Reform plans promise significant change, but what does that mean for foreign healthcare players?

Whenever Wang Hui, a product manager in Shanghai, needs to consult a doctor, it means hours queuing for a few minutes of an overburdened doctor’s attention. Yet Wang Hui is relatively well off. His father, a factory worker in Shanghai’s suburbs, does not trust his local clinic and prefers to make a day-trip to a downtown hospital. His uncle, a farmer on the outskirts of Shanghai, worries about being able to afford medical expenses and puts up with physical discomfort instead.

China’s healthcare system is deeply flawed, and Chinese citizens increasingly expect rapid improvement in the accessibility and affordability of healthcare. With the release of the new healthcare reform plan in early April, China is at a turning point. Even though its implementation will be an arduous and prolonged struggle, the reform plan has important implications not just for China’s healthcare sector but also for the country’s economic development. Only when Chinese citizens stop worrying that sickness means impoverishment will there be less precautionary saving and a greater readiness to spend. This makes the healthcare reform plan another building block in support of a sustained consumption boom in China.

China’s reform plan

China released two healthcare reform documents in early April. The first, the State Council’s Opinions on Deepening Healthcare System Reform (Framework Plan), is a broad document that sets the reform framework through 2020. The second, the Ministry of Health’s Implementation Plan for Immediate Priorities in Healthcare System Reform, 2009-11 (Implementation Plan), provides a more detailed roadmap for the next three years. The Implementation Plan is comprised of five major programs.

Universal coverage of basic medical insurance

The government aims to extend each of the three main medical insurance schemes to cover 90 percent of the population by 2011. In particular, the Urban Employed Basic Medical Insurance scheme will be expanded to cover students, migrant rural workers, temporary contract workers, and retirees from closed-down and bankrupt enterprises, in addition to the urban employed.

In 2010, The government will also raise subsidies for health insurance premiums to ¥120 ($18) per participant in the Urban Resident Basic Medical Insurance and New Rural Cooperative Medical Insurance schemes, which together cover 900 million people. The schemes’ service scope, reimbursement level, and maximum amounts payable will gradually be raised to narrow the huge differences in benefits provided by the various schemes.

Finally, China will gradually integrate the three main medical insurance schemes to accommodate population mobility. Medical insurance handling bodies will negotiate with healthcare providers to contain costs, and direct settlement systems between medical insurance handling bodies and healthcare providers will be created.

Establishment of an essential drug system

The government will publish a National Essential Drug List (NEDL), expected to contain 400-700 items with many low-cost generics and traditional Chinese medicines. The central government will guide prices, provincial governments will be responsible for procurement and distribution, and basic medical insurance will cover prescriptions. The government also aims to step up supervision and sampling to ensure a safe supply of drugs.

Provincial governments will run open tenders for drug procurement and drug distribution in their region. The tenders will be open to private and foreign participants, supposedly in fair competition. Provincial governments may replace up to 10 percent of the drugs on the NEDL to tackle diseases that are more prevalent in their locality.

Purchasing prices of all drugs on the NEDL will be set within central-government guided retail prices. Grassroots healthcare providers may not levy a surcharge on drug sales. (In rural areas “grassroots healthcare providers” includes county hospitals, township health centers, and village clinics. In urban areas they include community health centers and community health service stations.) Basic medical insurance will cover prescriptions of drugs on the NEDL at a much higher reimbursement level than non-essential drugs.

The government will require all healthcare providers and retail pharmacies to stock and retail drugs on the NEDL, and grassroots healthcare providers may stock and retail only drugs on the NEDL. All other healthcare providers will be encouraged to use drugs on the NEDL as their “primary choice remedy.” Thus, the NEDL is expected to largely define the drug market in all but the urban hospitals.

Improved primary care infrastructure

China will construct and renovate county hospitals and health centers, as well as train and rotate healthcare professionals to staff them. This activity will focus on grassroots healthcare providers.

To improve the quality of China’s grassroots healthcare professionals, a training program will cover 360,000 healthcare professionals for township health centers, 160,000 for community health centers, and 1.4 million for village clinics. The university fees and student loans of medical graduates who choose to work in township health centers will be subsidised, and doctors in urban hospitals will earn promotions only if they have practiced one year in rural regions. Moreover, urban hospitals must support county hospitals on a long-term basis to transfer expertise.

To strengthen the primary care system, patients will be encouraged to visit health centers as a first point of consultation, or receive visits from mobile medical teams, and be referred to hospitals only if they have secondary or tertiary care needs. In addition to improving accessibility, the health centers will ensure the affordability of their primary care services by using “appropriate” techniques, equipment, and essential medicines.

Pilot reform of public hospitals

The government will attempt to improve the governance of public hospitals and gradually reform their revenue structure. Critical here will be the reduction in drug surcharges and shift to government subsidies and fees-per-service only. The proportion of “non-public” (or private) hospitals, although not necessarily for-profit hospitals, will also increase.

