existence of parallel vertical delivery system. The duplication of facilities and the excess capacity in urban areas is a long-standing problem in Mexico that results in inefficiency and waste. For the most part, the segmentation of the health system is due to the nature of insurance coverage, with access to the health system guaranteed according to employment status and employer, rather than through risk-pooling arrangements according to population or income level. 3 "Admirnistrative Cost of Health Insurance". Woolhandler and Himnnelstein in New England Journal of Medicine. May 2, 1991. 6  Distribution of Health Sector Coverage, 1995 Insurance Status Insured Uninsured I M Institutional S No Coverage > g 50l; j Access Coverage ~~~~~~~~~~~~~~Soli- dari- dad Population (in millions) 5 39 30 9 10 Higher Income < Lower Income Source: Poder Ejecutivo Federal (1995) 21. As shown in the above chart, health care provision remains dominated by the public sector, with a growing but weakly regulated private sector concentrating in the ambulatory care market. Recently, two major corporations have announced plans to invest over US$100 million in Mexico for ambulatory and hospital based care over the next 5 years, signaling the potential expansion of private provision in Mexico. The public sector institutions providing health services include a diverse network of social security institutes, including IMSS and parastatals (e.g., PEMEX), the Secretariat of Health (SSA), IMSS-Solidaridad and the health department of the Federal District (DDF). The following sections describe the characteristics of the main players in the health sector. 22. Mexican Social Security Institute (IMSS). IMSS provides health insurance coverage and services to around 34 million people, comprised mostly of private sector workers and their families. It is the largest organization within the Mexican health care system, accounting for about 33 percent of public spending on health care in 1996, and employing approximately 350,000 people, of which about 33 percent are medical doctors (33,900) and nurses (80,237). IMSS reports that it performs around 700,000 medical procedures and related services per day, in more than 1,500 provider units, 215 of which are secondary and 41 are Specialty Hospitals. IMSS not only provides health insurance, but also a variety of additional services, including Maternity insurance, Workers Compensation insurance, Disability, Old Age Severance, Pension and Life insurance, and Child Care Centers and Social Benefits. 23. IMSS has started a process of decentralization through the creation of seven Regional Directorates, which has resulted in the staff at the Head Office being reduced from over 13,000 to below 11,000 and the development of a significant role in financial accountability and planning for these Regional Directorates. The consolidation of primary and secondary provider levels into 139 budgetary Medical Area Units during 1997 has provided a strong platform for further delegation of management responsibilities and funding, and possibly further reduction of staff at the central level. 24. The provision of health services at the primary and secondary care level will be the responsibility of the Medical Area Units, which will effectively function within IMSS as public integrated delivery units, taking care of all the health needs of their eligible populations. Over the medium-term, the IMSS Medical Area Units will evolve into budgetholding organizations, which will be fully responsible for primary and secondary care for an average population of 7  roughly 260,000 members, and, when necessary, purchase specialist or tertiary level services for their patients from the 41 IMSS Specialty Hospitals. 25. Social Security Institutefor Public Employees (ISSSTE). ISSSTE is organized along the same lines as IMSS: it provides health care, retirement and housing benefits to approximately 8.8 million public sector employees. ISSSTE covers employees of the federal government, several government-owned parastatals, and municipal and state governrnents. Six states have their own ISSSTE system for their employees, but most public sector employees belong to the federal system. 26. Secretariat of Health (SSA). The SSA covers about 30 percent of the Mexican population. It is responsible for the definition of health sector policies and the regulation, supervision and strategic planning for the health system. It is also responsible for the delivery of public health programs and the control of communicable diseases, as well as the financing and provision of health care services for the uninsured. The SSA includes an extensive network of primary health care facilities and hospitals (about 7,000), ranging from small rural clinics to highly specialized hospitals. In 1996, the Government started an aggressive decentralization process to transfer power from federal institutions to state entities, supported by the Bank's Second Basic Health project (3943-ME). 27. IMSS-Solidaridad was created to channel health care services to rural populations who lack access to health facilities. IMSS-Solidaridad is supervised by IMSS with bi-partite funding from IMSS and the federal government. The affiliation with IMSS provides the program with political support, indirect subsidies, and a well-developed administrative structure. In June 1996, it was estimated that this progranm provided services to about 11 million people, with 3,540 rural clinics and 67 hospitals in more than 10,000 localities. 28. The Health Department of the Federal District (DDF) runs its own health services. Of a potential client population of 3.5 million in 1994, approximately 2.6 million used DDF services. The DDF runs 143 medical units, of which 80 percent are primary health care units. Productivity of services is low, however, as patients often prefer other services within the metropolitan areas. 29. The delivery systems described above are vertically integrated, self-contained systems operating separately from one another, with their own financing system, primary level health clinics and! secondary/tertiary level hospitals. All are centrally budgeted and operated by salaried stzaff. 30. The private health care system is currently growing rapidly but remains relatively under-developed and weakly regulated. Private providers tend to operate through small-scale clinics and doctors' offices, with only a few large private hospitals (the average number of beds in private hospitals is around 12). Regardless of size, private institutions typically charge based on a fee-for-service arrangement. Overall, the private sector is atomized on the provider side; even within the largest private hospitals, doctors operate independently and contract with hospitals for certain services. Most private sector facilities are located in urban areas with the highest concentration by far in Mexico City. The private health sector includes private health insurance plans, but currently these are estimated to cover only 2.4 percent of the population. It also includes private, Managed Care Organizations (MCOs), although this industry is in its infancy in Mexico. The two most prominent Mexican HMOs, Meximed and Premedica, appeared only within the last five years. Much investment in the managed care sector comes from abroad, particularly from Spain, Chile, and The United States. 