By Tom Armitage

BERLIN (Reuters) - Chancellor Angela Merkel's much-derided reform of the German healthcare system cleared a final legislative hurdle on Friday, as representatives of the German states approved the bill despite reservations.

The law was passed by a majority of state premiers in the upper house of parliament, or Bundesrat.

Of 16 premiers, five had indicated they would withhold their vote in protest over the planned overhaul, which threatened to bring down Merkel's coalition of conservatives and Social Democrats (SPD) during its one-year gestation.

The reform is meant to streamline the provision of state and private health insurance to cut costs and bureaucracy. Its supporters say it will make the 140 billion euro ($183.7 billion) a year system more transparent and market-oriented.

Critics however say the changes hammered out between the SPD and the conservatives will increase bureaucracy and raise costs for contributors.

The contentious reform placed Merkel on a collision course not only with the SPD, with whom she was forced to create a coalition in 2005, but also with rebellious state premiers from her own grouping of two conservative parties.

"The road to this reform was difficult, it was long and it was rocky," said Edmund Stoiber, leader of the Christian Social Union (CSU), the Bavarian sister party to Merkel's Christian Democratic Union (CDU).

Supposedly a key plank in Merkel's coalition agenda, the result has been criticised as a messy compromise between the conflicting desires of the conservatives and the SPD that does little to improve the system's chronic funding problem.

"Everybody knows that if this healthcare reform had not been completed then the coalition government would have collapsed," Frank Ulrich Montgomery, head of Germany's Marburger Bund association of doctors, told Reuters in an interview.

Nevertheless, Germany -- which spends almost as much as the U.S. and Switzerland proportionally on healthcare -- still has one of the best health systems in world.

"Whoever has had the misfortunate of falling ill in Scotland, Italy or France will be able to appreciate the standards of the German system," Stoiber said.

The reform is due to come into effect on April 1, 2007, but key aspects of the overhaul, including a new system for collecting and distributing the statutory contributions made by workers, have been delayed and will only be introduced in 2009.

The changes are meant to trim billions of euros from the overall healthcare bill and will ensure that around 300,000 Germans currently without health insurance are taken back in.