The Chinese Healthcare

Challenge

December 2014 Written by Stéphane PHETSINORATH

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East Wind – Business Note No.2

The Chinese Healthcare Challenge

Written by Stéphane PHETSINORATH

Abstract

As China modernized its economy during the last

decade, the country chose to overlook the basic

investments in public healthcare, focusing exclusively

on economic growth, exponential urbanization and

increasing industrial output. As a result, China's total

healthcare expenditure is lagging behind at 5.4% of

2012 GDP1, and the public part is low and well short of

WHO standards2. Health spending tends to rise with

incomes, without surprise, China is ranking among the

lowest ratios of the OECD countries: with a spending of

$480 in 2012 (calculations based on ‘Purchasing Power

Parity’)1, to be compared with the OECD average of

$3,484 per person capita1, which 7 times more than

China.

How will the potential of Chinese IVD

market look like?

In 2013, the global IVD market reached the

milestone $50 bn mark, with expected CAGR% of

4-5% for 2014-20203,4. In 2015, the Chinese IVD

market is estimated at $5.5 bn5, it will be more

than 10% of the global market, maintaining a

sustained growth between 15-20% every year.

The Chinese IVD market is expected to sustain

similar growth for the next decade too, as all major

companies continue to report exceptional

performance in China, making it a potential pillar

of growth in the future. Companies are looking to

invest heavily in a complex and challenging

environment6, with the hope to secure a profitable

(big) slice of the IVD market.

1 Source: WHO: China Country Information 2 Source: World Health Assembly 1981. A34/5, Section VII, para.6 3 “Global In Vitro Diagnostics (IVD) Market”, Allied Market Research, Jun. 2014 4 “In-Vitro Diagnostics (IVD) Market Analysis and Segment Forecasts to

2020”, Market Research & Consulting, Mar. 2014. 5 “Latest Chinese Guidebook for Application and Approval of Imported

In-vitro Diagnostic Reagent Registration: From Regulations to Practices

(2014 Edition)”, Sept. 2014 6 “Is China’s Healthcare Market Opening too Little, too Late?”, Forbes, Sep.

2013.

What are the key factors behind the

healthcare reform sustaining high pace

growth?

Several factors underlie this rapid rise in

demand for healthcare services. First, China’s

quickly aging population means the country is

experiencing an explosion of chronic conditions

such as diabetes, heart disease and cancer. All of

these conditions can be diagnosed and monitored

using IVD products. Adding to this, the critical

need for detecting infection diseases is crucial, but

especially for a country of 1.3 inhabitants1 and

more than 53% urbanized in close proximity7. The

pandemic/epidemiological risks of infectious

diseases have been numerously demonstrated,

such as: seasonal influenza, H1N1, Ebola ; or even

hospital acquired infections and antibiotic resistant

organisms.

What are the critical success factors to

tap into this unique growth opportunity?

The new healthcare reform(s) from the

government will shape the new healthcare

environment rules. The deep understanding of the

implications of the reform(s) will be center of the

success in the Chinese market. More importantly,

China’s Ministry of Health is shifting its healthcare

focus to preventative care, largely as a cost

containing measure.

China’s healthcare reform will focus on

attracting a large portion of private foreign (or

domestic) capital to boost the new developments

in healthcare. Trying to attract valuable FDI and

private capital resources, the government wants

to alleviate part of the health burden, encouraging

the private sector to expand quickly.

7 Source: Worldbank Data, 2013

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Part I – The Challenge’s Origins

From the 1950s to the 1980s

China has been an ‘administrated’ country for

nearly 2,000 years, especially in the field of

healthcare, where almost all the major medical

facilities and healthcare organizations are entirely

run by the government. In 1949, China is putting

in place the 1st Cooperative Medical System along

with the development of the collective economy,

improving considerably the quality of healthcare

services.

Between 1950 and 1980, China’s healthcare

system provided basic healthcare to almost all the

country’s population through public health

networks and rural/urban insurance schemes.

Despite government promises to implement

WHO’s primary healthcare strategies designed to

achieve “Health for All by 2000” 8 . But, the

economic reforms of the late 1970s, introducing

market principles, started to destabilize the

balance of the whole healthcare structure9.

By the late 1980s, the rural health insurance

scheme entirely collapsed and the urban health

insurance schemes were also crippled by the rapid

rise of medical costs and the inefficiency of

state-owned enterprises (main healthcare

expenditure financers). Then, the healthcare

system continuously suffered from chronic

government underfunding, urban and rural

inequalities and overpriced, low quality products

and services. Leading much of the population

without access to medical care, in 1998, and only a

mere 9.5% of the entire rural Chinese population

had medical insurance10.

