China's medical-care system is undergoing reforms that could have lasting effects on the nation's pharmaceutical market
China's health-care system, like other parts of its economy once based on central planning, is in transition. Over the past two decades, China's universal health care system, a landmark of the PRC socialist system, has been dismantled. Currently, only about 25 percent of its population can claim some kind of health insurance coverage. It was not until recently that the government launched a series of health policy reforms, with important implications for the pharmaceutical sector. Changes in both insurance schemes and health-care financing could have important implications for medical and pharmaceutical suppliers.
THE LAY OF THE LAND
There are four financing mechanisms for health care in China, each applying to different population groups: insurance for government employees, insurance for employees of State-owned and collective enterprises, cooperative insurance schemes for rural areas, and self payment. The public service medical care system covers government workers; officials of labor unions; youth and women's leagues; staff of cultural, educational, health and research institutes; and students at approved colleges and universities. About 30 million individuals are covered by this system, which traditionally has reimbursed 100 percent of medical care expenses.
Roughly 140 million workers and 60 million family members were covered under the State-owned enterprise (SOE) and collective insurance system as of year-end 1997, according to China's Ministry of Health. This system has reimbursed 100 percent of employees' medical costs, and 50 percent of family members' costs. The system has been funded, in name at least, by the enterprises.
Only about 120 million farmers and townand-village enterprise employees are covered by cooperative medical system (CMS) plans. These schemes are funded by local governments, collectives, and individuals, and reimburse participants for 20-80 percent of health care expenses, depending on the funds available in the given locality. CMS plans are growing; by the end of 1997, roughly 12 percent of all farmers were participating. The government's goal is to cover 70 percent of all farmers by 2000. In the meantime, however, the 900 million farmers, private-sector employees, and self-employed individuals not covered by any of these health-financing systems must pay the entire cost of health care themselves.
Hoping to reduce enterprise subsidies of all types, the State Council launched pilot reforms in 1994 of the two health insurance systems under its control. Begun in two midsize cities, Jiujiang, Jiangxi Province, and Zhenjiang, Jiangsu Province, and expanded to over 60 cities in 1997, this experiment is likely to become national policy, applicable to domestic and foreign-invested firms. If that happens, the State Council has indicated that the two State health insurance systems would be consolidated.
Under the experimental system, individuals and their employers together pay an insurance premium equal to 10-12 percent of the beneficiary's salary. Individuals pay 1 percent of their salaries, and employers (the government or enterprise, as the case may be) fund 9-11 percent. For instance, if an employee's salary is SO,OOO per year, the amount of the employee payment would be $500, and the amount of the employer payment would range from $4,500-$5,500. About SO percent of the total premium is deposited into an individual account, which is used exclusively for the individual's medical care. The other 50 percent is placed in a pooled cooperative account, which can be used by all the participants in the system.
Foreign-invested enterprises are required to provide health insurance benefits, but are not required to participate in this experimental plan. For example, for employees of foreign enterprises in Beijing hired through Foreign Enterprises Service Corp. (FESCO), foreign enterprises pay FESCO, and FESCO then buys insurance policies for these employees.
A person's medical care expenses are paid by his or her individual account, the cooperative account, a co-payment, or entirely out-of-pocket, depending on the final cost of the care. A patient covered by the pilot system uses the money in the individual account first. When the individual's account is exhausted, he or she pays out-of-pocket up to 5 percent of his or her salary. Reimbursement from the cooperative account is possible at this point but is subject to co-payment. For example, if a person's annual salary is S10,000 and his medical care expenses are $5,000, the amount to be deducted from his individual account is $10,000 x 5 percent, or 5500. The amount to be paid out-of-pocket is $10,000 x 5 percent, or $500. The amount left after he has paid from his individual account and out-ofpocket is then S5,000-($500 + $500) = $4,000. If the co-payment is 10 percent, the patient pays $4,000 x 10 percent. The amount paid from the cooperative account is $4,000 x 90 percent = $3,600. So of the original $5,000 medical cost, $500 comes from the individual account, $3,600 comes from the cooperative account, and the individual must come up with the remaining $900. Some organizations are experimenting with other health insurance systems. One variation, which may have an important impact on the future of the pharmaceutical market, is commercial health insurance. The government plans to allow commercial health insurers to cover the 50 million uninsured people in urban areas. As the government attempts to contain health care costs and at the same time improve quality and access, it has welcomed experimental participation from foreign insurance companies. A cooperative effort between Shanghai Medical University and Kaiser Permanente International has produced a feasibility study for a health-maintenance organization (HMO) associated with the Shanghai Petroleum Co. Ltd. Kaiser is planning to launch a pilot HMO in China for Shanghai Petrochemical in the near future. The Ministry of Health is also planning to launch a pilot HMO project in an automobile company.
