China’s Health Care Reform: Groundbreaking Plan to Reshape and Drive Expansion in Health Care Spending
By Karen Wang

On April 6, 2009, China unveiled Guidelines on Deepening the Reform of Healthcare System (hereinafter the “Guidelines”), a blueprint for health care over the next decade, kicking off a muchanticipated reform to fi x the ailing medical system for the country’s 1.3 billion citizens. By 2020, the world’s most populous nation plans to have a basic health care system that can provide “safe, effective, convenient and affordable” health services to urban and rural residents, according to the tone-setting document. The Guidelines will be supplemented by a more detailed implementation plan for the three years until 2011. The plan has yet to be published, but the State Council announced earlier this year an investment of 850 billion Yuan (US $124 billion) to fully implement the health care reform plan.

These are the five major themes from the Guidelines.
Upgrade of the basic medical insurance system – The percentage of Chinese citizens covered by the basic medical insurance plan is expected to surpass 90 percent by 2011. Healthcare reimbursement and subsidy limits for the unemployed and farmers will increase to six times annual average income.

Setup of essential (or basic) drug system – In order to reduce prescription costs and ensure the supply of basic drugs, public hospitals and clinics will be supplied with essential medicines at government-regulated prices. The essential drugs will be selected based on disease prevalence, effi cacy and safety evidence, and comparative cost effectiveness.

Replenishment of grass-roots medical service system– Central and local governments will increase investment in grass-roots-level hospitals and clinics in cities and rural areas, which are often ill equipped and understaffed.

Improvement of community sanitary services – Urban and rural citizens will be provided basic community sanitary services, including disease prevention and control, planned immunity, female and infant care, and health education.

Reform of state-run hospitals – Public hospitals will receive greater government funding and be permitted to charge higher fees for treatments. However, these hospitals will be banned from realizing profits generated by prescribing unnecessary expensive medicines and treatments. Private hospitals will also be encouraged to invest in their facilities to eliminate shortages of medical supplies.

After more than ten years of debate, China’s medical reform plan has the potential to fundamentally change the country’s health care industry for the next few decades. There are many stakeholders including state-run hospitals, private hospitals, doctors, patients, pharmaceutical companies, medical device manufacturers and distributors. The reform of the health care system also has significant implications for investors in Chinese health-care industry equities.

First, the reform will drive an even faster pace of expansion in health care spending, which has already been growing at more than twice the rate of GDP. The rapidly expanded insurance coverage and higher percentage of reimbursement will increase available spending on pharmaceuticals, medical devices and health care services.  Statistics from urban hospitals illustrate that anti-infection drugs now account for 24 percent of all prescription drugs, followed by drugs for tumors, immunity, cardiac and blood system, digestive system, hematopoietic system and nerves, whose sales are all growing rapidly.  The basic drug system will likely drive consolidation in the manufacture of basic medicines as only large-scale, highly efficient producers will be able to generate profi ts on generics under the new pricing scheme. While the detailed action plan hasn’t been publicized, a wail of protest has already arisen from many small producers.

Pharmaceutical companies face the dilemma of whether to have their products offered in the national basic drug catalogue. While the catalogue will generate significantly expanded product volumes, the prices of most basic drugs will likely decrease by approximately 20 percent. Given the high cost of participating in public tenders, most companies without cost advantages will voluntarily give up supplying these basic medicines. Smaller producers are likely to focus their attention on OTC products that don’t depend on government reimbursement or proprietary drugs (including fi rst-to-market generics) without direct price competition.

Meanwhile, large commercial pharmaceutical enterprises are more likely to be appointed as the distributors of basic drugs due to their wide sales networks, modern logistics capability, disciplined distribution practices and high-profile drug consulting services. The reform aims to reduce the markup of drug price by distributors, so many wholesalers who are currently winning hospital supply contracts though kickbacks, bribery and tax evasion risk being swept out of the market.

Government investment in grass-roots-level hospitals and clinics will result in huge purchase orders for medical devices. The investment of each hospital or clinic will be relatively small, which will provide an attractive opportunity for suppliers of basic devices such as disinfectors, diagnostic kits and medical detectors who have a strong sales network and competitive pricing. Compared to foreign products, “Made-in-China” medical devices will likely experience greater demand since they are more cost-effective and easier to operate for countryside doctors, most of whom only have basic medical training.

Expansion of planned immunity services will greatly benefit vaccine providers. The Guideline also mentioned that China will build a public sanitary service network, including blood gathering and supply. The Guideline emphasizes that the reformed health care system will make good use of Traditional Chinese Medicines (TCM) and will support the development of TCM technology.

Finally, we note that it is extremely diffi cult to transform the business model of state-run hospitals. But if the reform is successful, the marketing practices of Chinese medical products will be changed and the discretion of doctors and hospital administrators (with their attendant profit opportunities) will be reduced. The voting power will shift from doctors to consumers since consumers will not have to buy all the drugs that doctors prescribe them.

Pharmaceutical shares are often favored by investors due to their defensive and counter-cyclical attributes. There are roughly 70 Chinese pharmaceutical companies listed overseas, offering investors many opportunities to play to profound shifts that China’s health care reform will engender. Any investor who is going to make a major commitment to investing in this sector should visit China and speak to the company management teams, distributors, doctors, pharmaceutical company sales representatives, hospital officials, and pharmacists. Below are some of the key factors to consider when picking potential winners in this sector:

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