8  III. THE GOVERNMENT'S HEALTH SYSTEM REFORM STRATEGY A. Achievements To Date - The Reform Framework 31. During 1995, health reform became a Government priority and a new program for 1995- 2000 was established. Responsibility for health care provision is assigned to the SSA and IMSS, with the former concentrating on low-income groups who lack access. One intention of the reforms is to restore the SSA as the coordinator and regulator of the entire sector (including social security and private sector institutions) as it delegates service provision responsibilities to state health services. To facilitate the extension of health services, the SSA is in the process of decentralizing its primary health care facilities to the states. IMSS would, in turn, extend social security benefits to those who were previously outside the system, namely the unemployed and those in the informal sector. Under the proposed reform, these populations would enjoy access to medical services through a voluntary, publicly subsidized health insurance scheme. 32. The Government's reform program for the health sector focuses on: (a) limiting the fiscal impact of the proposed health insurance reforms and promote financial transparency in the management of resources; (b) increasing health coverage under the social security system; (c) promoting better quality and efficiency in services provision; and (d) introducing accountability and supervision in health care delivery and finance. 33. Reform Principles. While the specific strategies to implement the reforms will vary over time, there are a number of common principles that have been embraced to strengthen the health care system: * a clear separation of financing and delivery, as a key element in the introduction of competition, transparency and accountability to the health insurance system; * decentralization of responsibility and accountability from the center to the level at which management can best respond to user needs; * development of internal market mechanisms to ensure that resources follow the patients, rather than the other way around; * greater accountability to patients; * the pursuit of the highest level of care quality and value with the resources available in the system; * gradual introduction of competition, both among public health care providers (IMSS and others) and between public and private providers of health care; * ensure a high degree of flexibility, allowing for variations in local services in order to respond to specific local needs, test alternative models of financing and provision, and adjust strategies throughout the reform process. 34. During the first half of the 1990s, a number of actions had been undertaken to address the problems in the sector. The main achievements include the decentralization of responsibility for the provision of SSA health services to the states, the definition of a basic public health package for the uninsured population, and the approval of the SSL in December 1995. The initial efforts of the reform process can be viewed as having two major components: (a) the decentralization and extension of coverage, spearheaded by SSA; and (b) improving quality and user choice, spearheaded by IMSS. 9  SSA Refoxrm 35. Decentralization and Extension of Coverage. The reform of services for the uninsured relies mainly on further decentralization and devolution of power from the federal health institutions to state institutions for the provision of services. State institutions will assume a new comnmitment to deliver minimum health care services to the uninsured. A gradual reform process is envisioned, with state health services first taking up the functions of the SSA. In the longer run, state institutions will merge with other decentralized institutions, such as IMSS- Solidaridad. 36. Decentralization is already well underway. A National Health Council was set up in 1995 to supervise the reform process in SSA. A framework agreement between federal and state level authorities and trade unions was signed in August 1996 and individual agreements between 28 states and the Federal Government have also been signed. The current decentralization process is intended to go beyond the limited decentralization of the 1980s. A major improvement is the introduction of minimum health care programs to be provided by the decentralized states. A more transparent capitation formula to distribute federal resources among states has also been defined in order to improve resource allocation efficiency and equity. The reform of the SSA is being supported by the Second Basic Health project (3943-ME) currently umder implementation. The 1995 Social Security Law - IMSS Reform 37. Reform of the social security system was debated during 1995 and a new Social Security Law (Ley del Seguro Social, SSL) passed in December of that year. The new law was scheduled to take effect in January 1997, but this was later postponed to July 1997. As the largest organization in both the social security and health sectors, IMSS will play a key role in the reform. The framework for IMSS reforms are based on three major instruments: (a) the introduction of mechanisms to stimulate greater efficiency and better quality; (b) changes in financing and delivery schemes: opt-in and opt-out reforms4 (see para. 40); and (c) a change of financing through the modification of the premium structure. 38. Increasing User Choice. This reform has already gotten underway on a pilot basis by letting IMSS patients having their choice of general practitioner. The eventual goal is to clearly separate financing and service provision within IMSS, thereby increasing incentives for quality and efficiency in service provision. It is hoped that market mechanisms will allow patients to secure the benefits of competition within IMSS. Establishing internal competition will, in broad terms, require the development of a structure which allows a degree of free movement by patients, capitation payments, and the ability on the part of Medical Area Units and MCOs to control costs, most likely by taking an active role in contracting with providers. Since January 1998, the Medical Area Units have received budget allocations based on a capitation formula, adjusted for age and sex. This constitutes an important first step to promoting competition and user choice within IMSS. 4 In the IMSS case, 'opting-in" refers to new entrants into the IMSS health care system, ostensibly from the self-employed and informal sector populations. Conversely, "opting-out" refers to a system whereby beneficiaries choose to receive health benefits through alternative providers, which will guarantee a minimal level of service provision in exchange for a fixed fee based on a risk-adjusted capitated payment scheme. However, they remain part of the overall social security financing and insurance system. 