“How the new medical insurance system will impact our business and what we can do innovatively to maximize the benefits of the new system?”


  Table of Contents

 


 


a. Main body


 


b. Conclusions and recommendations


 


c. Final comments


 


d. Introduction


 


e. Appendices


 


f. Executive summary


 


Main body


1.        Introduction: new medical insurance system


In 1998 the State Council formulated the new medical insurance policy for employees working in cities and towns, and thus kicked off the reform to the medical insurance mechanism.


1)        Problems with the old medical insurance system:


a)        Under the old medical insurance system, the state and the employers make excessive contribution to the medical expense of the participants of the system (employees). The participants pay very little and as a result, medical expenses become an incredible burden for the state and employers. During the decade from 1978 to 1997, employee medical expenses grew from 2.7 billion Yuan to 77.4 billion Yuan with an annual growth rate of approximately 19%. Drugs accounted for 60% of the total expense. In a sharp comparison, the annual growth of state fiscal income during the same period was mere11%.


b)        The behaviors of the medical service providers and receivers are not monitored in the old system. As a result, medical services are usually associated with high cost, low efficiency and big waste. Small ailments sometimes incur big medical expense; and some patients cheat by taking drugs for their families. A survey conducted by a government agency reveals that abnormal medical expenses account for somewhere between 20% to 30% of the total. In the same time, reform initiatives within medical institutions score very little progress.


c)        The old system has a small coverage and it only covers employees of state owned enterprises and institutions. Employees at non-state owned enterprises are excluded from the system. State owned enterprises usually take the enterprise-wide insurance approach instead of social insurance method. As a result, insurance management and service provision are decentralized, and the capability to contain risk remains low. More, this approach doesn’t conform to the spirit of social fairness.


2)        Objective and principles


The objective of the reform is to provide a remedy to the existing ailing medical insurance system. Its principles are as follows:


a)         Wider coverage and lower state/employer contribution. The medical insurance capacity will be defined against the financial strength of the state and the employers, and may not meet all needs of the participants. In the meanwhile, the new system is designed to reach every employee at every enterprise/institution in cities and towns.


b)        Shared contribution by state/employer and employee. The basic medical insurance fee will be provided by the employer (6% of payroll) and the participant (2% of the salary). The participant contribution and 30% of the employer contribution will go to the insurance account of the participant; while 70% of the employer contribution will go to the medical insurance fund. The insurance account is independent of the medical insurance fund in terms of settlement. The new system is expected to curb the explosive growth of medical expenses and encourage rational use of resources.


c)         Separation of drug from medical service. The tie between medical service and drug sales will be broken to cool down the interest of medical institutions in drug sales. In 1996 drug sales accounted for 56% of revenue of county-and-above level hospitals, and the percentage was even higher at smaller hospitals; while the average ratio in the global medical industry is around 30%, and in developed countries only 15% to 20%. Designation of participating hospitals and drugstores. The new system introduces the concept of participating hospitals (including Chinese herbal treatment hospitals) and drugstores as well as a new method for settlement of medical expenses. Candidates will be reviewed competitively to determine the participating medical institutions and drugstores. Participants will then be able to buy drugs at the participating hospital or drugstore. Drug Catalogs. Drug catalogs (catalog A and B) will be developed as part of the system, together with regulation policies and criteria for medical treatment services and facilities.


3)        Elements of the medical insurance reform:


a)        The medical expense of the participant will be covered by his/her insurance account, social insurance fund and himself/herself (and/or complementary commercial insurance).


I.                   The money in the participant’s insurance account will cover: 1) fee of clinic treatment or first aid and drug fee at participating drugstores; 2) hospitalization fee, when it is below the payment threshold of the insurance fund; 3) a defined ratio of the amount of hospitalization fee when it meets the threshold of the insurance fund.


II.                                                                    The participant has to pay out of his/her pocket: 1) the remaining clinic treatment fee or first aid fee after using up the money in the insurance account, if the remaining amount falls short of the threshold of the insurance fund (which is usually no higher than 10% of the average annual salary of the city/town. E.g., the threshold in Shanghai for retirees is 2% to 5% of the average salary of the previous year; while the threshold for working employees is 1,400 Yuan); 2) hospitalization fee, when it is below the threshold of the insurance fund (5% to 8% of average salary in the previous year for retirees and 1,400 Yuan for working employees); 3) a defined portion of hospitalization fee when it meets the threshold of the insurance fund; 4) a defined portion of the drug fee when the drug is on Catalog B.