The historical legacy

Today, the country’s healthcare system

remains today deeply troubled, plagued by

perverse incentive schemes, and policies. With

spiraling drug costs, inadequate insurance and big

out-of-pocket expenses are all cause for public

distress. In poor rural areas, many forgo

8 “Global Strategy for Health for All by the Year 2000”, 3rd edition, WHO, 1989 9 “Trade Liberalization and its Role in Chinese Economic Growth”,

International Monetary Fund, Nov. 2003 10 “Development of the Rural Health Insurance System in China Health”,

Harvard School of Public Heath, 2004

treatment because they simply can't afford it.

Chinese public hospitals have the notorious

reputation of underpaying their physicians and

medical staff, which led them to rely on “kickback”

payment through overprescribing drugs and

medical procedures to patients. Over-prescription

of drugs and imagining procedures has led to

soaring medical expenses for Chinese Patients.

“医药洋医” “Feeding Hospitals by selling drugs”

The Chinese public generally has a low level of

trust in local and community clinics. As results,

public hospitals deliver 90% of inpatient 11 and

outpatient services in China, which account at

least for 2.9% of the Chinese GDP12.

“看病难，看病贵” “Seeking medical care is difficult,

seeking medical care is expensive”

With ageing population, 177 m older people

aged > 60 years (13.3% of the total population)13;

China is facing three main challenges: mounting

costs, problems at public hospitals and a surge of

chronic diseases (heart disease, diabetes and

cancer). Out of every 100 deaths, more than 85

are now caused by chronic diseases, according to

China’s Ministry of Health14. By comparison, the

U.S Centers for Disease Control and Prevention

says the rate is 70 per 100 in the U.S, and an

average of 63% of deaths world-wide (from WHO).

11 “Healthcare in China: Entering Uncharted Water”, McKinsey, Nov. 2012 12 “China’s 12th Five-Year Plan: Healthcare Sector”, KPMG, May 2011. 13 “Loneliness and Social Support of Older People in China: a Systematic Literature Review”, Health & Social Care in the Community, March 2014 14 “China Calls for Health System Overhaul”, The Wall Street Journal, Jul. 2014

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Chinese demography is undergoing a very

concerning ‘scissor’ effects, due to the famous

‘One-Child’ policy implemented in 1979. The

favorable demographic dividend of many workers

and few elderly that benefited China’s economy

since 1980 is coming to an end. Soon the numbers

of working-age Chinese per retiree will fall to levels

of more developed countries.

6

Fearing that the rapidly growing population

places an untenable burden on economic growth

and improving standards of living, the policy

prevented 400 m births until 201115. But Today, in

an attempt to mitigate a near-certain demographic

future of rapid aging, shrinking labor force and

critical gender imbalance, the Chinese

government has adjusted its one-child policy. The

new policy, set at the provincial level, will permit

couples to have two children if either the husband

or wife is an only child. But the country would

continue to age, its labor force shrink and its

gender imbalance persist for generations.

15 Source: China’s National Population and Family Planning Commission

“The [Chinese] population will become

old before it is rich”

“China may soon discover, as many developed

countries have concluded, raising low fertility rates

is more challenging than reducing high fertility”.16

Part II – The Healthcare Reform

The foundations of the reform

In this context, the government is fixing the

objectives of the healthcare reform, aiming to

achieve universal healthcare coverage for the

entire population by 2020. However, the scope

and pace of changes seem more akin to a

‘revolution’ than a reform, which started with an

initial reform cost of 850 bn RMB ($124 bn)17 for

the next three years (2009-2011). And to achieve

this objective, the government has estimated that

the spending will triple to $1 tr. by 202018.

China is adopting a multiphase reform

strategy to transcend the current payment system

into a Diagnosis Related-Group (DRG) system.

This system classifies patients and set averages

costs and payment for treating similar types of

patients. Hospitals are then rewarded for efficiency,

as they pocket every dollar saved from treating a

patient. Putting in place a real DRG system means

to train managers of over 20, 000 hospitals to DRG

management and collect medical data from the

large number of hospitals and numerous types of

treatment patterns.

“Implementing DRG system will be colossal work, better to start early”

In 2009, China’s government launched the

official policy entitled ‘Guidelines on Deepening

the Reform of Health-care System’, aiming to

provide ‘safe, effective, convenient and

affordable basic health services’ to all urban

and rural residents by 202019. The challenge is

enormous, as for bringing the whole healthcare

16 “Easing One-Child Policy May be Too Late”, Yale Global, Jan.2014 17 “The Changing Face of Healthcare in China”, KPMG, Oct. 2010 18 “Chinese Healthcare Improves, but More Reforms Needed”, Voice of

America, Dec. 2014 19 “Towards Universal Health Coverage: China Lessons Learned”, WHO, Jan.