10  39. Actions to promote quality and efficiency would include: (a) introducing greater choice of health care providers within Medical Area Units; (b) assigning clear goals, management responsibilities and instruments to IMSS providers and MCOs; (c) establishing minimum accreditation standards for providers and eligibility criteria for MCOs; and (d) establishing a clear and equitable expenditures allocation mechanism. Finally, accountability will be introduced into the system through clear rules and regulations to be followed by providers and management institutions, decentralization of decision-making and management at public health care and social security institutions, and supervision of compliance with regulations and performance contracts. These actions will be reinforced through the policy conditions of the proposed loan. 40. Changes in Health Insurance Schemes - Opting-In and Opting-Out. Another key aspect of IMSS reforms includes the extension of coverage under a publicly subsidized insurance scheme (opting-in) and the introduction of managed care through an opting-out scheme under which IMSS members, through their employers, are given the option of receiving a per capita fee to receive services through alternative public and private integrated care systems. These two alternative components will be gradually incorporated to avoid potential risks, including risk selection and segmentation by income level. Opting-In. The aim of the opt-in reform is to attract the population that falls in the gap between social security and SSA coverage or between social security and the private sector. This population is mainly urban and, while it has the capacity to pay for better health care, does not belong to the formal economy. Hence, under the old system it was unable to register with a social security institution. With the opt-in reform, informal sector families will be able to assume IMSS health insurance at an attractive price under the Family Health Insurance Program (Seguro de Salud para la Familia, SSFAM). In addition to introducing the possibility of health insurance for a previously excluded population group, the changes in the SSL have important implications on the financing of health insurance for the self-employed and informal sector workers. Under the previous 1973 Social Security Law, voluntary insurance was available for US$38 per month (305 pesos), financed entirely by worker contributions. With the new law, self- employed and informal sector workers are now able to enroll for IMSS health coverage with a payment of US$24 per month (235 pesos per family) and a public subsidy of around US$15 (116 pesos per direct enrolled). Opting-Out. Opting-out (prestaci6n indirecta) is the most far-reaching reform element. The opt-out reform represents a major structural change for the social security system, introducing choice of health care provider for members and opening the door for a major expansion of private managed care and health care provision. The opt-out program will be introduced gradually, to allow IMSS providers time to improve the quality and efficiency of services. The central element of the opt-out reform is an alternative delivery strategy by which IMSS members, through their employers, can opt out of IMSS' delivery system and into coverage by MCOs, as alternative public and private providers. These MCOs will receive a risk-adjusted capitated fee in return for the provision of an integrated health care package, and in turn guarantee provision of health services in place of IMSS. Under the opt-out scheme, IMSS will act as a financier and purchaser, while the MCOs. will organize the provider network. In general terms, the opt-out reform is expected to achieve the following goals: 11  (i) The reform will stimulate two relatively undeveloped industries: insurance and public and private health care provision. It wilL also serve to encourage competition within the health sector, stimulating greater efficiency and higher quality of care. On the finance side, based on a gradual process, public and private MCOs would compete to capture a new mass market, rather than the more limited market of those wealthy enough to pay for dupLicate insurance. On the provider side, primary care physicians, hospitals, and suppLiers of pharmaceuticals and medical technology would also compete, innovating and increasing efficiency wherever possible to win contracts with competing insurers. (ii) Opt-out will reduce employment costs and stimulate formal employment. Due to perceived inadequacies of the social security system, many large employers offer additional private health insurance to employees or assume health related expenses. To the extent that opt-out provisions prove a satisfactory alternative to double insuring, non-wage employment costs will decrease and formerly uninsured workers may join IMSS. (iii) Finally, opt-out would likely increase user welfare by generating greater user choice among health care providers and raising the quality of medical care and services. 41. Change in Premium Structure. Distribution of Health Insurance Revenues, Following the SSL, IMSS instituted a Before and After Reforms change in the premium structure in July 1997 to address chronic deficits (see para. 90 19) and systemic inefficiencies. Under the contrbutionst new system, the premium is divided into r0 70 two parts: a flat capitated rate, and a 60 variable contribution linked to income for 0 50 those earning salaries above three times 40 the minimilum wage. Contributions are 30 Payrolltaxes capped for salaries above 25 times the 20 minimum wage. In sum, the composition 10 of IMSS health insurance financing will 0 change from roughly 95 percent employer More_(1996) After_(1997) and employer contributions and 5 percent Government contributions to 67 percent employer and employee contributions and 33 percent Government contributions. The adjacent figure summarizes the main changes in IMSS financing promulgated under the 1995 SSL. 42. For all salaried employees, emiployers and the Government will each make a contribution equivalent to 13.9 percent of the 1996 minimum wage (or roughly US$14 per member per month), with the Government share indexed to inflation (IPC) and the employer's contribution indexed to minimum salaries in the Federal District. The share paid by employers will rise to 20.4 percent of the minimum wage by 2007, while payments by the Government will be adjustecl according to increases in the Ininimum wage. For workers earning more than three times the minimum wage, additional contributions will be paid as a fixed share of income: employers will pay 6 percent of the wage above this level and employees will pay 2 percelAt of the same portion. This total of 8 percent will be gradually reduced to 1.5 percent over the next decade. By 2007, marginal rates of social security health care contribution on salaries above three times the minimum wage will be 0.4 percent for workers and 1.1 percent for employers. 12  The final 1.5 percent will remain to comply with a constitutional provision that calls for a proportional element in social security contributions (see Annex 9 for a detailed explanation). 