1 A New Direction in Social Welfare: China s National Healthcare Reforms Roberta Lipson CEO, Chindex International, Chairwoman of United Family Hospitals Jing Ulrich Managing Director, Chairman, China Equities, JPMorgan Amir Hoosain Premier Wen Jiabao s annual government work report to the National People s Congress emphasized the importance of healthcare reform as a crucial element in achieving the government s top policy priority: the expansion of domestic demand. In January, China s State Council approved a proposal for a new round of healthcare reforms that seeks to redress some of the system s current limitations in terms of affordability, rural access and service quality. Key elements and implications of the plan include: A total of RMB 850bn ($125 bn or about 3% of GDP) in healthcare spending has been budgeted from central and local government levels over the next three years. The government aims to expand basic medical insurance to 90% of the population by 2011 An increase in overall healthcare spending will boost construction-related expenditure to upgrade basic medical facilities. Domestic medical equipment makers stand to benefit from higher demand, while details on basic medicine coverage will take some time to finalize, and will likely benefit generic drug-makers. Healthcare costs in China have grown rapidly to become a substantial burden to the average citizen. Per capita costs have on average increased 10% faster than CPI since Today, the cost of the average hospital stay represents 33% of urban and 92% of rural annual incomes. Many Chinese have no health insurance, and the country's current pay-as-you-go system often means that when people run out of money, they can no longer receive treatment, sometimes even for basic care. As Figure 1 shows, the government currently shoulders only 20% of healthcare costs. Figure 1: China s Healthcare Expenditure Mix 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Government Social Health Insurance Out of pocket Source: Ministry of Health, J.P. Morgan To offset higher running costs, hospitals typically charge up to a 15% premium on prescribed medications. This has led to questionable practices such as rampant overprescription and doctors receiving incentives to promote specific pharmaceutical products. In some cases, drug sales account for up to 50% of hospitals total revenues. The inadequacies of China s healthcare system have stirred significant public discontent and are a major factor behind the high level of precautionary savings in the country.
2 Aside from broad strategies to overhaul the national healthcare framework, five near-term objectives are highlighted in the Chinese government s medical reform policy: 1. Expanding the provision of basic medical insurance to at least 90% of the population by 2011, from less than 50% at present. Government insurance subsidies are to increase to RMB 120/person from RMB 80/person in Developing a catalog of approved medicines to be covered by public insurance, with the production and distribution of these drugs supervised by the government. 3. Narrowing the urban-rural healthcare gap through an improved network of local clinics, with an emphasis on tier 3 and tier 4 hospitals, township medical centers, remote clinics and community medical centers. 4. Promote greater equity in the delivery of public medical services, reducing discrepancies between cities and rural areas. 5. Improving service quality and reforming the funding of public hospitals to reduce the current dependence on drug revenues. Encouraging diversity in the ownership of medical facilities. With details of the precise budget allocation as yet to be determined, many observers are looking to the 11th National People s Congress for further clarity on the upcoming reforms. We recently hosted a Hands-on China conference call with Roberta Lipson, CEO of Chindex, a leading independent provider of private healthcare products and services in China. Ms. Lipson discussed the contours of the plan and her views on the likely impact on various segments of China s healthcare sector. The following is a summary of her presentation: An Overview of Premier Wen Jiabao s Remarks on Healthcare The main points outlined by Wen Jiabao in his work report included the following: 1. An increased commitment for government spending of RMB850 billion over 3 years or approximately RMB260 billion more than had been previously announced. The budget revealed on March 5 called for total government healthcare spending of RMB 341 billion, in 2009, which will be shared 35% by the central government and 65% by the local government. This represents a 26% increase in total government spending and an increased share contributed by the central government. This spending will go toward expanding public healthcare insurance coverage, building new healthcare facilities, and basic public health and prevention. 2. Expansion of public medical insurance to cover 90 percent of the Chinese population by 2011; some reports have suggested that roughly 49% of urban residents are currently covered. In addition, the amount of coverage for services per person, both on the rural and urban plans, will also be increased. Chen Zhu, the health minister, has implied that the average out-of-pocket share for the individual might actually decrease from 61% to 50% for major illnesses. The reform proposal issued last November also suggests that commercial insurance products would be encouraged to supplement government social welfare plans. 3. Enhancement of the national drug catalogue of essential drugs, including commitments for safe and reliable supply, a roll out of set price ranges for the 700-plus drugs included in the catalogue, as well as increased central purchasing. There will 2