2014

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system up to speed, with the “reborn” basic

healthcare insurance coverage of more than 95%

[1.35 m people]19 of the population. The main

focus was to help the people with no resources, no

ability and no one to support them (so-called

“Three No” people20).

Four years later, the government has actually

spent more than $371 billion21, as a result, now

over 95% of the country's population has some

basic level of government-provided healthcare

insurance. The central government has spent $100

bn on funding programs related to healthcare

insurance, public health, public hospitals reform,

and strengthening community healthcare

institutions alone. An estimated 46% of that will

be allocated to medical insurance initiatives, 47%

to healthcare provisions, and 7% to public22.

In 2011, with the release of the Twelfth Five

Year Plan, China made public its plans to spend an

additional RMB 4.4 trillion ($720 billion) beyond

what had already been allocated for the sector.

Healthcare reform becomes one of the top10

priorities of the governments23. If successful, the

latter investment will fund 150,000 new primary

care physicians, add 2,000 new county-level

hospitals, create 29,000 new township hospitals

and clinics and upgrade 5,000 existing township

health facilities.

At present, practicing physicians in China are

severely underpaid. They have become reliant on

prescribing expensive drugs and imagining

services, as well as getting side payments from

20 “China’s Latest Revolution: Basic Healthcare for All”, International Labour

Organization, Sep. 2009 21 “四年医改财政投入逾 2 万亿 学者称应多补需方”, 财新网, Mar. 2013 22 “Healthcare Reform In China”, IMS. 23 “China’s 12th Five-Year Plan: Healthcare Sector”, KPMG, May 2011.

patients, to make extra income24. And profits from

drug sales have driven doctors to overprescribe

which has resulted in soaring out-of pocket

medical expenses for Chinese patients. By aiming

for a full DRG payment system, China is tackling

the most pressing challenge which is access to

affordable healthcare25. The augmentation of the

price of the medical consultation is unavoidable,

then the price of medicines will decrease, as

consequence the doctors will switch their income

from drugs sales to consultation and the volume of

patients will decrease in Tier 3 hospital.

The increased government spending has

expanded health insurance coverage. As a direct

consequence, the share of out-of-pocket spending

decreased from 56% to 36% in that same period26.

The reform also generated increased demand for

healthcare, with hospital bed utilization rate up

from 36% to 88%26. By the end of 2015, the

government plans to increase its budget for total

health expenditures to 33%, compared to 28% at

present, reducing the individuals’ out-of-pocket

expenses from 36% to 30%23. And to effectively

control medical expenses, clinical pathway is

promoted, and recognition of medical examination

and lab test results among hospitals at the same

level is promoted. In order to eliminate subsidizing

medical services with drug sales a comprehensive

reform on county level public hospitals by

reforming their personnel management, drug

distribution, funding and performance evaluation,

with a focus on enhancing service capacity, and

establishing a new pattern featuring first

diagnoses on grass-roots level27, mutual referral

24 “How Much Does the Average Chinese Doctor Earn?”, China Medical News,

Mar. 2014 25 “Making Healthcare affordable in China”, WHO, Nov. 2008 26 “What Money Failed to Buy: The Limits of China’s Healthcare Reform”, Asia Unbound, Mar. 2014. 27 “China to Accelerate Public Hospital Reform”, Xinhua, Nov. 2014

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between hospitals, cross-level hospital

cooperation and division of labor28.

The Essential Drug List (EDL)

Following the reform in 2009, the Essential

Drug List (EDL) system has been established from

scratch. Essential drugs without zero markups are

offered in government-run grass-roots health

institutions. Currently this practice is expanding to

village clinics and other non-government-run

grass-roots health institutions.

All government-run primary healthcare

institutes are now required, to restrict drug

utilization to only EDL-listed molecules (a core

pillar of the essential drug system). Meaning that

hospitals are banned from applying their

traditional mark-ups on sales to patients, in theory

ensuring that rural and low-income patients can

gain access to the most basic medicines at an

affordable price. EDL drugs have retail prices set

by the government, and face further price

suppression through being purchased in bulk by

the government in provincial-level tenders29. The

provincial tender system also produced such fierce

price competition that tenders were won at below

the manufacturing cost, leading to supply and

quality issues.

28 “Governing Health in Contemporary China”, Yanzhong HUANG, 2013 29 “Exploring Impacts of the Revised EDL and Associated Policies”, IMS

Consulting Group, Apr. 2013

In grass-roots level, the price of essential

drugs has reduced by 30%30. The proportion of

government funding and medical insurance in the

total revenue has reached 72%, up by 22%

compared to before the reform31.

