Healthcare

Following initial reform of the approval system for drugs and medical devices in 2015, Beijing recently issued new guidelines to accelerate clinical trials for new drugs and medical devices, streamline their review process, and enhance IP protection.

To shorten the period for new drug approvals, for the first time, China will accept foreign clinical trial data as long as the trial data meet Chinese standards. Urgently needed drugs, such as those for treating life-threatening illnesses, will be allowed to enter the China market even if they are in the clinical trial stage.

To enhance IP protection of new drugs, a patent linkage system will be adopted for the review and approval process. This new system can help discover IP disputes and issues before the drug hits the market. Currently, patent applicants only need to submit a non-infringement declaration, and the regulators have a difficult time identifying what patents are actually being used by the applicants for the new drug. The new system requests applicants to describe the relevant patents, and relevant patentees will be notified of the application and can file a lawsuit if infringement is discovered.

In addition, similar to the US Food and Drug Administration’s Orange Book—basically a catalogue of all approved drugs in the United States—China will compile a similar catalogue of drugs and make it publicly accessible online. This measure is meant to help implement the mandatory consistency test for generic drugs that had been previously announced—that is, this catalogue will include only generic drugs that have passed the consistency test, and a drug’s inclusion signals its quality and credibility.

The Chinese government wants to consolidate resources through the formation of healthcare clusters. All clusters will contain a combination of primary, secondary, and tertiary hospitals that provide differentiated care. By 2017, all tertiary hospitals, the first-tier hospitals, will have formed their own cluster, and secondary and primary hospitals are all expected to join a cluster by 2020.

The benefit of such a cluster is that it will allow specialization by different types of hospitals. For example, patients currently are accustomed to visiting tertiary hospitals for virtually everything, even though many of their health issues can be best addressed at primary care facilities by generalists. The current situation significantly taxes tertiary hospitals’ capacity and limits their ability to focus on providing advanced treatment and premium care. Moreover, the government will encourage more patients to seek primary care by making the same service relatively more expensive at higher end hospitals, thereby further allowing tertiary hospitals to focus on their core competence.

To encourage collaboration within the cluster, patient information and medical equipment are to be shared. In addition, tertiary hospitals will be in charge of allocating patients and disbursing funds within the cluster to improve the efficiency of the whole system. For example, after surgery, patients will often be transferred to secondary or primary care facilities for post-surgery rehabilitation, thus freeing up capacity at tertiary hospitals.

Clustering can also improve the efficiency of inpatient transfers. Currently, recovering patients in tertiary hospitals cannot be easily transferred to secondary or primary care facilities. This is because secondary and primary care hospitals usually receive a lump-sum payment from the social security fund regardless of the amount of services they provide. This means these second tier hospitals usually don’t want to receive inpatient transfers from other hospitals, especially during the fourth quarter when their money from the social security fund is about to run out. In other words, these hospitals will have to spend additional funds to take care of transfer inpatients rather than have it all covered by the social security fund.

Under the clustering system, tertiary hospitals will be in charge of disbursing funding for the entire cluster, so secondary and primary care can be assured that they will receive payment when they accept additional inpatient transfers. At the same time, tertiary hospitals can be relieved of the burden of having to allocate hospital capacity for patient recovery.

Shortly following the push to consolidate the drug wholesale industry, the Chinese government now aims to consolidate the entire pharmaceutical industry. Not only does Beijing hope consolidation will lead to lower drug prices—which play a disproportionate role in overall healthcare spending (about 40%)—it also wants to address issues of drug approval and quality.

First, the approval of drugs in high demand will accelerate to clear the current backlog of applications. For new generic drugs, they must pass a bioequivalence test to gain approval, meaning that they need to demonstrate its bioequivalence to the brand name drug, which was previously not required. That’s because currently, even if the generic drugs contain the same active pharmaceutical ingredient as the original, branded drug, the generics can still be very different as it may use different inactive ingredients. Moreover, Chinese drug manufacturers are allowed to make copies based on generics, which can further widen the difference between generic and original drugs.