43. The changes indicated above will have a significant impact on IMSS financing and coverage and imply an important increase in government contributions to social security. The changes would: (a) reduce part of the incentives to under-report economic activity; (b) allow a wider range of the population to opt into the social security system by reducing the cost of enrollment through a government subsidy for informal sector and self-employed workers; (c) shift a major burden of payroll taxes from employers and employees to general tax revenues; (d) increase the progressiveness of the financing system by eliminating contributions for all workers earning less than 3 minimum salaries and providing public subsidies for insurance to the self-employed and informal sector workers; and (e) allow the opting-out of IMSS members by returning a per capita fixed fee to employers to opt out of IMSS' delivery system and into coverage by MCOs, as alternative public and private providers. B. The Social Security Law- Issues And Challenges 44. Implementation of the SSL in IMSS will need to consider the following main issues with regard to health insurance in Mexico: (a) how to ensure the financially sustainable implementation of competition and the extension of coverage; (b) how to prepare IMSS health insurance and service delivery network for the introduction of competition from other public and private insurers and providers; and (c) how to introduce the institutional and regulatory framework necessary to oversee the gradual development of health insurance and managed care markets. These issues define the major challenges for the IMSS health reforms, and set the stage for the broader health system reforms. Limiting the Fiscal Impact 45. The shift in health insurance financing from payroll taxation to general revenue financing will have a significant short-term fiscal implication. While it is expected that government revenues from general taxes will eventually increase due to higher incentives to formal sector employment and lower incentives to evade taxes, over the short-term the impact of the SSL is estimated to increase government contributions to IMSS from 0.07 percent of GDP to 0.7 percent by the year 2010 and from 0.3 percent of government expenditures to roughly 3.4 percent over the same period. Estimated government contributions would jump almost tenfold from US$218 million in 1996 to over US$2 billion in 1998. 46. Estimated Impact on IMSS Revenues and Expenditures. After years of chronic deficits in the health insurance program, the 1995 SSL would restore IMSS to financial equilibrium - eveni a surplus in some years - due to the rapid rise in Government contributions, incentives to formal sector employment, and the new insurance schemes for the self-employed and informal sector workers. During loan preparation, a detailed financial model was developed to estimate the impact of the changes in the SSL on health insurance financing and coverage until the year 2010 (see Annex 9). 47. Over the long-term, financial projections using a medium case scenario indicate that IMSS health-related real revenues would more than double, from US$4.1 billion in 1996 to over US$9.6 billion by 2010. On the expenditure side, however, the projections (see box next page) underline the importance of introducing cost-containment mechanisms and of carefully phasing in the opting-out and opting-in policies. Without the introduction of cost-containment 13  The Financial Projections Model-Impact of the 1995 SSL on IMSS Net Revenues A financiial projection model was developed to simulate the implications of the social security reform on Government expenditures and on IMSS revenues and expenditures to the year 2010. The model was used to determine the short term irnpact of the reform based on four basic policy issues relevant to the 1995 reforms: * evaluate the fiscal consequences of the changes in the social security financing and health insurance; * estimate the impact on IMSS revenues ind expenditures of changes in the financing of the health insurance system, and the consequences of demographic changes on total insured and health expenlitures; . simulate the potential impact of the introduction of opting-out and opting-in on expenditures and revenues of Federal Government and IMSS; . provide long-term estimates on the total potentially insured population of IMSS, given estimated changes in the demographic profile of the population and the Mexican labor market. [A detailed analysis of the results and the explanation of the model, as wvell as sensitivity analysis under various assumptions, are presented in Annex 9.] Addressing these issues is critical to ensure fiscal discipline and to determine the impact of the health insurance reform on overall health sector financing. The medium case scenario shown below assumes the following: zero wage growth over the medium-term; 1 and 2 percent annual increases in fixed and variable costs, respectively; IMSS coverage would reach 35 percent of the econornically active population (EAP) by the year 2010; the family health insurance scheme would reach 7 percent of IMSS members; and opting-out would be extended to 3 percent of IMSS members. GOM contributions (US$ nillion) 218 1,764 2,639 3,367 GOM contributions as % of non-financial sector public sector expenditures 0.3 % 2.1 % 2.6 % 2.8 % GOM contributions as % of GDP 0.07% 0.48% 0.56% 0.60% He!alth insurance revenues (US$ million) 4,105 5,417 7,590 9,654 Health insurance expenditures (US$ million) 4,256 4,380 6,166 7,974 Total surplus (deficit) (US$ million) (151) 1,037 1,425 1,680 % IEAP in IMSS 29% 29% 32% 35% measures, IMSS health expenditures would rise to over US$10 billion, once again leading to a financial disequilibrium fueled by medical inflation and an aging population. 48. Impact of Demographic and Labor Market Changes. The totail insured population under IMSS should increase from current levels of 28 percent to around 35 percent of the economically active population (EAP), based on the reduction in payroll taxes, the increase in coverage iFor informal and self-employed workers, and increases in female labor market participation. Over the medium- to long-term, the aging of the population would have a significant impact on IMSS health insurance revenue and expenditure. Demographic projections estimate that the population over 65 years of age will increase from 6.5 percent to over 10 percent by the year 2015, thus leading to a substantial rise in expected spending and a decline in overall revenues. The demographic changes underscore the need to implement cost- containment reforms and the timeliness of the shift to general revenue financing. 48. The Government is responding to the need to implement reforms in the financial management and reserve policy through a two-pronged approach which addresses the two main policy objectives: (a) transparent management of the different insurance programs, 14  including improved asset-liability management, and (b) clear targets for investment in the IMSS health care delivery network through the execution of an investment program under the Innovative Development Fund (IDF, see para. 62(d) and Annex 7). First, in the short-term, IMSS and the Ministry of Finance (SHCP) have agreed upon a financial strategy that will implement a regulatory and institutional framework - within the context of an IMSS reserves policy - for the transparent administration and allocation of the surpluses that are likely to be formed over the next ten years in the different IMSS insurance programs. Through the implementation of the proposed reserves policy, the Government will gradually address the main issues associated with IMSS financial management and asset-liability. Second, over the medium-term, the reserves policy would align incentives among the insurance programs. The framework will be negotiated annually through an agreement between IMSS and SHCP establishing annual targets for the use of IMSS reserves from the different insurance branches, to ensure maximum transparency and avoid the commingling of funds. The implementation of the regulatory and institutional framework will be supported by technical assistance from the Technical Assistance Loan (TAL, see para. 86 and Annex 8) which will accompany this operation. The Effect of Opting-In and Opting-Out Scenarios The estimates regarding the impact of opting-out and opting-in are dependent on assumptions about the number of workers that select each of the insurance schemes. The opting-in