In contrast, there are no requirements or

restrictions regarding EDL usage in Grade 2 and

Grade 3 hospitals, thus highlighting large

implementation loop holes and scope differences

in the old system32. However, public hospital pilot

reform has been making steady progress. Pilot

reform has been carried out in more than 2000

hospitals of 17 national level pilot cities and 37

provincial level pilot cities31. Modern hospital

administrative systems are tentatively established,

which means the separation of administration and

operation under the larger health system. In pilot

cities such as Beijing and Shenzhen, recent public

hospital reform has made some breakthrough and

achieved preliminary progress in canceling drug

markup, and establishing a brand new funding,

operating and monitoring mechanism.

Primary care

The rise of the Community Healthcare Centers

(CHC): ‘a certainty among a sea of uncertainties’.

The 2009 reform was the 1st stone to build a real

primary healthcare system, but the investments

are unleashed with the 2nd step of the 2011 reform.

The development of community hospitals (CHC) in

rural areas has been 100% funded by the

government, and they will provide medical

consultations, chronic diseases follow-up and

preliminary diagnosis.

By the end of 2011, there were 954,000

health institutions, including around 22,000

hospitals and 918,000 grass-roots health

institutions, an increase of 148,000 institutions

compared to 2003 33 . The initial investment

created the foundations for a new primary care

system and the expansion of the overall hospital

30 “Progress and Prospect of Healthcare Reform in China”, Prof. CHEN Zhu, Minister of Health, May 2012 31 “The Reform and Development of China’s Health Sector Since the 16th

CPC National Congress”, China.org.cn, Sept. 2012 32 “China’s Pharmaceutical Distribution: Poised for Change”, ATKearney, 2012 33 “党的十六大以来卫生事业改革与发展”, 中华人民共和国国家卫生和计划生育委员会, Sep.

2012

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capacity. If successful, the latter investment will

fund 150,000 new primary care physicians, add

2,000 new county-level hospitals, create 29,000

new township hospitals or clinics and upgrade

5,000 existing township health facilities34.

Making it mandatory for those who do not

have a serious emergency to do a first diagnosis

in a CHC, the primary healthcare network will

provide medical consultations from general

practitioners to Traditional Chinese Medicine (TCM)

and will make the first diagnosis, but no surgery.

Improving the reputation and the quality of the

community hospitals, those will be a great asset to

diagnose and to follow the chronic and infectious

diseases. In the past, those same institutions have

lacked of credibility to provide healthcare, and the

Chinese population would always prefer to go to

Grade 3 hospitals before even considering any

diagnosis at a CHC hospital35.

The ‘Irony’ of the Healthcare Reform

“The average Chinese expects the

government to provide healthcare at no cost”. The

government is under pressure to fulfill its promises,

as delivering the social returns and noticeable

wealth distribution (topic related to corruption) for

the population. Many Chinese families rationalize

the damage to their environment and food supply

because they believe that the eventual economic

progress will result in social benefits, of which

healthcare is the most basic and essential.

Those important healthcare reforms are all

important, but will the results arrive early enough

to satisfy the huge demand in healthcare? The

changes are critical to the country's healthcare

infrastructure, but given China's proclivity toward

34 “Mixed Prognosis”, China Hands, May 2014 35 “Fixing the Public Hospital System in China”, The World Bank, 2010.

spending on infrastructure rather than on services,

questions remain about how impactful this new

funding will be at the ground level. “Why and how

did the well-intended and well-invested healthcare

reform go awry?”

For the Chinese government, the main issue is

the costs: “How do you fund healthcare for a new

group of insured people, in both rural and urban

areas, who had until recently been lacking

coverage for even the most basic healthcare

needs?” Referring to the ‘Iron Triangle’ 36

principle, there is always a trade-off between

increasing access to healthcare, maintaining the

quality, and continuously funding that access,

those are the three cornerstones of healthcare:

Access, Cost and Quality. The challenge comes

when the government try to improve all three, or

even two, at once. Increasing the ‘Access”

definitely increases the cost burden, this requires

extreme agility as to balance everything.

Contrary to the rosy picture portrayed by the

government and some scholars, the reform has

failed to fundamentally address the problem of

access and affordability. According to a survey

released by the Independent Horizon Research

Consultancy Group (Oct. 2013), Chinese people

continue to have difficulty in accessing healthcare

coverage. About 81% of the survey respondents

said it was difficult to see a doctor, and more than

57% said it was more difficult than it was four

years earlier to see a doctor. On the affordability

front, 95% of the respondents noted that it was

expensive to seek care, with 87% saying that the

cost was higher than it was four years earlier. Of

the respondents, 27% said that they opted out of

hospitalization, with 74% attributing this to the

high cost of inpatient care and 41% attributing it

to the difficulty of being assigned a hospital bed.