As such, generic drugs that have already received approval are now required to retroactively undergo bioequivalence tests. The higher standard for approving generic drugs is also meant to have the knock-on effect of consolidating the industry. That is, since currently 97% of China’s drug products are generics, raising the bar for generics is expected to weed out low-quality and sometimes fraudulent drug manufacturers from the market. In addition, Beijing will set up special R&D funding to encourage drug manufacturers to move up the value chain.

Drug expenditure accounts for about 40% of China’s total healthcare spending, so controlling drug costs is crucial for containing overall healthcare costs. The government believes one of the reasons for high drug prices is the fragmentation in the drug wholesale industry that involves numerous intermediary suppliers and distributors—each of which has the incentive to mark up prices—before the drugs are finally sold to hospitals. By cutting out the middle men through industry consolidation, Beijing believes that could have an effect on lowering drug prices.

So this policy mandates that by 2018, there can be only one intermediary between the drug manufacturer and hospitals. The government will also implement a measure dubbed “two invoices”—whereby the number of times the drugs change hands will be streamlined into presenting only one invoice for the transaction between the manufacturer and the distributor, and one invoice for when the drug is actually sold to the hospital.

In China’s cutthroat and highly competitive drug wholesale industry, whether such a policy will achieve the intended outcome remains to be seen. Preliminary results from certain pilot programs suggest otherwise. That is, the policy seems to be having the opposite effect of raising prices because as the existing distribution network is being disrupted, drug manufacturers and wholesalers need to make additional investments in marketing. What is clear, however, is that smaller drug wholesalers will have to either exit the market or get acquired by larger players as the industry moves forward with consolidation.

China unveiled sweeping goals for reforming its healthcare industry and improving the general health of its population over the next 15 years. Like most plans of this type, it is relatively heavy on listing targets and light on how they can be achieved. The intent of these plans is primarily about setting the direction of industry development, signaling support for the growth of the healthcare sector.

Key targets in the plan include achieving an average life expectancy of 79, on par with that of the United States. Other goals are largely aimed at reaching the current average level of health in high-income countries, including addressing the country’s longstanding gender imbalance.

This plan also projects the size of China’s healthcare market to double between 2016-2020, growing significantly faster than the overall economy. From 2020-2030, however, the sector’s growth rate will gradually slow to about 7%, converging with anticipated economic growth. At the same time, out-of-pocket healthcare expenses will decline from 29% to 25% of total healthcare spending, while the supply of healthcare professionals is expected to increase by about half.

Beijing will also tackle public health concerns. For instance, China aims to fight its growing obesity problem and campaign against smoking, in part by promoting a healthier lifestyle that includes exercise and sports. In fact, the plan even includes a specific target for expanding per capita sports facilities to 2.3 m2. Finally, by 2030, all rural population will have access to basic sanitation—as of 2015, about a quarter of the rural population still didn’t have basic sanitation.

Specific policies and measures for executing on this plan will be issued separately and over time, some of which have already been promulgated. The general approach will be to double down on healthcare reforms, including diversifying and increasing the supply of services where they are scarce, controlling the cost of drugs and healthcare spending, and allowing privatization of hospitals.

This policy marks another step towards market pricing for public hospitals, as the government aims to solve industry-wide distortions caused by below-market compensation for health professionals. For instance, other than primary care, all other prices can be negotiated between health insurance providers and the public hospital. Many of the measures under this policy have already been piloted and will now be implemented nationally.

Even as it lifts some price controls, Beijing’s concern over a resulting spike in healthcare costs means that it will have to compromise on its goal. So the price of basic healthcare will still be administratively set at public hospitals, while premium and specialized treatments will no longer be subject to price controls but must not account for more than 10% of the hospital’s total revenue. By the end of 2016, a full list of services covered by price deregulation will be published.

Part of the intent behind price liberalization is to discourage doctors from relying on over-prescription of drugs and bribes as additional sources of gray income. These behaviors reflect the distorted compensation structure in public hospitals where doctors are not paid properly.