option for self-employed and informal sector workers has the potential to significantly increase fiscal obligations to the system, over and aDove the current tenfold increase in Government contributions, as each individual opting in would carry a subsidy of approximately US$168 per year. The potential liability to the Government with 450,000 people opting-in (out of an estimated maximum of 6 to 10 million self-employed and informal sector workers) would be an additional US$80 million per year. At present, there are an estimated 200,000 people affiliated under the opting-out scheme (1.5 percent of the total insured population), mainly in the banking and financial sectors and several of the country's largest employers. The changes in the legislation and the Government's reform program aim to increase this number by extending the program to companies with roughly 15,000 workers or 50,000 beneficiaries (workers and their families). Assuming the program were to reach a 10 percent opting-out level, the estimated outflows from IMSS under the proposed system (returning a risk adjusted capitation payment to employers to purchase services from alternative insurers/providers) would increase from less than US$100 million now to over US$1 billion by the year 2010. Failure to regulate and actively manage the opting-out provision represents a potential weakening of IMSS' financial base due to adverse selection and cream skimming, namely the opting- out of "good risks" while leaving the institution with relatively "bad risks," those who contribute less to the system but use it more. Furthermore, opting-out has the potential to increase IMSS health expenditures as the opting-out program essentially costs IMSS twice: first through the cash payment made to an outside provider, and second through the fixed, or sunk, costs that stay with the institution. The increased average costs derived from these actions may have detrimental effects in IMSS financing and may require additional government support if not adequately managed. Extending Coverage 50. The first major issue is extending coverage of the social security system to reduce wide disparities in the level of coverage among labor market sectors and geographical regions. While the majority of urban, formal sector workers are covered through either IMSS or ISSSTE, coverage is extremely limited among rural workers, the self-employed, and informal sector 15  workers. Outside of major urban areas, coverage by IMSS is low: 42 percent of formal, private sector workers are enrolled in IMSS, while IMSS coverage of all private sector rural workers is only 4.6 percent. Coverage is even lower among the self-employed and irnformal sector workers at only 3 percent. 51. Even among the 34 million Mexicans covered by IMSS, access remains a serious problem due to inefficiencies within the system and a lack of client focus. IMSS services at both the ambulatory and hospital leve:l are characterized by long waiting times and poor service. A study of IMSS family medicine units found that, on average, patients had to wait two hours for an appointment lasting 10 minutes, while waiting lists for elective surgery reach up to 15 months for selected procedures. For the estimated 6 to 10 million self-employed and informal sector workers the problem of access is even more acute.' The extension of coverage to these workers, specifically through the proposed publicly subsidized health insurance system, would have to be balanced against the fiscal costs of doing so and the capacity of IMSS to provide additional services with the existing infrastructure and personnel. Preparing IMSS for Competition 52. The second major issue facing IMSS policymakers is related to reducing institutional inefficiencies in the provision and financing of health services, associated with the need to improve the quality of care and to prepare the IMSS health care delivery network for increasing competition from the private sector. 53. Reducing Inefficiency in the Delivery of Health Care Services. Evidence that the system as a whole is inefficient is highlighted by comparing Mexico's health outcomes given the amount ol money spent with those of other countries. This aggregate evidence is fairly convincing that Mexico could do better when measured in terms of two key non-health outcome intdicators - access and efficiency. Several indicators point to the lack of value for money in the health system. Nearly 10 percent of the population remains; without access to the health system and less than 5 percent of rural, formal sector workers are covered by health insurance; moreover, for the population enrolled in IMSS, access to services is often complicated by long waiting times. Nearly 55 percent of IMSS users complained about excessive waiting times in IMSS facilities compared with 26 percent for private facilities. In terms of efficiency, the fact that total health care spending has been growing -even as some key indicators of health status have not improved -suggests that the system is facing a mounting problem of inefficiency. The pattern of IMSS spending favors less cost-effective hospital services - roughly 85 percent of total IMSS health spending - over highly cost-effective primary care services or over more cost--effective technologies. Moreover, the duplication of providers 'has led to excess capacity and waste: in many IMSS hospitals occupancy rates are well below 70 percent while others are saturated with long waiting lists. Risk pooling and provider compensation arrangements need to be designed to contain costs, extend access, and promote the provision of greater quality care and value for money. Two of the major sources of inefficiency within IMSS are centralized management and deficiencies in the financing and management of service delivery. 54. Centralized management and vertical integration limit the efficiency of health care service provision. Despite the fact that the IMSS is Mexico's largest institution with over 350,000 5 Based on estimates of self-employed and informal sector workers as a share of EAP (approx. 15 to 25 percent). Evoluci6n de los Mercados Laborales en Mxico, Enrique Davila. 16  employees and roughly 1,600 provider units, until 1997 nearly all management decisions were made at the central level. The vertical integration of the institutions is coupled with centralized, "top-down" budgeting and management. Care providers across regions are by- and-large centrally budgeted by line items for both their operational and development budgets. Budgeting has followed historical patterns rather than the health needs of the population. The centralized management and historical resource allocation system, coupled with a lack of performance-related pay systems, have contributed to a general lack of accountability which has resulted in: (a) an unequal distribution of resources across regions and populations, and even within medical institutions (in addition to inter-institutional differences); (b) a lack of responsiveness to local health needs; (c) a lack of responsiveness to clients; and (d) no incentives for efficiency. 