ABSTRACT
This chapter describes the various types of formula funding mechanisms commonly used. It starts by highlighting the analogy between local public services and insurance risk pools, and then describes two broad approaches towards designing funding formulae. In the capitation approach, an estimate is made of the expected level of activity local services would experience if they were to deliver some standard level of service to their local population. In the case payment approach, local services are reimbursed according to some measure of the actual level of activity. The chapter then considers three fundamental issues relevant to all systems of formula funding: the practical implications of data limitations; what constitutes a ‘legitimate’ source of expenditure variation; and the role of supply side influences on funding levels. The insurance analogy highlights a central consideration in designing funding mechanisms – how risk is shared between the payer and the budget holder. Although discussed in this chapter, the issue of risk sharing is treated in more detail in Chapter 6.