III.             Insurance fund will pay part of the clinical treatment fee, first aid fee or hospitalization fee when the total amount meets the threshold.


IV.             This means at stage I the medical fee will be paid from the participant’s insurance account; at stage II, the participant will pay the rest part of the fee after deducting the full amount in the account; at stage III, the remaining amount after the deduction will be shared by the participant and the insurance fund when it reaches the threshold. However, the participant will pay the hospitalization fee right from his/her pocket if the fee doesn’t meet the threshold of the fund, and when it reaches the threshold the fee will then be shared by the participant and the fund. At stage IV, when the remaining amount (after using up the money in participant’s account) is larger than the ceiling contribution of the fund (four times of the average annual salary in the location), the participant will have to resort to commercial insurance, social medical relief or other sources to cover the rest part of the expense.


b)        The new system introduces two drug catalogs: Catalog A and Catalog B. The payment of drugs falling into Catalog A will follow the above-mentioned policy; when using drugs in Catalog B, the participant has to pay a defined portion of the fee before applying the same procedure. Catalog A lists basic drugs for treatment, including their imitations. The price of drugs in Catalog A is subject to government control (e.g., in the form of ceiling retail price).


c)        The new system is a compulsory social insurance mechanism and covers all employers and their employees in the cities and towns. However, retirees who started work before 1949 (altogether 1.8 million people in the nation), ex-soldiers of the Red Army, soldiers with class II or higher rating of disability (270,000 people in the nation) will continue to receive benefits from the old medical insurance system. Public servants are eligible to additional medical benefits after participating in the new insurance system.


4)        Pilot projects and national roll-out


The pilot projects of the reform were launched in Zhenjiang City, Jiangsu Province and Jiujiang City, Jiangxi Province in 1994, and the reform was then extended to some 40 cities nationwide. Results have shown a noticeable slowdown of the growth rate of average annual medical expenses (e.g., the growth in Jiujiang goes down from 33% before the pilot project to 12%). However, the frequency of going to hospital every two weeks and hospitalization ratio has increased. The contribution of drug sales to hospital revenue has decreased (e.g., the ratio in Zhenjiang decreases from 52% to 42%).


a)        Brief case study of Beijing:


Beijing rolled out the reform on April 1st, 2001. The new system covers the employees at all subsidiaries of CPC and State Council in Beijing and employees at enterprises in the city and towns, self-employed businessmen and freelancers. The initial coverage is 200,000 participants, and the number will increase every month. The objective of the reform is to bring the 12 million residents in the city and town area of Beijing under the umbrella. However, retirees who started work before 1949, ex-soldiers of the Red Army, soldiers with Class II or higher rating of disability will continue to receive benefits from the old system.


As part of the initiative, the city government of Beijing requested all medical institutions to implement centralized bidding into the purchasing process. The centralized bidding of anti-biotics among the first participating ministry-level and city-level medical institutions has completed late June this year. This involves anti-biotics on national Catalog A and Catalog B and those listed on the reimbursement catalog of Beijing. The bidding process reviews drug quality, price and service of the supplier and categorizes drugs into original products, GMP and non-GMP products. The timeframe for this bidding is six months and another round of bidding will start at the end of 2001. After the adoption of the bidding process, the purchasing price for hospitals has decreased 15% to 20% at average; price of locally made imitations has decreased over 30%. The ministry-level and city-level hospitals in Beijing are now reviewing their anti-biotics and suppliers to re-price the drugs.


b)        Brief case study: Shanghai


Following the decision by the State Council, Shanghai has developed a scheme to implement the reform measures, and the scheme was passed at the city congress in August, 2000. Stage I and stage II implementation took place in late last year and March this year respectively.


On the whole, the reform has solicited the support from the citizens. The number of participants in the new system has overtaken that of the old system and reaches 10 million (including the family members of the participants). The medical expenses of participants are now covered by their insurance account, insurance fund and themselves; other sources include various complementary medical insurance policies. So far, the surge in medical expense has flattened out (sales of imported drugs have decreased considerably, while local drugs have grown strongly in sales). The reform has also offered a solution to the delay in reimbursement of medical fee and in disease treatment. Shanghai has followed closely the principles set by the central government.