Equitable access to public health services

The government will strengthen the prevention and control of disease with various community-level programs, as well as the launch of a new television station for health education.

To strengthen mother, infant, and elderly care, pregnant women will receive prenatal and postnatal checkups, and those younger than 3 and older than 65 years old will be entitled to regular examinations. (As these checks are considered public health efforts, the government will likely fund them directly.) China will also continue or launch major public health programs to prevent or control major diseases. Programs to be continued include the national immunization program and the prevention and control of HIV/AIDS, while programs to be launched include the provision of folic acid for pregnant women to help prevent birth defects and supplementary vaccination against hepatitis B for those under 15 years old.

Implications for multinational healthcare players

Once the reforms get under way, opportunities for multinational healthcare companies will likely remain centered around drugs, devices, and services offered in Grade 3 hospitals. For companies that can provide low-cost medical products and services, however, China’s plans to make healthcare accessible and affordable to its vast population may offer significant potential.

Pharmaceuticals: A switch to low-cost generics

When the NEDL is published, pharmaceutical multinationals will scan the list for matches against their own portfolios but probably will not find many patented or innovative drugs. Instead, the real opportunity will be in generics. As basic medical insurance will cover drugs on the NEDL, more Chinese citizens will purchase drugs, creating a high-volume demand for low-cost generics. Tapping this demand will require pharmaceutical multinationals to reconfigure their portfolios and adjust their pricing strategies, as well as rethink their target customers and means of reaching and serving those customers. The scale of the challenge should not be underestimated. Even China’s largest drugs distributors, SinoPharm Group and Shanghai Pharmaceutical Co., do not have the infrastructure to cover grassroots healthcare providers thoroughly. Few pharmaceutical multinationals will have the appetite for such a thin-margin, mass-market play.

When NEDL is released, domestic generic drug makers will perhaps be best positioned to benefit from the reform. They will likely strengthen their portfolios and rapidly expand sales and distribution networks to reach grassroots healthcare providers and rural regions. As larger players strive for economies of scale to drive down costs and improve competitiveness, the industry will consolidate.

For most pharmaceutical multinationals, China accounts for a relatively small share of their global business. In the short term, most will likely take a cautious approach to the reform and continue to focus on the 1,200 Grade 3 hospitals. These hospitals may still impose drug surcharges and will still cater to the high end of the market, which can better afford patented and innovative drugs. The introduction of the NEDL is unlikely to have an immediate impact on business with these hospitals, and the reform of their revenue structures will be slow and incremental.

Medical devices: Domestic players to benefit most?

The reform plan is generally good news for medical device makers. The growth in public spending, especially on the construction and upgrade of healthcare facilities, will be an obvious demand driver for medical equipment, including medical devices. But with the government generally encouraging the substitution of expensive imported medical devices with cheaper domestic versions, domestic medical device makers will perhaps benefit most from the reform.

Nevertheless, healthcare reform may still generate new demand for advanced medical devices. As drug surcharges are phased out in public hospitals, these hospitals will look to fees-per-service to compensate for lost revenue. As a result, there will be greater use of diagnostic, therapeutic, and surgical devices and technologies that command relatively high services fees.

Healthcare IT: Sooner or later

Information technology (IT) investment in China’s health-care sector has been relatively weak, and the current level of computerization is lower than in many other countries. This is because market-oriented reforms led to healthcare providers investing in medical equipment and devices that could directly generate revenues. IT is set to play a much more important role, however, as China’s healthcare system will not achieve accessibility and affordability without it.

One of the first priorities will likely be the establishment of an electronic medical record system, which will facilitate patient data sharing among healthcare providers. Next up could be the establishment of regional health networks that would integrate the hospital, clinical, and radiology information systems of China’s highly scattered and fragmented healthcare providers. Numerous pilot projects are already under way in different parts of the country, such as the Shanghai Hospital Union project, which covers 23 hospitals and numerous health centers in Shanghai. Further down the road, a nationwide, unified health network that integrates health administrators, healthcare providers, medical insurers, and the public health system, among others, is a possibility.

Healthcare provision: Is this really privatization?

Private hospitals currently account for less than 15 percent of China’s total. While public hospitals will remain dominant, the proportion of private hospitals will rise. The Implementation and Framework plans remain vague on the opportunities for private and foreign healthcare providers, however. Though it is clear that private investment in non-profit hospitals will be encouraged and diversity of ownership—including foreign ownership—is envisaged, the plans do not directly encourage private investment in for-profit hospitals. Moreover, the reform plan does not address the significant entry barriers that exist for foreign healthcare providers. (Because foreign investment in healthcare provision is restricted, foreign ownership is limited to 70 percent, a minimum investment of ¥20 million [$2.93 million] is required, and branch organizations are prohibited.)