At the heart of China's medical sector, and of the health care reform process, are the nation's hospitals. In contrast to the modern US health care system, hospitals in China have historically been the primary suppliers of both medical care and medicines. Through the 1980s, hospitals relied on government funds and operational revenue to finance these services. The government covered hospital staff and capital costs, including both buildings and capital equipment, and set prices for health services without considering those costs. Prices of diagnostic and other non-pharmaceutical services were thus set far below costs. Governments and enterprises in turn reimbursed hospitals on a fee-for-service basis. Because of these price-setting and reimbursement policies, only pharmaceutical services could produce a profit, typically 15 percent of total sales. Hospitals used government funds and pharmaceutical sales revenue to offset the losses incurred in the provision of non-pharmaceutical services.
Since the late 1980s, the governments have gradually reduced their investments in hospitals (see p.47). From 197896, the share of hospital revenues accounted for by government investment decreased by roughly 50 percent nationally. At the same time that governments have cut their hospital investments they have raised prices above costs for new services, such as computerized tomography (CT) and magnetic resonance imaging (MRI) scanners, and other non-pharmaceuticals services, such as surgery, hospital rooms, and physician fees for outpatient visits. But charges for most traditional services still remain below costs. To compensate for the reduced government financing, hospitals have had a strong incentive to buy the most advanced equipment and sell as much medicine as possible. Many experts believe that hospitals' heavy dependence on revenues from medicines and hightechnology services has contributed significantly to soaring health care expenditures. The increased use of high technology will definitely improve the quality of health care, but some officials are concerned that there has been improper use of high-technology services in an attempt to generate revenue.
To control pharmaceutical expenses, in 1996 the State Council issued a document requiring local health bureaus in 0 pilot cities to collect all pharmaceutical service revenues of government hospitals and then reallocate the money to those hospitals. The hospitals that sold more drugs would not necessarily receive money in proportion to their sales. This measure was intended to eliminate physicians' financial incentive to over-prescribe drugs. Moreover, in the last two years, many local governments have started to set higher prices for their hospitals' nonpharmaceutical services to reduce dependence on medicine-related income. It is very likely that government investment in hospitals will continue to decrease and that hospitals will have to cover most, if not all, of their costs themselves.
Although fee-for-service reimbursement systems-under which some State insurance providers reimburse the hospitals, and some reimburse the individuals, for care-are still dominant in China, other payment mechanisms are already emerging. The three major forms of government payment to hospitals are average payment, capitation, and global budgeting. Under the average-payment system, the State reimburses hospitals for in-patient care according to their average daily patient charges and length of stay, regardless of actual costs. This system, first instituted in Zhenjiang, is becoming widespread. For outpatient services, the State reimburses hospitals based on average charges of outpatient visits.
The capitation plan, in place in over 100 counties and cities, pays a flat perpatient rate for medical care. A hospital receives a fixed payment from the State to provide a beneficiary's care for a specific length of time, and this payment is unrelated to how much the hospital actually spends. Thus, if the hospital spends less than this capitated payment, it may retain the rest as profit.
The Shanghai government employs a third strategy, which is spreading to other cities, known as the global budgeting method. In this case, the government determines the maximum allowable rate of growth in a hospital's revenue. If a hospital's revenue increases by more than this amount, the government confiscates the revenues over the limit and may even fine the hospital. At the same time, the government sets ceilings for revenues from pharmaceutical services and for price increases for non-pharmaceutical services.
MAKING THE GRADE
Though overall health care reform, and changes in hospital administrative policies, will affect Chinese patients in a variety of ways, no government policy affects drug makers more than the government's drug reimbursement rules. In the past, the government health insurance systems reimbursed 100 percent of all drug expenses. But in 1992, the Ministry of Health began developing a national essential drug list (NEDL) on which to base reimbursement for medicines prescribed to patients under State insurance plans (see The CBR, July-August 1996, p.16). Selection criteria included clinical necessity, effectiveness, safety, and consistency between price and effectiveness. The list covers about 50 percent of the medicines currently available on the PRC market. Local governments have drawn up drug reimbursement lists based on the NEDL, and the central government has done the same for public service medical care.