 


2.        Impact on pharmaceutical companies


1)        Finance


The reform is aimed at reducing medical expenses, particularly drug fee. The state very possibly will impose price limit to drugs included in the catalogs, particularly Catalog A (e.g., Capoten, Glucophage and Velosef). Chances are BMS will be forced to cut the price for some existing products, e.g., Capoten and Velosef, which are the biggest contributors to the sales and bottom-line of the company. What’s more, these products have moved down on their life curve.


Example: Assume all product lines of SASS have similar EBIT/Sales, and the price reduction of drugs on Catalog A is 10%. After the price cut, the EBIT/Sales of the products will fall from 30% to 22.3%, a decrease of 25.9%. Please refer to the appendix (P/L Account ending December 31st, 2000 of BMS) for details of the calculation.


The price reduction incurred by the reform will bring huge pressure on the financial control of pharmaceutical companies. Soon the impact will be felt by other players in the supply chain. Every member of the supply chain will be under tremendous stress in terms of stock management, account receivable and SADAR cost management, etc. to protect the shareholder value, operation margin and cash flow.


2)        Supply chain


Price will become a sensitive issue after the implementation of the new medical insurance system. Competition among wholesalers (tier I, II and III drug companies) and retailers (drugstores and hospitals) will be intensified. Their margin will fall significantly and this will lead to consolidation in distribution. This trend will lead to the rise of powerful super-wholesalers, which will have bigger national coverage, deeper penetration into retailers and better services. Hospitals will form alliances to reduce purchasing cost and acquire more patients. Retail drugstores, on the other hand, are the biggest winner in the reform. Though a weaker voice than the hospitals, the retail drugstores have recognized the benefit of chain store business model and have seen their potential in the ethical market. For instance, the Healthcare Bureau of Shanghai has designated six Hua’s drugstores as the first participating pharmacies, where participants of medical insurance will be able to purchase medicines against prescription out of their insurance account. The trend of wholesalers consolidation, hospital alliances and retail chain store operation will result in a smaller voice of pharmaceutical companies in the supply chain.


3)        End users


Patients will be motivated to control their medical expenses, and will have higher awareness of health and drugs. The impact of this change is two-fold:


a)        Positive impact: patients will have stronger concern over their health; the treatment rate and their knowledge of diseases will increase phenomenally. In addition to that, the increasingly important role of the patients will challenge the authority of doctors over prescription. These rational patients rise as an important segment for pharmaceutical companies to target.


b)        Negative impact: patients’ concern over medical expenses and drug price will threaten the patent and products of joint ventures. In the past, as the medical expenses could be reimbursed 100% by the government or the employer, patients tended to choose joint venture products or imported drugs, which are priced higher than local ones. While under the new system, these patients will be reluctant to choose these products as they will have to pay their part in the drug expense.


4)        Reimbursement


Drugs listed in the state catalogs will automatically enter the provincial or city level catalogs. This creates a big opportunity for products that fail to enter the reimbursement catalogs at local level, yet are included in the state catalogs. This is exactly the case for Pravachol in Beijing and Monopril in Zhejiang Province.


The State Labor and Social Security Ministry and its local branches have commenced to review candidates for the catalogs. As they come from different background compared with the previous catalog makers, communication with these officials has become very crucial.


In this reform, each province or municipality will only develop one catalog; there won’t be city-specific catalog any longer. The good part about it is that pharmaceutical companies will be able to focus resources in their marketing efforts; however, the barrier of entry will be higher. Competition among pharmaceutical companies will be increased, and winning the support of government officials and the recognition of the review committee has been more critical than ever.


Product entry into the catalogs is key to the survival and future growth of pharmaceutical companies. Experience at developed markets shows that pharmaceutical economics is a major determinant of the entry of a product into a catalog. Pharmaceutical companies need to invest in research and promotion of pharmaceutical economics information, and educate officials and members of the review committee on the advantage of their products against competition. For instance, pharmaceutical economics study shows that Cefzil (oral 2nd generation Cephilasporins) is superior to the competition- CeClor in efficacy, bacteria sensitiveness and daily treatment expense.