The problem of access to quality care is

especially acute in rural areas of China. Physicians

find big disparities in terms of income, status and

access to technology in the countryside versus the

city, noting that doctors naturally tend to gravitate

to the research opportunities, higher salaries and

36 “Ticking Time Bombs: China’s Healthcare System Faces Issues of Access,

Quality and Cost”, Wharton University, Jun. 2013.

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clearer career paths offered by big urban medical

facilities. The incentives are then very weak to

attract qualified labor from a Grade 3 urban

hospital to the lower pay, lower prestige and lower

support of a Grade 1 or 2 hospitals, especially

when in a rural area.

Funding for the transformation

By far the most complex challenge China has

set for itself, the government needs to find a new

balance to finance its public hospitals, which

account for more than 86%37 of all hospitals of the

country, dealing with 90% of the total healthcare

demand from the Chinese population11. At the

same time, the number of outpatient visits in 2012

increased by 9.9%, close to double digit growth

from the previous year38.

The public hospitals receive funding from a

variety of sources. However the government’s

direct subsidies to them have always been

historically low. The fees they charge for medical

services are usually even below true costs (for

example, consultation fees in hospitals). The

healthcare system has been abnormally distorted,

allowing very cheap consultations and

over-prescription of drugs to compensate the

finances. The over-reliance on drug revenue

locked the hospitals in a dangerous funding

situation. Here comes the promising Healthcare

reform, but its progress will be quickly impeded by

the fact that the heads of many Chinese medical

institutions or centers tend to be political

appointees rather than professionally trained

managers, resulting in serious performance and

governance issues. Nor does the country’s medical

education system really offer hospital

administration programs. Adding to that the

existence of widespread corruption, exacerbated

by the new pricing control policies of the

government on low-cost items to make them

widely accessible and available.

Although, the cause of the financial problem is

clear, but the solution is less so. The government

37 “Industry Trends and Investment in China’s Healthcare Market”, PWC, Aug. 2014. 38 “China’s Healthcare Costs Increase: Official Data”, Xinhua, Jun. 2013.

would like to eliminate the drug markups

(~15%39), by offsetting the lost through public

subsidies and medical service revenues. However,

the drug revenue weights already more than 40%

of the public hospitals revenues40. Without strong

financing from the government or real reforms in

the hospital governance, the bottom line of those

institutions are deeply affected, and to

compensate they tend to charge much higher

prices on high-tech equipment and offer more

expensive drugs, devices and procedures.

The following reforms planned for the public

hospitals will target the hospital management

performance: financial, clinical and operational.

This will require a total transformation of the

mind-set and the capabilities of the public

hospitals managers. Although public intuitions will

continue to dominate as the main healthcare

provider, but the private hospital market will grow

significantly over the next few years because the

government has loosened its restrictions in the

field of healthcare private sector. The central

government has clearly voiced a need for the

oversea expertise and experience, opening new

opportunities for international entrants to the

private sector 41 , 42 , changing the regulatory

environment in favor of foreign investors. Public

sector will definitely share the gain in experience,

improving care quality, management efficiency

and healthcare delivery performance.

Affordability disparities

China’s State Council recently announced that

commercial health insurance would be enhanced

to meet demand for improved healthcare services.

39 “Evaluation, in three provinces, of the introduction and impact of China’s National Essential Medicines Scheme”, WHO, Bull World Health Organization,

2013. 40 “Healthcare Reforms”, Health International, 2010. 41 “China's Healthcare Reforms: Addressing Discontent while Creating a

Consumer Economy“, NBR, Mar. 2013. 42 “China Looks to Boost its Healthcare Service Industry”, China Briefing, Oct.

2013

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Reform in this area is much needed, as dramatic

shortfalls in some areas remain. Inequality in

health care provided is a persistent problem

between urban and rural areas, richer and poorer

provinces, and east and west.

Health insurance programs through the Urban

Employee Basic Medical Insurance Program

(UEBMI), the Urban Resident Basic Medical

Insurance Program (URBMI), the New Cooperative

Rural Medical Scheme (NCMS), and the urban and

rural medical assistance program provide access

to health care for select groups of Chinese

citizens43.

While in name China has achieved 95%

universal health coverage in recent years, benefits

remain low and quality and extent of care and

coverage vary widely. Copays are often very high,

certain drugs are excluded from coverage, and out

of pocket expenses are insufficiently reimbursed.

The out-of-pocket cost issue is the most

pressing, especially in rural areas44.