Public sen ants' medical care plans do not reimburse expenses for drugs not on the reimbursement lists, regardless of whether the medicines appear on the NEDL. The local governments' own drug reimbursement lists may include up to 10 percent more products and are used to reimburse residents covered by citybased insurance systems. While drugs not on any list can be sold anywhere, consumers cannot be reimbursed by government health insurance systems for them. Thus, these national and local lists are of crucial importance to pharmaceuticals producers, because only payments for listed drugs can be reimbursed by the two State-run insurance systems.
Meanwhile, regulation of the market is in flux. As part of the government restructuring announced at the March 1998 National People's Congress meeting, the Ministry of Health's Department of Drug Administration has merged with the State Pharmaceutical Administration of China (SPAC) to become the State Drug Administration (SDA). As a result, the Ministry of Health will no longer be responsible for new drug approvals; rather, SDA is to oversee all drug manufacturing, trade, and registration. The Ministry of Health's role in regulating drug markets will decline significantly. Other former functions of the ministry have been assigned to different government bodies. The most important of these is probably the transfer of medical insurance responsibilities to the new Ministry of Labor and Social Security. Nonetheless, the Ministry of Health will retain its other main functions-regulatory development and oversight, healthcare resource allocation, and medical research and education.
Among the reforms under way is stricter regulation of the PRC drug market. In 1996, the Ministry of Health began drafting laws and regulations intended to improve safety and prevent fraud. In April 1996, the State Council issued a document (Guo Fa Vo. 14, 1996) on the production and sale of counterfeit products. In 1996, the licenses of over 400 manufacturers and retail pharmacies were revoked, and over 8,000 unregistered retail pharmacies were closed.
Enforcement of the 1992 Good Manufacturing Practices (GMP) regulation, aimed mainly at domestic producers, also has been reinforced in the last few years. The regulation states that new manufacturers of drugs must first pass GMP inspection before they can receive production licenses. Existing manufacturers not GMP-approved may not produce new products.
SCENARIOS FOR DRUG PRODUCE RS
How health care reform develops and how pharmaceuticals firms adapt to the reforms will affect drug sales significantly. Pharmaceutical costs account for over 50 percent of health care expenditures in China, and constitute the largest single category of medical spending. From 1990-95, total drug sales grew at an average rate of over 20 percent per year, and sales of imported and jointventure drugs in big cities such as Beijing and Shanghai grew by over 30 percent per year, according to the Chinese Pharmaceutical Association.
Health insurance reform to date suggests that pharmaceutical market development could take a number of directions. The first possibility is that drug sales in urban areas will stabilize or grow more slowly than in the past, when hospitals were eager to purchase imported medicines. The ongoing health system reforms should moderate the rapid growth of health expenditures over the next few years, diminishing the demand for imported drugs.
In fact, many of the recent health care measures have been aimed precisely at controlling pharmaceutical expenses, including the national and local drug reimbursement lists, the reallocation of pharmaceutical service revenues, the use of capitation or averaged payments to hospitals, price hikes for non-pharmaceutical services, and increased cost-sharing by patients. These measures will eliminate hospitals financial incentives to sell more drugs and will simultaneously increase the price sensitivity of patients. The results of the pilot program in Zhenjiang showed that total health-care expenditure was 20 percent lower in 1995 than in 1994. From 1991-94, before the reform, the annual growth had been 37 percent. Similarly, drugs sales were about 20 percent lower in 1995 than in 1994. While sales of local drugs fell by 10 percent, sales of imported drugs fell by 29 percent, and sales of joint-venture drugs declined by nearly 45 percent. Equally dramatic declines were noted for physician services: the number of patients receiving CT scans or MRIs fell 47 percent.
On the other hand, pharmaceuticals consumption by uninsured urban residents not eligible for reimbursement could grow. Many of these uninsured are owners and employees of private and small businesses with high incomes. As their numbers rise, together with their disposable incomes, the consumption of pharmaceuticals by this group is expected to increase.
A second possible trend is higher spending in rural areas on pharmaceutical and other health care. Though most foreign pharmaceutical companies have focused their marketing efforts on the cities, where greater patient awareness of the efficacy of foreign drugs would seem to promise greater sales, the rural market is gaining importance. As Beijing attempts to rebuild the rural CMS, more farmers stand to be reimbursed for drug purchases. In most cases, the CMS only reimburses low-cost domestic and jointventure products, so the sales of these low-cost products are expected to increase. Moreover, in a few wealthy rural areas near Shanghai and in Guangdong, the CMS is starting to reimburse patients for imported products. Indeed, the rapid increase of disposable incomes in rural areas along China's southeastern coast has made this area an important market for imported and joint-venture drugs.