To change such behaviors within public hospitals, the majority of services will see price hikes so that doctors should be able to obtain sufficient and legitimate income from providing such services, including surgery and patient care. At the same time, the government will also mandate hospitals to sell drugs at a lower margin to further dissuade doctors from engaging in inappropriate behavior. The ultimate goal is to use price increases on services to offset the drop in drug sales, all the while ensuring that total healthcare spending stays roughly the same.

China’s investment in drug R&D is only about one-tenth the level of the United States. This underinvestment has led to several problems. First, many drugs cost significantly more in China than they do abroad because there is no domestic substitute. Second, the domestic pharmaceutical industry is mainly manufacturing generic drugs and not focused on bringing new drugs to the market. For instance, one reason behind the recent surge in Chinese travelling abroad for medical treatment is because many advanced drugs are not domestically available. Multiple factors have contributed to the underdevelopment of China’s pharmaceutical industry, but one key issue is distortion in the drug regulatory regime.

Since Beijing wants to reduce drug costs while improving the competitiveness of the domestic pharmaceutical industry, reforming drug-related regulations is important. However, this reform, from the vantage point of foreign drug manufacturers, ultimately serves Beijing’s goal of building a more competitive domestic drug industry that will give China leverage to make foreign drug makers cut prices too.

Existing regulations have created two major incentive problems, both of which stem from the fact that China’s pharmaceutical industry is not vertically integrated. First, drug manufacturers, not R&D entities, are liable for any defect in drug formulation, which means the manufacturers aren’t as willing to be contracted to produce new drugs. Second, drug R&D entities have to transfer their intellectual property for new drugs to the contracted manufacturer. This of course dissuades R&D entities from developing new drugs. In effect, this regulatory distortion creates a situation in which drug manufacturers aren’t willing to take a risk on new drugs and R&D entities are disincentivized from developing new cutting-edge drugs. It comes as little surprise, then, that Chinese drug manufacturers are predominantly making low-end generic drugs.

Under this pilot program, drug manufacturers can now make new drugs from R&D entities without shouldering any liabilities for potential defects. At the same time, R&D entities no longer have to transfer IP to the contract manufacturer and can get licensing fees and royalties on the drugs they developed if the products prove to be market successes. Moreover, R&D entities that hold drug licenses can solicit multiple bids for contract manufacturers to make the drugs.

This pilot will be conducted through November 2018 and covers ten provinces and cities. Only drug R&D entities located in specified regions are qualified for this program, and they can contract drug production, with the exception of certain types of drugs, to any manufacturer located within these regions.

China will add another 100 million people in the 60 years-and-over cohort in the next decade, so ensuring seniors have access to basic healthcare has become an urgent task. Knowing that it won’t be able to build enough senior homes to accommodate a rapidly expanding elderly population, the government hopes to instead bring healthcare services directly to the homes of the elderly.

According to the policy, primary care hospitals are required to provide on-site services to the elderly. These hospitals are also required to maintain dedicated staff for senior assisted living and when elderly patients make hospital visits. In essence, hospitals are expected to take on certain functions of hospices or senior homes to supplement the shortage of such services. By 2020, more than 70% of senior citizens will have their own family doctor, and all hospitals are required to set up a geriatrics department.

China faces a scarcity of primary care providers, which leads Chinese patients to flock to first-tier hospitals for treatment that is usually taken care of by primary care physicians in other countries. As a result, tertiary hospitals (China has three categories of hospitals, with tertiary considered first tier) are overwhelmed by primary care patients and cannot devote enough capacity to specialty care.

Beijing plans to initially expand primary care services in four provinces: Jiangsu, Anhui, Fujian, and Qinghai. By 2017, in these pilot provinces, primary care is expected to handle at least 65% of patient visits, up from under 60% in 2015. This will also require increasing the doctor/patient ratio, where the government hopes to have 2-3 generalist doctors per 10,000 urban residents by 2017. Although this ratio is still low by Western standards, it is already double the average ratio in 2015. Later, in a 2016, announcement, this program is further expanded to cover the majority of China’s cities.