Provincial contributions to the URBMI scheme

and county contributions to the NCMS scheme vary,

while contributions to the UEBMI are somewhat

more stable since they are based on employment

and fixed at 8% of the payroll. Together, the

URBMI and NCMS schemes account for the vast

majority of the population. Differences in

43 “Health Insurance Systems in China: A Briefing Note”, World Health Paper,

2010 44 “The Healthcare System Reform in China: effects of out-of-pocket

expenses and saving”, CEIS, Oct. 2013

contributions, particularly outside of the urban

employee medical insurance scheme, have given

rise to large differences in health insurance

coverage. Variations in benefits packages also

contribute to this disparity.

Exacerbating these differences, healthcare

staff in rural areas are often far less qualified than

those in urban areas. Some community health

centers face a problem of poor management.

Services provided to insured patients may be less

cost effective to allow providers to charge more to

these patients. Leading to a medically-induced

poverty, the three insurance schemes focus

primarily on inpatient care, while outpatient

services and catastrophic illness are usually paid

out-of-pocket by the patients45.

Part III – The Growth Opportunity

Healthcare private sector

The average Chinese consumer is now willing

and able to pay more for premium healthcare than

he was ten years ago. Chinese healthcare

consumers have long been wary of private

healthcare, largely because of the negative

experiences many had with small privately-run

clinics that proliferated across the country in the

'90s. In addition, while paying a doctor a "red

envelope" has become commonplace, most

Chinese anticipate private healthcare to only cost

more.

45 “Private Health Insurance in China: Finding the Winning Formula”,

McKinsey, 2012.

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In early 2012, Chen Zhu, China's minister of

health, stated the government's goal to see 20%

of all hospital beds across the country funded

through private investment by 2015. Considering

that as of 2012, only 8% 46 of the country's

hospital beds were privately funded, this is an

ambitious goal.

China’s healthcare reform has emphasized

attracting private and foreign investment to

healthcare institutions. In 2010, several PRC

government agencies released Opinions on

Further Encouraging and Guiding Healthcare

Institutions Set Up by Social Capital, and the State

Council announced that it would encourage

privatizing state-run hospitals and cancel the

70% 47 foreign ownership cap to allow wholly

foreign-owned hospitals.

Because China’s healthcare infrastructure and

services have traditionally been concentrated in

the country’s eastern region and in medium and

large urban areas, the central government aims to

provide more financial subsidies to central and

western provinces and build and upgrade more

facilities in those regions. Foreign healthcare

investors will likely find more incentives outside

the country’s already developed eastern areas. To

expand their presence in the China market, foreign

companies should consider looking to healthcare

facilities that are new or being upgraded and need

assistance developing information technology

systems and stocking medical devices and

pharmaceuticals.

Although, the Chinese government seems to

understand the importance of this dilemma: if it is

46 “China Taps Private Hospitals in Overhaul—Will It Work?”, CNBC, Oct.

2012 47 “China Opens the Door Wider to Private and Foreign Investment in

Healthcare”, WilmerHale, Dec. 2010

successful in spending all of the 2009 and 2011

stimulus money wisely, the country's healthcare

needs will still outstrip the government's

resources 48 . For this reason, new options are

necessary to the realization of those changes,

putting forward two additional sets of policies

designed to draw in private capital, which will

complement the "20% by 2015" goal.

The first policy announcing that the country's

Foreign Direct Investment (FDI) catalog would be

modified in 2012 to allow for 100% foreign

ownership of hospitals, under the so-called Wholly

Foreign Owned Entity (WFOE) structure.

Previously, foreign capital was largely limited to

joint ventures (JV) in China's hospital space, with

capped ownership at 70%.

The second policy would make it possible for

private investors to own entirely a public hospital.

The MOH had piloted this idea several years before

with terrible results, largely because the

privatization scheme was limited to poorly located

and badly under-performing public hospitals that

private capital did not want to own.

The combined effect of the "20% by 2015,"

FDI catalog, and public-to-private transaction

policies is a positive indicator that China's health

care reforms will carve out space for FDI. However,

healthcare investors remain cautious about how

future FDI reforms could impact their ability to

invest capital successfully in China. Leading their

fears is the uncomfortable reality, made especially

clear during this summer's anti-corruption drive

against bribery in the pharmaceutical sector, that

healthcare in China is entering an era where

access and affordability are political matters.

While this is always the case in any part of the

world, it is a particularly sensitive issue in China.

Investors will need to understand the unique risks

they face as providers of a scarce service in China.

These investors will hence need unique

reassurances by the Chinese government that

their investments are safe and secure from future

regressive FDI reforms.

48 “China Healthcare Reform Poses Risks and Opportunities for Foreign

Firms”, China Business, Apr. 2014

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Pharmaceuticals (Outlook)

China’s healthcare reform aims to improve the

quality, accessibility, and regulation of

pharmaceuticals. Though access to drugs

increased significantly when China opened its

economy, the steady decrease of government

subsidies has left hospitals reliant on drug sales as

a main source of income. As a result, hospitals

have over-priced and over-prescribed

pharmaceuticals to increase revenue, making

drugs unaffordable for much of the population. To

address this problem, the central government in

2009 created the National Essential Drug System

(NEDS).