A third trend concerns joint-venture products, which are sure to become more popular. The perception among both doctors and patients in China is that imported and joint-venture drugs are of higher quality and efficacy than domestic products. Patients eligible for reimbursement have opted for imported and high-quality drugs regardless of price because their work units pay their medical care expenses. Though it remains difficult for imported products to be included on national or local drug reimbursement lists because of their high prices, joint-venture products tend to be less expensive and thus more apt to fall within State-imposed price ceilings for the reimbursement lists. Because of the Chinese preference for imported and joint-venture products over domestic products, however, many physicians and patients may choose joint-venture products in the future, even if they are not on the reimbursement drug lists.
Retail pharmacies also could become a new battleground among foreign, jointventure, and local companies. The number of retail pharmacies, roughly 60,000 in 1996, is growing rapidly. Currently, the retail pharmacies serve mainly the uninsured. But many imported drugs, once reimbursed by the State insurance plans, are now left out of the reimbursement system, and insured patients are turning to retail pharmacies in ever-greater numbers. More important, under the capitation or average payment mechanisms, hospitals have financial incentives to sell as few drugs as possible. The sales of over-the-counter (OTC), imported, and expensive drugs will likely shift from hospitals to retail pharmacies.
Finally, the emergence of the OTC market and the expansion of retail pharmacies will create new opportunities for drug firms. The Ministry of Health began establishing OTC regulations in 1995, classifying pharmaceuticals as either OTC or prescription drugs, and plans to implement a separate OTC system by the year 2000. The Chinese Pharmaceutical Association also has begun to select drugs for the OTC market. The establishment of OTC regulations together with retail pharmacy networks should facilitate expansion of the OTC market.
One of the main concerns behind the Ministry of Health's move to develop the OTC market is the desire to avoid improper use of drugs. Currently, retail pharmacies can sell a wide range of medicines without prescriptions. Many patients who buy drugs from retail pharmacies use those drugs improperly because they lack adequate knowledge and because retail pharmacy sales staffs do not have formal training to dispense medicines. The establishment of OTC regulations will permit only OTC drugs to be sold without prescription and prevent improper use of prescription drugs.
Another motivation for expanding the OTC market is to eliminate patients' long wait for drugs. In hospitals, all drugs, regardless of the type, require prescriptions. Patients with prescriptions to be filled face a minimum of an hour's wait. The OTC rules are intended to improve the efficiency of health care by bypassing physicians and hospitals in the drug dispensation process. They will also help slow medical care cost increases by reducing physician consultation fees, though these fees, at roughly $1 per visit, are already quite low.
Until additional OTC regulations are promulgated, it is unlikely that the rapidly proliferating supermarkets around China will be permitted to sell drugs, since only licensed retail pharmacies, hospitals, and clinics are allowed to sell prescription medication. But those stores will surely serve as a major distribution channel if the OTC regulations allow them to sell drugs.
THE DEMAND FOR QUALITY
Many PRC citizens place a high value on medication, and have come to expect prescriptions when they visit physicians. In fact, many Chinese believe that if a physician does not prescribe medication, then either the complaint must be incurable, or the physician must have failed to diagnose the problem. Not surprisingly, physicians tend to accommodate patients' requests, even if they doubt a prescription's benefit. Thus, drug sales, especially of new foreign and joint-venture drugs without local equivalents, are likely to rise, even as overall pharmaceutical expenditures drop.
Further, the increase in drug sales in rural areas and to the uninsured in urban areas probably will exceed the falloff in sales among people covered by State health insurance systems. And assuming incomes continue to rise, the government is likely to include more and more imported and joint-venture drugs on reimbursement lists.
The current policies to control drug costs likely stem more from concern about the affordability of medical care than from protectionism. If the Chinese economy's growth remains steady, more money will be available for medical care, and demand for imported drugs will increase. In addition, the NEDL and reimbursement lists will have to include those drugs that are essential for certain treatments and which have no local equivalents. In spite of the higher cost of these pharmaceuticals, the Chinese-like populations everywhere-will demand the best products available.
Li Xuesheng (Xli@MCCSPO.MEDCTR. ucla.edu), a former officer with China's Ministry of Health, is now an analyst with UCLA Medical Center and a consultant with RAND Corp. Stuart 0. Schweitzer is a professor at the University of California at Los Angeles School of Public Health.…