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What Are More Than a Billion Insured Patients Worth?

What Are More Than a Billion Insured Patients Worth?

China’s population suffers from a debilitating lack of access to healthcare. To improve it, the government last year opened up the sector to foreign investors who are rushing in despite daunting challenges.

Fewer than 10 years ago, only 30 percent of China’s population was covered by national healthcare. Today, 95 percent of China’s population is covered, with the government providing insurance to more than 400 million urbanites and 800 million rural residents.

This dramatic increase was born of necessity. As China embraced free market principles and dismantled or privatized many of the country’s collectives and state-owned enterprises, these institutions no longer provided healthcare to a large portion of the population. To avoid a public health catastrophe — and public discontent — the government promised, in 2009, to provide basic health insurance to all its citizens.

Essentially, it has met that goal.

But the crisis continues. China’s healthcare system is ill-equipped to meet the needs of all these millions of newly insured citizens. (About 30 percent of China’s urban population currently possess some kind of private health insurance, while another 20 percent are planning to buy some in the near future. However only 20 percent fully understand their policies and coverages. In addition, private health insurance for now is targeted at the elite, and co-payments can be excessive even as benefits often are limited.)

China has 1.4 physicians per 1,000, compared to 2.4 in the U.S and 2.8 in the UK, according to the World Health Organization. The number of doctors per 1,000 in China has fallen by an average of 20 percent since 2008. And while there are more than 22,000 hospitals in China, the definition of a hospital is quite broad. Hospitals in rural settings are really family clinics that do not possess the full scope of services offered by larger acute care facilities.

This is a critical issue as people in China do not receive primary care at independent facilities. Their first interaction with the healthcare system is within a hospital setting. Even for those with private insurance, the first stop is often still a hospital, and the biggest hospitals can have nearly 5,000 beds.

In this resource-constrained environment, patients often need to bribe doctors in order to receive care, and rural residents frequently must travel long distances for consultations that last only a few short minutes with no guarantee of treatment. In China, there are an estimated 3.8 hospital beds per thousand people. By comparison, in Germany, there are more than eight beds for the same number.

To ease the strain on a healthcare system bursting at the seams, the Chinese government made a revolutionary move. In 2014, the government eliminated restrictions on foreign ownership of hospitals in nine provinces, and within five years, it likely will lift constraints in the remaining 14. China also eliminated investment restrictions on foreign medical devices companies, as well as on healthcare services providers, allowing foreign direct investment in clinics, rehabilitation centers and senior care facilities. Such a rapid and extensive opening of a sector is unprecedented in China’s history.

A gold rush has followed. According to Thomson Reuters, healthcare mergers and acquisitions in China more than doubled between 2013 and 2014, valued at $18.5 billion. In January 2015 alone, the value of deals in the healthcare industry reached nearly $7 billion, outpacing activity in the white-hot services, software and Internet sectors.

With China’s population aging and its per capita wealth increasing, the opportunities in China’s healthcare industry are obvious and attractive. But the risks and complexities are not as evident, and investors should approach these opportunities with their eyes wide open.

Older, Sicker, Richer

From a demographic perspective, the Chinese market simply is too big and too important to ignore. China’s middle class is growing rapidly, and it has the income to spend on healthcare (if appropriate services are accessible). Like many emerging markets, China’s population, in addition to experiencing the impact of changing diet and lifestyle options, is growing older and is encountering the chronic diseases that come with age.

By 2020, it is estimated that nearly 200 million Chinese, or one-fifth of the population, will be aged 65 or older. That’s similar to the United States in terms of percentage, but, of course, it is much larger in terms of raw numbers. (By 2020, the number of Americans aged 65 or older is expected to approach 60 million.) By 2050, the ranks of those older than age 60 in China will swell to 400 million. Right now, 260 million Chinese suffer from cancer, diabetes and various chronic diseases associated with age and lifestyle. For example, one out of five Chinese adults has cardiovascular disease, and that does not include the many estimated to be undiagnosed.