55. Improving the Quality of IMSS Health Care Services. Lack of competition, inadequate control mechanisms, obsolete equipment, chronic deficits, and deficient management practices have led to increasingly poor quality health services in the IMSS. A major survey of Mexican public attitudes toward health care was carried out in 1994.6 Fifty-nine percent of Mexicans thought that the current system "has some positive aspects but requires fundamental change." Another 24 percent were less content and thought that "the system works so badly that it needs to be rebuilt completely." Results from recent household surveys indicate that between 65 and 70 percent of respondents rate private health care services as of better quality than IMSS. Among the insured population of the social security systems, dissatisfaction with the quality of service has led many to seek health care outside the institution with which they are affiliated so they are often enrolled in more than one system. Their principal reasons were: (a) poor service; (b) lack of resources, such as drugs and well trained personnel; (c) lack of access; and (d) high costs. In addition, the study revealed that quality issues are not limited to the lack of resources, personnel and technical problems: 40 percent of patients felt they were not treated adequately, 61 percent considered services too bureaucratic, 8 percent did not receive medical treatment when needed, and 26 percent had to postpone an intervention for economic reasons. Any lasting reform of IMSS care network will have to instill a strong user orientation in both administrative and medical service personnel, supported by a meaningful performance-based incentive system linked to customer satisfaction. In addition, investment in new administrative support systems and biomedical equipment, accompanied by updated training, will be necessary. Development of An Institutional and Regulatory Framework 56. The regulatory framework for the health insurance market is a limiting factor to the development of greater competition and improved quality and efficiency in Mexico. The Government's proposed reform program will rely heavily on the capacity to formulate and enforce regulations designed for a contractual relationship between the IMSS and its providers. While progress has been made to improve information systems and to hire better trained personnel, institutional capacity is generally quite weak, and the support systems-MIS, accounting, financial administration, and quality control-are inadequate to manage in the competitive environment envisioned under the reform. 57. Specifically, the proposals to promote competition through the opting-out scheme, along with the need to regulate the purchase of services through its own Medical Area Units, 6 The survey was carried out by Dr. R. Blendon of the Harvard School of Public Health and FUNSALUD. Personal interviews were conducted with 1,419 users. 17  will require strengthening of the institutional capacity within IMSS and, at the same time, the SSA. Regtlations will need to be developed to define the content of the basic health benefits package and ensure that all Medical Area Units and private MCOs are delivering it to their members, introduce new resource allocation mechanisms for the purchasing of services, develop quality control and performance benchmarks to allow regulatory agencies to evaluate the quality and efficiency of service provision, and, moreover, introduce clear guidelines to set and enforce minimnum financial standards and insurance-related provisions necessary for the operation of MCOs and the private health insurance market. 58. The Government has established a Task Force for Health Reform, including members of IMSS, SSA, SHCP, and other governmental agencies to set the framework for sector reform and oversee its implementation. This constitutes an important first step towards the development of a regulatory framework to oversee the purchasing of health services from IMSS Medical Area Units and the gradual extension of purchasing to private MCOs. C. The Long-Term View Of Reform 59. The long-term result of the Government's health system reform would be a system in which: (a) an essential health package is defined and accessible to the full population; (b) the responsibility for the provision of health services to the population with no pre-payment capacity is assigned to SSA; (c) a single fund receives resources from all sources (government contributions, employers and employees) corresponding to all social security institutions and transfers resources to MCOs - including public, e.g., IMSS Medical Area Units, or non-public, e.g., private MCOs - on a risk-adjusted capitation basis; (d) the MCOs assume the risk of delivering the services included in the comprehensive care package with the capitated allocation from this fund, and rules are set in place to resolve market failures; (e) the internal market is fully developed, whereby the IMSS Medical Area Units and MCOs use DRGs7 or case-based payment systems to purchase services from public and private providers which comply with minimum accreditation criteria and standards for service delivery; (f) there is an independent supervisory capacity to ensure that the services provided meet quality and financial regulations; (g) additional market mechanisms are fully operational to allow the Medical Area Units and MCOs to act as budgetholding organizations, purchasing services for their populations; and (h) there is a fully developed market for supplementary health insurance to complement the comprehensive care package with a supplemental package providing for improved q[uality and service. A more detailed discussion can be found in Annex 4. D. Reform Imnplementation - IMSS 60. Instruments and Timing. For the short-term - i.e., 1998-2000, the Government has opted to concentrate an important part of its reform implementation efforts on IMSS, mainly because (a) the 1995 SSL will have an immediate impact on IMSS financing and sets the framework for structural reforms, and (b) IMSS is likely to remain the most important public health care provider for some time. The reform program for the period 1998-2000 to be supported by the loan would follow a two-pronged approach: (a) developing and 7 DRGs, or diagnosis-related groups, is one of several methods of patient classification systems that have been developed as an instrument for clinical management and hospital payment systems. The underlying principle of the system is based on grouping similar diagnostic categories, using the ICD-9 classification system, according to expected resource utilization for a given group. The system allows health managers to benchmark a number of quality and productivity indicators according to diagnostic group. 