3 certainly be implications here for pharmaceutical companies including pricing pressures which might cause some companies to rethink their product mix. 4. Improvement of community-level medical and health services, which targets the disparity in access to and quality of services between urban centers and rural areas. Plans have been announced to build 5000 new central health clinics in towns, 2000 new county level hospitals and 2400 community health service centers in urban areas. Increased access and increased cost coverage should lead to higher utilization on all tiers of the system 5. The plan also intends to reform the public hospital system, for example by structurally shifting the focus away from for-profit pharmaceutical sales and toward the provision of basic care. This could also impact drug distribution and pricing. Furthermore, if the proposed 0 mark up plan is implemented for public hospitals and their income is not otherwise sufficiently subsidized, it might also lead to greater utilization of other income earning services such as increased use of diagnostic technologies and other treatment modalities. There is also speculation that pilot hospital reform programs may lead to share transformation and privatization of some public hospitals, but at this point this is only speculation. Reducing Out-of-Pocket Spending Changes in out-of-pocket spending will have important implications for service demand as well as what it means for private sector health insurance products, which is currently a nascent market in China but certainly could develop into an interesting opportunity. Between the additional expenditure and the structural reforms, we anticipate several outcomes: Increased purchases in medical equipment will be a long term positive for distributors and providers. Rural clinics and new hospitals will be built, tens of thousands of new primary care providers will be trained, while existing hospitals will benefit from additional investment. Burgeoning Demand for Private Healthcare and Insurance The reform plan proposal released in November acknowledges that while public investment should focus on expanding basic services, alternative levels of services could be provided by private capital. Despite significant barriers to entry, we believe that healthcare reform bodes well for private premium care and this sector should continue to grow consistently over time. The driving factor is the simple reality that those who can pay for services will increasingly do so. Additionally, the reform proposal states that companies will be encouraged to develop commercial insurance products. Until now there have been very limited private health insurance options available to Chinese citizens. Many local and international insurance companies are exploring opportunities in the vast and untapped segment of the market, and there are certainly great opportunities for insurance companies both as policy providers and as third party administrators. 3
4 Conclusion In summary, the healthcare reform plan is extremely ambitious and far-reaching and although many of the details have not been completely fleshed out, the government has definitely made a strong commitment to substantial increased spending. We will need to see if the local governments actually step up to the plate on their portion of the spending commitment. If the government succeeds in its commitment to reduce the out-of-pocket burden on consumers, it will not only ensure greater satisfaction and social stability but will also allow the consumers to feel more comfortable in reducing their savings rate and stimulate consumption in general. This should make it likely that funding will be available to allow these ambitious healthcare reforms to proceed. The greatest opportunities exist for companies operating in the private sector whose growth plans are aligned with the Chinese Government s initiatives. Social Welfare in Focus at China s 11th National People s Congress While healthcare reform is a priority, lawmakers are considering a broader social welfare agenda at the 11th National People s Congress, encompassing healthcare, pensions and unemployment benefits. The NPC Standing Committee announced a draft social insurance law in late-2008, which establishes the right of all citizens to pensions and insurance covering basic medical care, childbirth, work-related injuries and unemployment. This law is likely to be approved by the legislature at this year s NPC session. Importantly, considering the highly mobile nature of the China s work force, the draft law allows for portability of pensions, enabling workers to pay premiums in one region and draw benefits in another. With the rapid deterioration in employment, social security (especially in relation to unemployment insurance and pensions) has been a hotly-debated topic. Since the announcement of the draft social insurance law, a phenomenal amount of public feedback has been lodged. One of the key issues with the current social insurance system is that residents must reside in the same region where their contribution payments are made. This is a problem for migrant workers, who often find themselves not covered under any region s social insurance system. This also discourages employed residents from participating in the program, stretching the funding adequacy of the system. According to a senior member of the Legislative Affairs Commission of the NPC Standing Committee, there are currently funding surpluses in the social insurance accounts of certain regions. However, the lack of fund flows between regions has led to funding imbalances. 4