5)        Marketing


Our marketing strategy has to be changed to adapt to the changing customer structure and role.


a)        Hospitals and doctors


In the new system, the ratio of self payment for retirees is lower in Tier I hospitals than in Tier II and Tier III hospitals, where SASS has a strong product presence. As a result, patients may move from Tier II and III hospitals to Tier I hospitals.


Hospitals are now implementing bidding in the purchasing process to reduce product cost and increase profit. Imported drugs or joint venture products are usually losers in bidding due to their uncompetitive price and inflexible pricing policy. For instance, Velosef lost the bid in Beijing and therefore lost 20% hospital customers.


b)        Retail drugstores:


After the reform, patients will be able to buy drugs at participating drugstores against prescription. Therefore, drugstores will become an important sales driver. When it is difficult to build product presence in the hospitals, drugstores become a good alternative.


c)        eCommerce:


As price sensitivity on the part of the hospitals and patients increases, eCommerce will be a necessary vehicle for doctors and patients to obtain product information and for retailers and wholesalers to purchase products in a speedier way.


d)       Patients:


Patients will be sensitive to price and will turn to cheaper local products.


Branding (including corporate image and drug image) will be a major differentiator for any segment. Promotion of ethical brands that target patients should not copy the academic approach for doctors; rather, it should borrow marketing strategy and tactics from OTC products.


 


Conclusions and recommendations


We need to respond proactively to the impact of the new medical insurance system to the company to ensure sustained profit growth.


1.        Finance


Product price reduction, as a result of the reform, will generate significant negative financial impact on pharmaceutical companies.


Solutions to protect our bottom-line include:


1)        Increase sales by 15.54%; or


2)        Increase efficiency, reduce cost and increase sales.


If the cost savings of the item 2 and item 3 below reach 5% or 10%, and in the same time the sales increase 11.7% or 7.9%, EBIT of the product will remain the same.


The following are measures to increase efficiency and save cost:


1)        Improve production efficiency, process, JIT management and material resource management; reduce stock; improve sales forecast; synchronize purchasing and sales. These measures will help increase stock turns and reduce cost;


2)        Reduce distribution lead-time, shorten account receivable cycle and extend account payable cycle;


3)        Save energy, maintain equipment to extend functioning period.


The price reduction incurred by the reform will bring huge pressure on the financial control of pharmaceutical companies. Soon the impact will be felt by other players in the supply chain. Every member of the supply chain will be under tremendous stress in terms of stock management, account receivable and SADAR cost management, etc. to protect the shareholder value, operation margin and cash flow.


 


2.        Business channels:


Competition among wholesalers (tier I, II and III drug companies) and retailers (drugstores and hospitals) after the implementation of the new medical insurance system will be intensified. Their margin will fall significantly and this will lead to consolidation in distribution. Therefore, relationship with key accounts and partnership with wholesalers and retailers are important solutions for the company to adapt to the changes in the market.


1)        Key account management: systematic data gathering and analysis will be crucial; also, the company has to replace the region-specific, differentiated rebate and incentive policy with a uniformed policy.


2)        Strategic partnership with wholesalers and retailers: win-win relationship has become a fact of life in the business. It will be rewarding for the company to involve in the channel consolidation and offer our assistance (e.g. staff and product training) in the consolidation process.


 


3.        Government relation and catalogs


Drugs listed in the state catalogs will automatically enter the provincial or city level catalogs. This creates a big opportunity for products that fail to enter the reimbursement catalogs at local level, yet are included in the state catalogs.  


The State Labor and Social Security Ministry and its local branches have commenced to review candidates for the catalogs. Communication with these officials has become very crucial.


Experience at developed markets shows that pharmaceutical economics is a major determinant of the entry of a product into a catalog. Pharmaceutical companies need to invest in research and promotion of pharmaceutical economics information, and educate officials and members of the review committee on the advantage of their products against competition. For instance, pharmaceutical economics study shows that Cefzil (oral 2nd generation Cephilasporins) is superior to the competition- CeClor in efficacy, bacteria sensitiveness and daily treatment expense.


 


4.        Marketing


Our marketing strategy has to be changed to adapt to the changing customer structure and role.