The quality and capacity of county hospitals will also be improved in rural areas to the point where 90% of rural patients will not need to leave their county for general treatment.

First, private investors’ market entry into the healthcare sector will be streamlined via a negative list—meaning any activity not included on the list will not require formal administrative approval. Local governments are also required to disclose their medium term public hospital expansion plans to help private investors avoid crowded and saturated markets.

Second, for-profit private investors will receive tax breaks such as the waiving of the business tax and other fees, benefits that will apply for the first three years of operations. Moreover, public health insurance providers must not discriminate against private healthcare providers or refuse to include them in their provider network.

Third, qualified for-profit and nonprofit private healthcare providers will get priority when applying to issue bonds, but only for-profit entities will be prioritized when applying for initial public offerings.

However, since public hospitals will still dominate China’s healthcare system in the near term, cooperation between private and public hospitals will be encouraged to increase overall efficiency of the healthcare industry. Some of the cooperation will take the form of allowing private hospitals to use public hospital’s expensive, high-end medical equipment. Local governments, meanwhile, will also provide subsidies and financing for private investment in healthcare.

Beijing successively released dual plans for reforming county and urban public hospitals. Although the urban public hospital reform effort is a pilot, there is considerable overlap between the two plans, as both focus on reforming hospital governance and cutting the cost and over-prescription of drugs.

China’s healthcare system is dominated by public hospitals, where more than 80% of healthcare professionals work. Public hospitals are still run as part of the state and are poorly managed as a result. Doctors are also discouraged from providing quality services because of administratively set prices that are below the market.

So improving the performance of public hospitals is key to China’s healthcare reform. As such, Beijing is piloting reforms that relax state management of the hospital system by forming a region-level committee that will essentially serve as the board for all public hospitals within that region.

This committee—which is composed of representatives from local government, healthcare regulators, and other stakeholders—will have the authority to evaluate the performance of public hospitals, hire senior management, and determine the amount of fiscal subsidy for each hospital. Regions designated for this pilot will set up the board for all county and city public hospitals. It is an approach similar to creating a board within central state-owned enterprises to improve firm governance.

Under this structure, local governments will no longer be directly involved in the management of public hospitals, but will instead supervise their performance through the new committee. In addition, the administrative rank of public hospitals and their top management will be abolished and doctors and nurses will no longer be deemed quasi-public servants that can’t be fired.

The long-term goal is to transform public hospitals from merely administrative branches of local governments to professionalized healthcare providers. In other words, this is aimed at making Chinese hospitals behave less like a danwei and more like professional service providers.

The problem of over-prescription and the high cost of drugs will also be addressed. It is a consequence of the fact that healthcare prices were controlled and subsidies limited, which led to doctors being poorly compensated, especially compared to their counterparts in other countries. As a way around these controls, it became common practice for Chinese doctors to prescribe unnecessary drugs to patients or take bribes to supplement their meager wages.

Consequently, public hospitals will no longer be allowed to earn income through the sale of drugs. Instead, both the price of healthcare services and fiscal subsidies will be raised. In addition, to reduce costs, hospitals should prioritize purchasing domestically manufactured medical equipment and doctors should prescribe domestic drugs whenever possible.

Moreover, the entire pricing mechanism for medical treatment will be reformed. Currently, hospitals charge itemized fees, but moving forward, hospitals should switch to pricing by service units and diagnosis related groups (DRGs)—a flat fee for the entire treatment process or for a specific duration of care. By moving to a flat fee system, hospitals should have more incentive to achieve outcomes while minimizing expenses. No fewer than 100 treatments of diseases will be priced based on the DRGs approach by the end of 2015.

For urban public hospitals, it is expected that by the end of 2017, drug sales at participating hospitals under the pilot program should contribute to less than 30% of their revenue, while their spending on medical equipment should contribute to less than 20% of total expenses. In addition, Beijing wants to keep out-of-pocket expenses at no higher than the current 30% of total healthcare spending.