Under NEDS, China released the national

Essential Drugs List (EDL), a catalogue of drugs

with capped prices that government-funded

hospitals, grassroots clinics, and other health

institutions must use and keep fully in stock. The

current list contains 307 drugs49, including 205

chemical and biological drugs and 102 traditional

Chinese medicines. China plans to update the list

every three years, or as needed, according to the

country’s economic growth, disease trends, and

scientific developments. The new pricing system

covers more than 30% of state-run grass-roots

hospitals and clinics, and about 50% of primary

healthcare institutions have implemented the

system since august 2009. The government plans

to implement the list nationwide by 2020.

Provincial governments conduct centralized,

public, and online procurement for national

essential drugs and coordinate distribution and

allocation to government-run healthcare

institutions, which can purchase only

pharmaceuticals that win their bids. To clarify

processes, the PRC State Food and Drug

Administration in June 2009 and the Ministry of

Commerce in February 2010 released opinions on

pharmaceuticals procurement and a circular on

drug distribution, respectively.

The government is also improving its

oversight of essential drugs by establishing a

digital network that assigns each medicine

49 “China’s New Essential Medicines List”, Intelligent Solutions, Apr. 2013

package a unique code and monitors the drug’s

transportation, storage, and sale. According to

state media reports, the digital monitoring

network will cover all companies that produce

essential drugs, and state-run hospitals may not

purchase essential drugs outside the network.

NEDS centrally controls overall drug pricing.

Under the system, the central government sets

maximum essential drug prices, and

provincial-level governments may set unified

prices under that ceiling, according to local

conditions. Institutions that have implemented

NEDS have faced a deficit from lost drug sales

profits, however the government promises to

support these institutions.

All listed essential drugs are included in

China’s national Reimbursement Drug list (RDL)

and enjoy higher reimbursement rates than

non-essential drugs. The national RDL sets the

percentage of drug costs reimbursed under

national insurance. The list, which currently

includes 2,127 drugs 50 , was last revised in

November 2009 and is set to be updated every two

years. Provincial authorities then draft local RDLs,

which adjust the national list based on local

conditions to determine reimbursement levels for

the region. Twenty-three recently released

provincial RDLs include all drugs on the national

RDL along with various additional drugs.

Pharmaceutical companies that want to

penetrate the China market should take into

account national and provincial RDLs. Selling a

product that cannot be reimbursed increases risks

because most Chinese cannot afford these drugs

out of pocket. The process for placing a product on

a provincial RDL varies depending on the product

type and targeted province,

NEDS has driven pharmaceutical bidding to

focus on low costs, and will likely polarize China’s

pharmaceutical industry, with a basic medical

market determined by the NEDL and a high-end

medical market of drugs not on the

reimbursement list. As demand for NEDL drugs

50 “The 2009 Revision of the National Reimbursement Drug List (NRDL)”,

IMS Health

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increases with fuller implementation of healthcare

reform, manufacturers that can meet government

price requirements may see more business.

Whether companies can make up in volume what

they lose in price reductions remains unclear,

however.

IVD (Outlook)

The Chinese in vitro diagnostic (IVD) market

just passed the $5 billion mark, becoming the

second largest market in the world. However,

China still spends less than $451 per person per

year on IVD products at the moment, which is still

far from the standard of developed countries

around $25-$30 per capita.

Since 2012, the ban on drug markups makes

its way into the public hospitals, but this activity

generates currently a large portion of the hospital

revenue (around 50% of the public hospital

operating revenues). If this source of funding is at

risk, then hospitals will likely turn to in-house IVD

and diagnostics labs to offset a part of the lost

revenues.

China’s medical device sector is expected to

have robust growth with a CAGR of 19.7%52 from

2011 to 2016, mainly fueled by construction of

new hospitals, upgrades of grassroots health

institutions, and rising patient demand for IVD

testing.

Most hospitals in China are evaluated as three

major levels (I, II, and III). Each of these levels is

further divided into A, B and C. With this

classification, class III A is the best. Most testing is

done in hospital laboratories. There is virtually no

physician office laboratory testing in China, and

51 “China – An Opportunity and a Challenge for Immunoassay Manufacturers”, The Immunoassay Handbook, Apr. 2014 52 “Medical Devices in China”, New Zealand Trade & Enterprise”, Jul. 2012

commercial laboratories only share less than 2%53

of the IVD market.

The IVD market in China is dominated by

foreign medical device firms, which generate more

than 65% of all sales revenue. Roche has the

greatest IVD market share, followed by Abbott,

Beckman Coulter/Danaher and Siemens.