18  implementing health insurance financing reforms (opting-in) and the necessary regulatory framework through (i) separating financing from provision of services, (ii) increasing user choice and extending coverage, and (iii) developing and implementing purchasing mechanisms; and (b) institutional strengthening of IMSS through (i) changing its corporate structure and (ii) strengthening its health care delivery network. The reform comprises the following instruments/ activities: Developing The Regulatory Framework 61. For the development of a regulatory framework, the following actions are necessary: (a) Establishing Risk Pooling, and the Separation of Financing and Provision: The Social Security Health Fund (SSHF). The pooling of risks under a single financing system will be designed to contain costs, extend access and promote greater quality of care and value for money. The separation of financing and provision and the introduction of provider compensation systems are important steps in order to ensure that the system is managed transparently, efficiently and under an even playing field for all institutions involved. The separation of financing and provision requires that the activities being provided are governed by explicit contracts, or management agreements, between the financing agency and the provider. The pooling of risks and the separation of financing and provision within IMSS will be carried out by establishing a Social Security Health Fund (SSHF). The SSHF will play a fundamental role in realizing the potential for increased choice and competition established within the health system introduced by the SSL. The SSHF will pool funds of those who opt out of IMSS, as well as funds from those workers who opt in (mainly the self-employed and informal sector workers). The SSHF will consolidate all IMSS health resources, including Sickness and Maternity, Family Health Insurance Program (SSFAM), Pensioners' Medical Care and Workers Compensation programs, and will allocate funds to each Medical Area Unit and, eventually, to IMSS MCOs on a capitated basis. Over the medium-term, the capitation payments will include additional resources to allow Medical Area Units and MCOs to purchase care from the Specialty Hospitals using DRG or case- based payment mechanisms.8 At the same time, the SSHF will continue to directly finance, a package of high-technology, high-cost cases at Specialty Hospitals on a diagnosis-related basis (DRGs). In the long term, the pooled-risk funds, such as SSHF, could merge all mandatory health contributions in the Mexican system, including those of other public health insurance institutions. As such, the SSHF could evolve into a national health insurance fund open to all medical institutions comprising the Mexican health care system and purchasing services from all public and non-public providers or MCOs. During the first phase of the reforms, representatives from SHCP, SSA, SECODAM, and other governmental agencies (the "SSHF Committee") will provide advisory functions and help monitor the SSHF to promote transparency of the supervision and regulatory regime. 8 The purchasing of health care at Specialty Hospitals by Medical Area Units will require that the new organizational and functional structures are fully operational to allow the Medical Area Units to act as budgetholders or purchasers. Until such time, the Medical Area Units will receive capitation payments that do not contain resources for purchasing care at the Specialty Hospitals and the SHIF will continue to finance the Specialty Hospitals through direct budget transfers. 19  Over the medium-term, a properly strengthened supervisory body, acting independently of all agents and with clear rules of the game would be established in order to have a properly working system of managed competition. In addition, a technical unit will be established within IMSS to support the execution of the operational activities of the SSHF. The main responsibilities of IMSS and its technical unit vis-a-vis the SSHF include: (a) setting standards for the budgeting, financial management, accounting and financial reporting of MCOs, starting with IMSS Medical Area Units; (b) assessing, approving, and monitoring the implementation of the capitation and DRG formulae; (c) coordinate with SSA to regulate private MCOs (d) setting the rules for enrollment of new members in MCOs, the movement of members among MCOs, as well as the rules and regulations for opting-in and opting-out; (e) appointing an auditor to monitor and audit the collection system and its performance as well as the financial processes of the MCOs; and (f) creating and administering an Innovative Development Fund (IDF, see para. 62(d) below and Annex 7) to assist IMSS providers in financing the purchase of modern medical equipment and mnodernization of health care faLcilities. Annex 5 provides additional information on the structure and operating procedures of the SSHF. (b) Establishing a Capitated System of Payment for Service Delivery. The development of a risk-adjusted capitation system is a key element to ensure greater efficiency and equity. The first phase of the reform -initiated in 1997 and extended to all Medical Area Units in 1998--includes the allocation of resources to IMSS Medical Area Units on a capitated basis. Later phases will include the use of this system as the principal allocative mechanism to distribute resources to MCOs under the opting-out system. For 1998, the Medical Area Unit budgets have already been distributed on a capitated basis. Over the next two years, additional variables will be included in the capitation formula to account for differences in the health needs of the populations in the Medical Area Units. A complementary action would be to complete the definition of Integrated Health Care Models to be used in the contracting of services with MCOs. In addition to the basic health package provided by the SSA for the population without pre- payment capacity, it is necessary to clearly define the content and cost of the integrated health care model that will be provided by IMSS Medical Area Units and private MCOs. (c) Creating a Database of Beneficiaries. A database of all beneficiaries is necessary for the proper management and monitoring of the health insurance system, the introduction of free choice, and the implementation, of a capitated payment system. The database will allow IMSS to consolidate the capitation resource allocation mechanism by improving the quality of data on Medical Area Unit populations, and to maintain an updated registry of all members, their insurance status and other variables which will affect the capitation formu"la. This information will become increasingly important as the opting-out program is extended. (d) Establishing a Regulatory Framework for Increased User Choice. [n the medium term, user choice will be introduced by allowing selection: (i) of family doctors within a given Medical Area Unit; (ii) among IMSS Medical Area Units; (iii) among IMSS Medical Area Units and MCOs (both private and public) under an opting-out scheme; and (iv) of Specialty Hospitals by budgetholding Medical Area Units that purchase high technology services. In order for user choice to work properly, regulation and contracting arrangements must be set in place to establish the quality and quantity of services to be provided and the rights and obligations of beneficiaries and providers. The regulations to 20  be issued must include minimum regulations for purchaser-provider organizations (i.e., MCOs) and minimum regulations regarding service delivery. Regulations for MCOs and other providers must set clear rules to prevent cream skimming and under-provision of health services and establish clear penalties in case of non- compliance. Specific attention will be paid to avoid segmentation by income levels. Finally, clear liquidation and closure mechanisms must be established for those MCOs and providers that do not comply with regulations and standards. These procedures must make sure that affiliates' rights are protected at all times. (f) Creating a Supervisory Authority. A supervisory authority is required to authorize MCOs, establish regulations, and supervise compliance by all agents in the system. A lack of capacity to regulate the health care market dictates that the supervisory function will have to be assumed under the SSHF during the first several years of the reform. Over the medium-term, a properly strengthened supervisory body, acting independently of all agents