Healthcare provision with public health functions, such as preventive services and infectious disease treatment, will likely remain in the hands of the government, as will healthcare provision toward the top end of the scale (Grade 3 hospitals) and the bottom (health centers and village clinics). Apart from the small but growing market for premium care, the main opportunity for foreign healthcare providers could be hospitals that handle routine patient care, such as Grade 1 or Grade 2 hospitals. These are the middle of the market, upon which the majority of the population will increasingly rely. It is unclear, however, whether these would be attractive opportunities for multinationals.

Commercial medical insurance to supplement basic

To date, Chinese citizens have had few medical insurance options. Now, insurance companies will be encouraged to develop and introduce commercial medical insurance products, with commercial medical insurance used to supplement basic medical insurance, and thereby cater to the diversity of needs in China’s market. In addition, the government will explore purchasing medical insurance management services from commercial insurers. Many domestic and multinational insurance companies are already seeking such opportunities in China, looking at participating as either policy providers or third-party administrators.

Takeaways for multinationals

The plans set a clear course for China’s healthcare reform, but the implications for multinational healthcare players are not so obvious. On the one hand, the healthcare sector will grow significantly. On the other, the limelight is about to shift from urban hospitals to grassroots healthcare providers, and a share of healthcare expenditure with it. As such, multinational healthcare players need to understand that the reform’s emphasis is not on expanding demand for high-end products and services or finding mechanisms for private or foreign participation. Indeed, access for multinational healthcare players is at best a backburner concern for PRC policymakers right now.

Many multinational healthcare players will continue to focus on the Grade 3 hospitals that have been their main market to date and where the high-end opportunities will continue. With more patients encouraged to consult their local health centers in times of illness, the strengthening of the primary care infrastructure combined with a functioning referral system could boost demand for secondary and tertiary care hospitals. This would have positive implications in terms of high-end opportunities for multinational healthcare players.

Meanwhile, the drive to improve the accessibility and affordability of healthcare will create an immense market opportunity for low-cost solutions. To take advantage, most multinational healthcare players would have to rethink their approach to China and realign themselves with the PRC government’s initiatives, at least to some extent. This could involve having stratified portfolios with less-sophisticated products at lower price points, expanding sales and distribution networks to reach grassroots healthcare providers and rural regions, and being sufficiently savvy to pick the right pilot projects in which to participate and influence. Companies could make a strong case for examining acquisition targets in China that could fulfill these needs.

Such strategies must be considered in the context of the next five or ten years. This is not easy. Using the healthcare systems of other countries as indicators of China’s future direction would be misleading. China’s unique circumstances, including the fact that it is home to a fifth of the world’s population, are reasons why China will inevitably follow its own path. Over the next decade, innovations and lessons from China’s healthcare sector reform that have relevance to other countries will emerge. In addition, some Chinese healthcare players will almost certainly become multinational players in their own right. The current healthcare reform plan will be a major milestone along the way.

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China’s Main Basic Medical Insurance Schemes

China has three main basic medical insurance schemes, which vary greatly.

  • Urban Employed Basic Medical Insurance (UEBMI), established in 1998, is employment-based and covers urban workers only. It consists of a pooled fund for inpatient stays and individual medical savings accounts for outpatient visits. Payroll taxes paid by employers and employees finance the UEBMI. Contributions are equivalent to 14 percent of annual salary in Shanghai, but only 8 percent in western provinces. About 200 million out of a total of 250 million urban employed participate in UEBMI.
  • New Rural Cooperative Medical Insurance (NRCMI), established in 2003, consists of a pooled fund for inpatient stays and is financed by various government bodies and participants. Contributions are commonly ¥50 ($7) in western provinces, split ¥10 ($1.50) from participants, ¥20 ($3) from provincial government, and ¥20 from the central government. Benefits are limited, with reimbursement rates that can be as low as 30 percent for impatient expenses, and operated on a “pay first, claim later” basis. Nevertheless, the scheme has expanded rapidly, and an estimated 800 million out of a total of 850 million rural citizens participate in NRCMI.
  • Urban Resident Basic Medical Insurance (URBMI), established in 2007, covers the urban population not covered by the UEBMI scheme, such as children and students. It consists of a pooled fund for inpatient stays and does not cover outpatient visits, except in wealthy regions. Various government bodies and participants finance URBMI, with total contributions per participant standing somewhere between UEBMI and NRCMI levels. Benefits are limited, and significant co-payments are required. Coverage is supposed to be available in all cities by the end of 2010, and an estimated 100 million urban residents already participate in the URBMI.

James A. C. Sinclair[/box]

Sinclair tables

[author]James A. C. Sinclair is partner and strategy practice director, InterChina Consulting, based in Shanghai.[/author]

Posted by James A. C. Sinclair