Diagnostics products sold by foreign firms include

reagents, diagnostic test kits, instruments and

other testing products. However, most sales come

from instruments like immuno-chemistry

analyzers. Chinese companies control the

remaining 35% of the IVD market. Leading firms

include Mindray, Da An and Fosun. China has more

than 400 manufacturers of IVD instruments and

reagents. Previously, these manufacturers focused

on reagents and inexpensive test kits. Now, they

are starting to move into the integrated

instrument/reagent sector, specifically in the area

of chemiluminescence immunoassay (CLIA).

Product registration is among the highest

barriers of entry for foreign IVD medical device

manufacturers. IVD reagents must be registered

separately from IVD instruments, and both must

be registered with the medical device division of

the China Food and Drug Administration (CFDA).

China is steadily expanding its regulatory regime

for the medical device sector; causing foreign

companies to worry that tighter regulation will

make business operations more challenging. For

example, the 2009-11 National Class II

Large-Scale Medical Device Allocation Plan aims to

regulate the number of medical devices each

province can purchase in the procurement process.

China has been shifting toward a centralized

procurement process that requires hospitals to go

through MOH or a provincial or municipal

procurement center, depending on the device’s

price.

MOH in May 2009 released a list of essential

medical equipment54 that community centers and

rural clinics must carry, similar to the NEDS.

53 “China Independent Clinical Laboratory Market Outlook to 2018 –

Escalating Significance of Diagnostic Tests to Impel Growth”, Ken Research,

Jun. 2014 54 “Market Analysis Report: China’s Medical Device and Healthcare IT

Industries”, APCO, Apr. 2010

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Essential equipment on provincial government

medical device insurance lists are reimbursable.

More often, the devices are reimbursed as an

expense of a medical procedure, making cheaper

devices more attractive. Imported products, on

the other hand, usually require some

out-of-pocket expenses as they often are not

reimbursed through medical procedures. Although,

China is changing its reimbursement policy, which

will not allow for differentiation based on the

methodology of testing.

China also aims to improve medical devices’

safety and quality, including by issuing a series of

trial regulations on medical device good

manufacturing practices in December 2009 and a

draft of revised Administrative Regulations for

Medical Devices in September 2010 that govern

safety standards and product registration. Though

when China will release the final medical device

regulations remains unclear, the rules will be

critical for understanding new companies should

track changes in China’s healthcare reform and

medical system going forward and take measures

to understand how their products will fit in the

market: product monitoring requirements,

product recall mechanisms, registration processes,

medical devices advertising rules, and safety

requirements. Foreign companies are particularly

interested in whether the regulations will follow

through on China’s promise to adopt a risk-based

approach that uses results from clinical trials

conducted outside of China, rather than

automatically requiring in-country clinical trials for

all medical devices55.

CONCLUSION

China’s Healthcare market is growing faster

than the market of any country in Asia. With an

aging population, a rapidly growing middle class

and a government encouraging preventive care,

China has the potential for more dramatic growth

in the future.

55 “Legal and Ethical Risks of Healthcare Businesses in China”, JDSUPRA, Apr.

2014

China likely will adopt a tiered approach to

meet the diverse health care demands of different

regions and economic levels. For top-tier cities,

the government is anticipated to allow health care

offerings to improve to reduce the gap with more

developed countries. Simultaneously, the

government is developing a basic care

environment for lower-tier markets. A wide range

of pilot programs have already began to take place

in various regions and localities; some may be

adopted nationally while others remain regional

due to political, economic, and demographic

differences.

With the ongoing reform of the hospital sector,

private hospitals will accelerate their growth.

There is great disparity between public and private

hospitals in terms of size, resources, and

capabilities. In 2013, only 10% of the healthcare

services provided were at private hospitals, still

quite a long way from the goal of 20% by 2015

described in Document No. 40. Given the favorable

current policy environment, private hospitals

should define their value propositions,

differentiate their services, pricing, and quality of

care, and create sustainable competitive

advantage through efficient management.

However, Chinese competitors are

increasingly competitive, especially in IVD market

such as the areas of instrumentation and

advanced molecular testing. Therefore, foreign

IVD firms should focus on disease areas where few

Chinese companies have a strong foothold,

exploring new delivery methods that are just now

entering the Chinese market, such as

Point-Of-Care (POC) and home based rapid testing.

China’s MOH is shifting its healthcare focus to

preventative care, largely as a cost containing

measure. Along with that will come support for

more diagnostic testing products. Companies with

a focus on POC systems and the oncology market

will benefit the most from any future changes to

national reimbursement policies

Contact

Some subjects that you interested to know more about?

Email: stephane.phetsinorath@biomerieux.com