1)        Hospitals and doctors


In the new system, the ratio of self payment for retirees is lower in Tier I hospitals than in Tier II and Tier III hospitals, where SASS has a strong product presence. As a result, patients may move from Tier II and III hospitals to Tier I hospitals.


Strategy: build product presence and reinforce product promotion at Tier I hospitals.


Hospitals are now implementing bidding in the purchasing process to reduce product cost and increase profit. Imported drugs or joint venture products are usually losers in bidding due to their uncompetitive price and inflexible pricing policy. For instance, Velosef lost the bid in Beijing and therefore lost 20% hospital customers.


Strategy:


a)        Promote the benefits of our products for patients and hospitals;


b)        Take differentiated bidding method: e.g., we can bid in three different categories- original product, GMP and non-GMP product for anti-biotics in Beijing;


c)        Establish a formalized system to target officials responsible for bidding and key accounts at hospitals responsible for purchasing. E.g., we can sponsor training courses provided by renowned medical institutions or training providers for hospital presidents and bidding officials. We can also invite them to serve as consultants or members of advisory board of the company;


d)       Assist the development of hospitals and their departments; tie the interest of the company with that of hospitals or their departments. E.g., we can donate hospitals’ internal awards or sponsor the activities of certain departments.


2)        Retail drugstores:


After the reform, patients will be able to buy drugs at participating drugstores against prescription. Therefore, drugstores will become an important sales driver. When it is difficult to build product presence in the hospitals, drugstores become a good alternative.


Strategy: build up product presence at participating drugstores; reinforce promotion and staff training.


3)        eCommerce:


As price sensitivity on the part of the hospitals and patients increases, eCommerce will be a necessary vehicle for doctors and patients to obtain product information and for retailers and wholesalers to purchase products in a speedier way.


Strategy: build eCommerce platform to form links with hospitals and drug companies, monitor market demand and put updated product information on the web as reference for doctors and patients.


4)        Patients:


Patients will be sensitive to price and will turn to cheaper local products.


Strategy:


a)        Educate patients on the benefits and advantages of our products against locally made products;


b)        Promote a rational understanding of price issue. As imported drugs and JV products have higher efficacy, safety and smaller side effects, they guarantee shorter treatment cycle and demonstrate better pharmaceutical economics;


c)        Imitate existing products by using cheaper materials and method to meet low end market demand;


d)       Reinforce patient education and build patient loyalty.
 


Final Comments


1.        Finance


Product price reduction, as a result of the reform, will generate significant negative financial impact on pharmaceutical companies. Solutions to protect our bottom-line include:


1)        Increase sales by 15.54%; or


2)        Increase efficiency and reduce cost.


a)        Improve production efficiency, process, JIT management and material resource management; reduce stock; improve sales forecast; synchronize purchasing and sales. These measures will help increase stock turns and reduce cost;


b)        Reduce distribution lead-time, shorten account receivable cycle and extend account payable cycle;


c)        Save energy, maintain equipment to extend functioning period.


 


2.        Business channels:


Competition among wholesalers (tier I, II and III drug companies) and retailers (drugstores and hospitals) after the implementation of the new medical insurance system will be intensified. Their margin will fall significantly and this will lead to consolidation in distribution. Therefore, relationship with key accounts and partnership with wholesalers and retailers are important solutions for the company to adapt to the changes in the market.


1)        Key account management: the company has to replace the region-specific, differentiated rebate and incentive policy with a uniformed policy.


2)        Strategic partnership with wholesalers and retailers: win-win relationship has become a fact of life in the business.


3.        Government relation and catalogs


Drugs listed in the state catalogs will automatically enter the provincial or city level catalogs. This creates a big opportunity for products that fail to enter the reimbursement catalogs at local level, yet are included in the state catalogs.   


 


4.        Marketing


1)        Hospitals and doctors:


a)        Build product presence and reinforce product promotion at Tier I hospitals.


b)        Promote the benefits of our products for patients and hospitals;


c)        Establish a formalized system to target officials responsible for bidding and key accounts at hospitals responsible for purchasing.  


2)        Retail drugstores:  


Build up product presence at participating drugstores; reinforce promotion and staff training.


3)        eCommerce:


Build eCommerce platform to form links with hospitals and drug companies, monitor market demand and put updated product information on the web as reference for doctors and patients.