5 About Roberta Lipson Roberta Lipson has perspective of observing and participating in the development of healthcare in China for the past 30 years. She is CEO of Chindex International and Chairwoman of United Family Hospitals. Since Ms. Lipson co-founded Chindex in 1981, the company has expanded from its business of capital medical equipment sales and marketing to healthcare delivery. She is the creative force behind the United Family Healthcare concept - the first foreign invested and managed private healthcare group in China, which now includes hospitals and clinics in Beijing, Shanghai, Wuxi and Guangzhou. An active leader in the business community in Beijing, Ms. Lipson currently serves as a director of the U.S. China Business Council, is on the Board of Governors of The American Chamber of Commerce - China (AmCham) and is Chair of the AmCham Healthcare Forum. About Chindex Chindex (NASDAQ:CHDX) provides premium healthcare services and supplies medical capital equipment, instrumentation and products to the Chinese marketplace. Under the United Family Hospital brand, the company has operated a network of hospital and clinics in China since the late 1990s and today its presence spans hospitals and clinics in Beijing and Shanghai, and stand alone ambulatory clinics in Wuxi and Guangzhou. The Chindex medical products division has been operating since the inception of the company in 1981, and today is the exclusive marketing, sales and service distribution partner to Siemens AG for premium ultrasound and Intuitive Surgical for the da Vinci surgical robotic systems, respectively. It also distributes a broad range of other products for Hologic mammography, Johnson and Johnson clinical diagnostics as well as other famous brands. Chindex has an installed base of over 3,000 Level II and III hospitals and continues to pursue expansion into new hospitals. 5
6 Disclaimer JPMorgan is a marketing name for investment banking businesses of JPMorgan Chase & Co. and its subsidiaries worldwide. JPMorgan Chase & Co. or any of its affiliates (collectively, "JPMorgan") makes no representation or warranty regarding the accuracy or completeness of the information herein. JPMorgan is not an advisor to any person in respect of any referenced transaction. This material is not the product of JPMorgan's research departments and along with any associated verbal presentation (together the Presentation ) is purely indicative and is based on current assumptions and market conditions. Although information contained herein has been obtained from sources which we believe to be reliable, none of JPMorgan, nor any person acting on their behalf, makes any representation or warranty, implied or express regarding the accuracy or completeness of the information contained herein. The Presentation is not intended as an offer or solicitation for the purchase or sale of any financial instrument, nor does it constitute a commitment by JPMorgan to enter into any transaction referred to in the Presentation. JPMorgan shall incur no responsibility or liability whatsoever to the client or to any other person in respect of the Presentation and in the event that JPMorgan enters into any transaction described in the Presentation then such transaction shall be governed exclusively by the relevant transaction documents. The recipient must make an independent assessment of any legal, credit, tax, regulatory and accounting issues and determine with its own professional advisors any suitability or appropriateness implications of any transaction referenced herein in the context of its particular circumstances. JPMorgan assumes no responsibility or liability whatsoever to any person in respect of such matters. This material is directed exclusively at market professionals and institutional investors and is not for distribution in any jurisdiction where such distribution contravenes applicable laws of any relevant jurisdiction, nor could it be distributed to any other person or replicated in any form without the prior written consent of JPMorgan. Notwithstanding any prior written consent provided by JPMorgan for the further distribution or replication of these materials and as consideration therefore, the initial recipient of these materials acknowledges to JPMorgan that it shall hold JPMorgan harmless for the consequences of such further distribution or replication (as the case may be). Copyright 2008 JPMorgan Chase & Co. All rights reserved. Additional information is available upon request. 6