To meet the healthcare needs of its population, the Chinese government has set aggressive goals for increasing the number of hospital beds.

By the end of 2015, the government wants one or two hospitals in each of the country’s 2,862 counties. It also intends to double the number of private hospitals.

Prominent North American and European healthcare providers are stepping in to build new hospitals and clinics. Some notable ventures include:

Delta Health Systems has teamed up with Columbia University to open a heart center in Shanghai — the first such clinic in the city.

The Mayo Clinic has joined forces with Hillhouse Capital Group, a Chinese investment firm, to build a hospital in Beijing that aspires to emulate Mayo’s Minnesota facility.

Columbia Pacific Management based in Seattle and already one of the largest healthcare providers in Asia, announced plans to build new hospitals in China.

Germany’s Artemed Group is building a 10,000+ square-meter hospital in a pilot free trade zone in Shanghai.

Partners HealthCare (whose flagship is Massachusetts General Hospital) is in preliminary discussions to build a 500- to 1,000-bed facility in partnership with a Chinese group.

However, before investors and healthcare providers plant their flags in China, they need to understand there are risks to operating in a legal and political terrain that is close to opaque.

Where’s the Profit?

Even investors with the best, most humanitarian intentions require a positive return on investment. In China’s healthcare sector, finding that return will be a challenge.

Currently, the public insurance carried by more than a billion Chinese citizens covers only 40 percent of total healthcare services costs. Sixty percent of the remaining costs — and often 100 percent of a hospital’s profits — is accounted for by in-hospital sales of drugs and medical devices to patients. The fact that almost all hospital profit comes from these sales leads to the rampant prescription of unnecessary medications and treatments. It also has created an environment ripe for corruption, as recent well-publicized bribery scandals in the pharmaceutical sector amply illustrate.

What Are More Than a Billion Insured Patients Worth?

Accordingly, the Chinese government is trying to stem unnecessary sales of drugs and medical devices and ensure affordable access to pharmaceutical products. In some provinces, for example, the government is limiting hospital markups to 15 percent for any treatments on the government’s Essential Drug List—a list that includes pharma products that authorities believe should be readily available at a reasonable price.

To improve the financial profile of hospitals as the government tries to control drug costs, it hopes to increase reimbursements. The country’s projected spending on healthcare could reach more than $1 trillion annually by 2020. However, if economic headwinds force the Chinese government to divert those funds to buttress faltering banks and state-owned enterprises and provide support to other sectors in the government-controlled economy, healthcare reimbursement could remain at a low level for an extended period. And private health insurance — a new concept in China — won’t be a real alternative for some time to come, if ever. Right now, there is only one pilot private health insurance program in the country. Offered by Chindex International, annual policy premiums can amount to $5,000, which is out of reach for most Chinese.

Therefore, how investors in China’s healthcare sector can reap a positive return on their investment remains a significant challenge.

The China Challenges

Operational and Staffing Costs

Blurring the profit picture even more, most Chinese hospitals are beset by operational and staffing challenges. Communications among leaders can be disjointed, and operational processes commonly are inefficient, burdened with the many redundancies typical of enterprises that never have been mandated or expected to be profitable.

Surmounting these inefficiencies will require leaders having appropriate training and skills. Before acquiring or partnering with a Chinese healthcare delivery entity, investors should look at the training and professional background of the target organization’s management to be sure it is as up to date as needed. In some cases, investors may have to station their own leaders on-site to steer improvement efforts and develop peer-to-peer learning opportunities and programs.

A nationwide shortage of clinical staff presents another challenge. Hiring retired Chinese doctors can help. However, those retirees most likely worked in the public sector, where records of their qualifications, skills and career are not nearly as comprehensive as those of medics in many Western countries. Moreover, in China, physicians have been known to have used bribes to pass certification exams. Since solid accreditation and career information may not be available, investors will need to factor in relatively high recruitment costs.