4)        Patients:


a)        Educate patients on the benefits and advantages of our products against locally made products; promote a rational understanding of price issue.  


b)        Imitate existing products by using cheaper materials and method to meet low end market demand;


c)        Reinforce patient education and build patient loyalty.


5)        Brand promotion:


Brand (including corporate image and product brand) will play an increasingly important role for any customer segment. The promotion strategy and tactics for OTC products will be useful for the promotion of ethical products targeting patients


 


Introduction


The new medical insurance mechanism, after successful pilot in Zhenjiang and Jiujiang, is now being rolled out nation-wide. The introduction of new drug catalogs, centralized bidding process and participating drugstores will produce tremendous impact on the pharmaceutical industry and the rest of the supply chain. On the one hand, it means opportunity, e.g., the anticipated boom of drugstores will drive sales. On the other hand, it means challenge, e.g., the stringent control of medical expenses will result in price reduction for many drugs. The task for a pharmaceutical company is to maximize the opportunity created by the reform and minimize its negative impact on the business.


Appendices

1.        A Guide to Medical Insurance System


2.        Selection of Policy Documents on Medical Insurance


3.        Brochure on Basic Medical Insurance (Shanghai)


 


Executive Summary


Objective:


The main objective of the medical insurance reform is to address problems in the old system. The reform will take the following principles: 1) smaller state/employer contribution and wider coverage; 2) shared payment by participants and state/employer through insurance account and insurance fund; 3) separation of drug sales from medical service; introduction of participating drugstores and new catalogs.


Key findings:


1.        Under the new mechanism, medical expense will be covered by the participant’s insurance account, insurance fund and the participant himself/herself;


2.        Results of the pilot projects show that the growth of average annual medical expense has slowed down, and the ratio of drug income in hospital revenue has also decreased; however, the frequency of going to hospital every two weeks and hospitalization ratio have climbed.


3.        In the future hospitals will purchase through centralized bidding process and purchasing price will decrease 15% to 20%.


 


Main conclusions:


1.        Finance: price reduction after the reform will impose tremendous pressure on financial control, e.g., stock, account receivables and SADAR;


2.        Supply chain: the consolidation of wholesalers, alliance of hospitals and retail chain store operation will encroach the power of pharmaceutical companies in the supply chain;


3.        End users: patients will be motivated to control medical expense, they will have increased concern over health and drugs;


4.        Reimbursement: product entry into the catalogs is critical for the survival and future growth of the company.


5.        Marketing: marketing strategy has to be redefined to address the changes in customer structure and role.


Key recommendation:


1.        Finance: increase sales or save cost. Higher efficiency, shorter distribution lead-time, shorter account receivable cycle and longer account payable cycle will help reduce financial pressure;


2.        Business channels: customer management becomes a priority. Uniformed rebate and incentive policy will be an important solution. Also, it is imperative to form strategic partnership with wholesalers and retailers to create win-win solution.


3.        Government relation and catalog issue: the company needs to invest on the research and promotion of pharmaceutical economics, and educate officials and experts on the review committee on the advantage of our products against competition;


4.        Marketing: reinforce product distribution and promotion at community hospitals and retail drugstores; build eCommerce platform; launch patient education campaigns on pharmaceutical economics information.


 


Chart1  Profit & Loss Analysis


 


No.


 


Current Status


 


(M)


Percentage of Sales


Price 10% off


Price 10% off,


Sales increase 15.54%


Price 10% off,


Item2, 3 saving 10%


Price 10% off,


Item 2, 3 Saving 10%


Sales increases 7.9%


Price 10% off;


Item 2, 3 saving 5%


Sales increases 11.7%


1


Sales


18216


100%


90%


104%


90%


97.1%


100.5


2


Cost


4759


26.1%


26.1%


30.2%


23.5%


25.4%


27.7%


3


Marketing, Selling and Admin


3860


21.2%


21.2%


21.2%


19.1%


19.1%


20.1%


4


Adv. & Promotion, R & D,  Provision for restructuring


4119


22.6%


22.6%


22.6%


22.6%


22.6%


22.6%


5


Earnings before Interest & Tax


5478


30.1%


20.1%


30%


24.8%


30%


30.1%


 



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