In addition, the government wants to alleviate demand pressures at first-tier urban hospitals. Currently, patients tend to flood first-tier, or tertiary, hospitals for even basic healthcare services because the cost is about the same as going to a primary care facility. This leads to the underutilization of primary care and crushing demand at flagship urban hospitals, whose core competence is not primary care.

As a result, Beijing will experiment with introducing primary care general practitioners in pilot cities. Patients will be incentivized to first visit their general practitioners at local, second-tier hospitals on the condition that they will receive priority treatment at tertiary hospitals if additional care and treatments are needed.

Part and parcel of addressing the scarcity of supply in healthcare services, the government wants to have more diversified service offerings to move away from a hospital-centric model. So certain smaller public hospitals will be converted into nursery homes, rehabilitation centers, and other services that are currently inadequately supplied by major hospitals.

Reform of county public hospitals basically follow the same approach and emphasis, though it is more focused on implementation. One distinction is that Beijing wants all counties to establish at least one high-quality hospital by 2017 so that rural residents no longer need to travel to big cities for quality healthcare.

Improving the quality and coverage of rural healthcare remains a top priority for the Chinese government, since 40% of the population will still be considered rural by 2020. A key objective is to recruit higher quality rural doctors and enhance the training of existing ones.

Only 60% of rural healthcare professionals have received the equivalent of a vocational high school education or higher. Within the next decade, the Chinese government wants more than 90% of rural doctors to have at least vocational high school or equivalent training. All new rural doctors need to both meet the education attainment requirement and pass the requisite exam.

Rural students who aspire to become doctors will qualify for free secondary or college vocational medical education. All rural doctors will receive free on-the-job training, or the equivalent of medical residency, at county or provincial hospitals. To increase rural doctors’ pay, there will be a 5 yuan ($0.75)/rural resident annual fiscal subsidy, which translates into an average annual allowance of 5,000 yuan ($750)/doctor—a fairly significant supplement to their normal income.

Healthcare coverage in remote and rural areas will also be improved, as Beijing mandates a doctor to patient ratio of at least one rural doctor per 1,000 rural residents. Rural doctors who practice in these poorer regions will receive additional subsidies.

The price of China’s healthcare services and exams in public and private hospitals are all set by the state. To reduce the burden of fiscal subsidies, the government usually sets these prices at an artificially low level that aren’t adjusted for inflation. Such a practice discourages doctors from providing quality services and has led to corruption within hospitals. Tension inside Chinese hospitals has gotten so severe that even violence has erupted between doctors and patients.

To fix this distortion, Beijing plans to take a step-by-step approach by first removing price controls on private hospitals. All provincial healthcare regulators need to publish a comprehensive list of public hospitals in their jurisdiction. Providers not on the list will be considered private hospitals and will be allowed to set their own prices for services rendered.

Nonetheless, regulators will continue to monitor private hospitals’ price-setting practices to make sure they are transparent and fair and to prevent similar instances of fraud and charging exorbitant fees that have become endemic in public hospitals. Indeed, regulators will still intervene if this price liberalization leads to rapidly rising costs in private hospitals. Moreover, since all qualified private hospitals are included in the public health insurance network, the insurance provider adds additional pressure against price inflation.

Rapidly rising healthcare demand has exposed the weakness and inadequacy of China’s public healthcare system run largely by bureaucrats. So as part of national healthcare planning for 2016 to 2020, the Chinese government has been actively encouraging private investment in areas where there is a high concentration of public hospitals to diversify ownership structure.

The Chinese government is particularly enthusiastic about leveraging private investment to bolster insufficient services such as senior care and rehabilitation and has mandated a quota where one-fifth of large medical devices will be allocated to private healthcare providers. In sum, these moves are aimed at creating more room in the healthcare market for private investment.

Although this plan is far-ranging, concrete actions taken have been modest. For instance, Hong Kong, Macao, and Taiwan investors can now set up wholly owned hospitals in all prefecture-level cities on the mainland, whereas previously they faced geographical restrictions on their investment. For other foreign investors, so far they can only open wholly owned healthcare facilities in the Shanghai Free Trade Zone.