Additionally, investors will have to develop and implement programs that assure compliance with all relevant international and local anti-corruption laws. Nurses and other technical staff likely will maintain their public servant and communist party status. That makes them government employees, increasing the risk that foreign investors may run afoul of anti-corruption laws.

Pitfalls in the Supply Chain

Hospital supply chains are another source of unpredictable costs. Suppliers to the healthcare sector in China have long operated under weak regulation, and investors must make sure they adhere to desired business standards. The same is true for the tendering process of medical devices. The Chinese government has been decentralizing; this will reduce government oversight of the medical devices industry. In the past when the government decentralized, the process was accompanied by risk, especially in third-, fourth- and fifth-tier cities as local officials took on more responsibility. Many insiders believe expanded decentralization will bring greater compliance risks.

An Opaque Legal and Political Terrain

When investing in Chinese healthcare delivery organizations, investors will confront legal and political issues that may not be readily comprehensible. Legal structures defining ownership, for example, frequently are blurry. Because the government owned and operated most hospitals in the past, it did not classify them as business operations. As a result, developing a solid legal definition of the target investment will require an extensive and costly legal effort.

Although the Ministry of Health may be the primary government liaison in a deal, it is not the only agency with oversight of the healthcare industry. Other ministries play a major role in approving investment opportunities but may not have an official seat at the table. The National Development and Reform Commission, the Ministry of Finance, the Ministry of Civil Affairs, and the Ministry of Human Resources and Social Security all have legacy relationships with parts of the healthcare system — and interests that may be at odds with each other.

The Communist Party of China, for example, has a mandate to assure that everyone in the country has a job. The Ministry of Human Resources and Social Security oversees that edict, which can conflict with investor and Ministry of Health desires to make healthcare delivery more efficient. If an element of an investor’s plan is to reduce headcount, the investor must be able to convince the Ministry of Human Resources and Social Security that cuts are necessary and will be beneficial in the long run. And no matter how strong the business case, that won’t be easy. It can be extremely difficult for foreign-owned businesses to reduce a workforce by more than 10 percent. Attempting to do so will trigger an extensive government examination of financial records and operating procedures that can significantly hamper operations.

Adding to that, board members, management and local politicians may have undisclosed business interests in the healthcare value chain. Kickbacks are common, especially in third-, fourth- and fifth-tier cities that, as the adage goes, are far from the emperor.

For instance, a U.S. healthcare organization looking to invest in a Chinese hospital that specialized in kidney ailments and which, therefore, had a large dialysis unit, engaged FTI Consulting to conduct an extensive due diligence investigation of the Chinese entity. After analyzing the board’s and management’s business connections, FTI Consulting informed the investors that a relative of the hospital’s chairwoman was a real estate developer who had built an apartment complex next to the facility. Physicians were paid under the table to overprescribe dialysis and convince patients and their family to rent an apartment in the relative’s building for the duration of treatment — a clear case of self-dealing and a scandal in the making.

No Rx for Success

China has been successful in providing health insurance to nearly its entire population. That’s an impressive accomplishment. However, the process of providing universal coverage is rapidly outpacing the country’s ability to meet the healthcare demands of its insured population. As the government turns to foreign entities to help expand access to effective healthcare, the opportunities for investors are huge. However, the risks cannot be ignored. Investors should take stock of the risks and of the measures that can be taken to mitigate these risks before planting a flag or extending one’s role in China’s great leap toward healthcare reform.

Published June 2015

© Copyright 2015. The views expressed herein are those of the authors and do not necessarily represent the views of FTI Consulting, Inc. or its other professionals.

About The Authors


Robert Youill
robert.youill@fticonsulting.com
Senior Managing Director
Forensic & Litigation Consulting
Global Risk & Investigations Practice
FTI Consulting

Jeff Benton
jeffrey.benton@fticonsulting.com
Senior Managing Director
Health Solutions
FTI Consulting

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The views expressed in this article(s) are those of the author and not necessarily those of FTI Consulting, Inc., or its professionals.
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