and with clear rules of the game would be established in order to have a properly working system of managed competition. Institutional Strengthening of IMSS 62. The following actions are necessary: (a) Restructuring the IMSS Corporate Structure. As a vital complement to the decentralization process and to promote the separation of financing and provision of services within IMSS, major changes will be necessary at all levels of IMSS' organizational structure. This structure will need to have clearly defined roles and to be strengthened at each level. The specific activities and functions for each are described in Annex 6. (b) Decentralizing IMSS. Continuing on the efforts initiated during earlier stages, additional decentralization of management responsibility and accountability is a critical element to improve efficiency and improve responsiveness to the health needs of the population. Decentralization of IMSS will be supported by ensuring that key policy decisions will be taken to: (i) transfer decision-making to the adequate decentralized level; (ii) ensure that resources flow transparently to the decentralized decision-making authorities; and (iii) provide the decentralized units with adequate institutional capacity (budgeting procedures, treasury systems and internal control systems). (c) Strengthening IMSS Service Delivery Capacity. The success of the reforms will depend to a large extent on the strengthening of the IMSS health care delivery network. Financial support will be provided to Medical Area Units and Specialty Hospitals to strengthen their delivery capacity and to improve the quality and efficiency of their services. Further support will be provided to develop the Medical Area Units into autonomous, self- managed, integrated health delivery units. (d) Establishing an Innovative Development Fund (IDF). The strengthening of IMSS service delivery capacity, particularly at the Medical Area Unit level, will require additional investments in equipment, information systems, and other measures to improve their production process so as to be more client-oriented and attempt to optimize costs. The actions to be taken include: better management of patient flows, increased introduction of outpatient services, and a more effective referral and counter-referral system between levels of care. The IDF, operating within the SSHF, will be an effective tool for IMSS to improve the quality and efficiency of care. The IDF will: (i) replace obsolete medical equipment and 21  technology to increase productivity and quality of services and rationalize operating and maintenance costs; (ii) improve the .management of health facilities at the primary, secondary, and tertiary levels; (iii) provide IMSS with a flexible instrument that will allow health facilities to adjust their production capacity in an evolving competitive market; and (iv) strengthen the organization and development of Medical Area Units. The IDF will receive gradual financing of US$200 million, as start-up capital, according to an investment program timetable; replenishment in subsequent years will be made according to an investment program, based on IMSS budgetary capacity and execution of the investment program. In addition to providing capital to finance basic investment needs to ensure minimum levels of quality and competitiveness, the IDF will use a competitive, demand-driven mechanism to link additional investments with IMSS reforms. Specifically, the IDF will evaluate management improvement subprojects and additional investments using a point system taking into consideration: (i) progress by Medical Area Unit in improvinlg its management, contracting, and financing functions; (ii) linkage with priority heaLlth problems; (iii) expected reduction in waiting lists; (iv) reduction in unnecessary referrals; (v) degree of integration with the health network in the Medical Area Unit; and (vi) innovations in management of health facilities and health delivery systems. Annex 7 provides further details on the operation of the IDF. Next Phase of the Reform 63. Once the above actions have been substantially achieved, the reformr would move to its next phase tc: (a) Include Other Institutions. Although the reform starts with IMSS (and the SSA under a different loan), future reform efforts will likely include other institutions managing compulsory contributions for health such as ISSSTE, PEMEX and others. (b) Promote Universal Health Insurance. Over the medium- to long-term, the reforms are aimed at promoting the development of risk pooling mechanisms that can integrate financing sources from all social security institutions (ISSSTE and others) and non-social security institutions (i.e., SSA) and purchase health services-for both the basic package currently provided by SSA and the managed health care model to be defined under the proposed reforms-from a wide array of providers including IMSS, ISSSTE, SSA and private providers. The fund would operate as a national, or sub-national, Health Insurance Fund to provide comprehensive coverage to the entire population. E. Bank Assistance 64. The Government has requested Bank assistance for its health system reform. In the first phase, Bank support is concentrating on IMSS and will include budgetary support to help meet the Government's immediate obligations under the SSL and technical input into the design and implementation of the reform and the strengthening of IMSS. The Government has provided a Letter of IMSS Health Insurance Development Policy (Annex 1). Bank support would consist of two complementary, parallel operations: (a) an adjustment operation, the subject of this Report, and (b) a Technical Assistance Loan (TAL) (see para. 86 and the Project Appraisal Document, Report No. 17349-ME). 22  65. Loan Objectives. The objective of the proposed loan is to support the initial implementation phase of reforms, which focus on improving the efficiency and equity of the health insurance system and increasing the quality and efficiency of health care service provision within IMSS. Specifically, the loan will support the design and implementation of major policy changes that aim at: * Improving the financial management of the IMSS health insurance system to ensure financial transparency, introduce new resource allocation mechanisms, and limit the fiscal impact of the proposed health care reforms; * Strengthening the institutional and regulatory framework for health insurance to extend coverage to the self-employed and informal sector workers, ensure greater transparency and accountability among providers, develop measures for quality assurance and users' rights, and promote user choice; and * Improving the quality and efficiency of the IMSS health delivery system by supporting the decentralization of decision-making, restructuring of the health care delivery network around a population-based system, and the introduction of performance-based incentives for providers. Country Assistance Strategy (CAS) 66. The loan is consistent with the CAS objectives of growth, stability, social development, and the modernization of the state set forth in the Mexico CAS (Report 16135-ME) discussed by the Executive Directors in December 1996.9 The proposed loan would directly address three of the five actions for the health sector identified in the CAS and support several other CAS objectives. Specifically, the proposed loan would support the development of policy actions aimed at the following objectives: