National Healthcare Security Administration's DRG Reform: A Deep Dive into the Upcoming Transformation of China's Medical Ecosystem

On December 20, 2018, the National Healthcare Security Administration officially released the Notice on Declaring National Pilot Programs for Diagnosis-Related Group (DRG) Payment (hereinafter referred to as the “Notice”). The Notice stated:To implement the task requirements set forth in Document No. 55, which states that “the state shall select certain regions to conduct pilot programs for DRG-based payment and explore the establishment of a DRG payment system,” the National Healthcare Security Administration is currently formulating DRG standards tailored to China’s healthcare service system and health insurance management capabilities, and has launched pilot programs for DRG-based payment in selected cities. Healthcare security administrative departments at all levels must attach great importance to this initiative, actively participate in the DRG-based payment pilot programs, accelerate the improvement of refined health insurance management, and gradually apply DRGs to actual payments while expanding their scope of application.。

Against this backdrop, VCBeat (WeChat Official Account: vcbeat) has launched a long-term column dedicated to in-depth reporting on the DRG payment system. For the inaugural issue, we have invited Ms. Liu Zhichen, a senior expert in the field of DRGs in China and a joint postdoctoral fellow at the Workstation of the Statistical Information Center of the National Health Commission and the Postdoctoral Mobile Station in Public Administration at Fudan University, to provide an in-depth interpretation of the National Healthcare Security Administration’s “Notice.”

In this article, you will learn about the following core content:

1. Three Major Factors Preventing Large-Scale Promotion of DRG Payment Pilots in China;

2. The Relationship Between the National Healthcare Security Administration and the National Health Commission Regarding DRGs;

3. The Relationship Between DRGs and the "4+7" Volume-Based Procurement;

4. The Impact of DRGs on Medical Institutions, Pharmaceutical Companies, Consumable Manufacturers, and Medical Device Manufacturers

Dr. Liu Zhichen

Liu Zhichen: Diagnosis-Related Groups (DRGs) are, in essence, a prospective payment system based on bundled payments per disease group. A payment framework built on DRGs helps establish positive incentive mechanisms that alter the behavior of healthcare providers, enabling refined management of health insurance funds and control over total expenditures. It guides and encourages medical institutions to adopt cost-control awareness, thereby shifting hospital revenue strategies, while strengthening oversight of healthcare service quality through competitive dynamics and the design of quality monitoring mechanisms. Under this system design, health insurance agencies become the overall controllers of medical costs and act as agents for patients, which curbs supplier-induced demand to some extent and incentivizes hospitals to minimize patients’ length of stay.

Therefore, its implementation will inevitably bring about changes to the rules of the game within the healthcare ecosystem. This constitutes a restructuring of stakeholder interests, involving a broad range of parties and requiring extensive preparatory work in advance. Consequently, the progression from preparation and pilot programs to large-scale rollout is a gradual process that cannot be achieved overnight. International experience, such as that of Germany, shows that it took more than 10 years from initial preparation to full implementation.

China began introducing DRG theoretical research in the 1980s and initiated its application in hospital performance evaluation in the 21st century. However, pilot programs for DRG-based payment have so far been limited to a relatively small number of cities, insufficient to form a trend toward large-scale adoption. The main reasons are as follows:

First, the issue of unifying technical standards. This is primarily reflected in the standardization of DRG grouper and coding systems, as well as the applicability of the DRG-based payment system, constituting a three-level framework for unified standards.

From an international perspective, the basis for DRG-based payment is to determine a bundled payment price for each group defined by the DRG grouper as a single payment product. The grouping is based on diagnosis and procedure classification codes. Although China has a unified national standard version for the coding system, it was established prior to the implementation of DRG-based payment and did not take this into account. Consequently, there are inconsistencies between the current coding system, the DRG grouper, and the applicability of the DRG payment system. Furthermore, China has not yet clearly defined a unified standard version for its DRG grouper.

In addition, scholars and vendors from different schools of thought in China have developed various versions of DRG groupers, drawing on international experience while constrained by factors such as technology and data availability. Meanwhile, to accommodate the requirements of these different DRG groupers, they have each developed their own coding systems, resulting in a lack of standardized criteria and hindering data normalization and effective comparative analysis. Therefore, the lack of unified technical standards is the primary factor constraining the large-scale rollout of DRG-based payment pilots in China.

The National Healthcare Security Administration’s launch of the call for cities to participate in the DRG payment pilot program is also aimed at summarizing pilot experiences, thereby providing better support for advancing the development of a standardized DRG system.

Second, issues regarding the accuracy, usability, and availability of data. These are primarily reflected in the data quality of medical record front sheets, as well as the accuracy, usability, and availability of cost data.

From a global perspective, the development of Diagnosis-Related Groups (DRGs) systems, along with accurate case grouping and weight determination, relies on two fundamental types of data: first, clinical information contained in medical record face sheets, including diagnosis codes and procedure codes; and second, cost information derived from medical records. Based on clinical information, each case is assigned to a specific DRG category. Using DRG cost data, the homogeneity of different DRG categories is evaluated; if homogeneity is insufficient, consideration is given to splitting them into separate groups. Therefore, the collection and analysis of medical record face sheet data and cost data are crucial for accurate DRG grouping and weight determination.

Quality Issues in Medical Record Face Sheet Data: As hospital medical record face sheet data was not previously linked to payment systems, poor data quality has been a widespread and long-standing issue. Furthermore, the generally low professional competence and skill levels of medical records department staff and coders constitute another significant factor constraining the quality of medical record face sheet data.

Issues Regarding the Accuracy, Usability, and Availability of Cost Data: In foreign countries, Diagnosis-Related Groups (DRG)-based payment systems commonly utilize cost data to calculate weights and rates, as well as to serve as the basis for grouping that evaluates healthcare resource consumption. However, due to China’s long-standing hospital compensation mechanism of “subsidizing healthcare with drug profits,” there has been a significant deviation between charges and actual costs. Consequently, hospital cost data fail to accurately reflect normal or reasonable resource utilization. The high costs of pharmaceuticals and medical consumables persist, failing to adequately reflect the labor value of healthcare professionals.

Furthermore, many hospitals do not place sufficient emphasis on cost accounting, failing to implement cost accounting systems or maintaining data with low authenticity and reliability. These factors significantly influence the calculation of DRG payment weights and pricing.

Third, issues regarding data standardization and interoperability. Currently, the degree of data standardization among various domestic information systems remains low, information silos are still prevalent, and the challenges of data exchange between medical insurance entities, hospitals, and government agencies have not been fully resolved.

For example, regarding the standardization of coding for medical consumables, the current situation is that individual healthcare institutions have yet to establish unified internal standards, which poses challenges for DRG grouping and standardized pricing and payment.

Based on international experience, many countries establish centralized departments for data collection and analysis when implementing Diagnosis-Related Groups (DRG) payment systems. These departments standardize data collection and grouping, while also overseeing data quality monitoring and analysis. In contrast, China currently lacks a clearly defined, unified department responsible for DRG data collection, quality oversight, and analysis, which is one of the reasons hindering the large-scale adoption of DRGs.

Liu Zhichen: Drawing from the experiences of Germany, Australia, and other countries in introducing and advancing the construction of DRG-based payment systems, it is evident that national governments typically begin with a comprehensive master plan or strategic framework from a top-level design perspective. Although China issued a series of policy documents in rapid succession in 2017—such as the “13th Five-Year Plan for Deepening the Reform of the Medical and Healthcare System,” the “Notice on Issuing the 13th Five-Year Plan for Deepening the Reform of the Medical and Healthcare System,” and the “Guiding Opinions of the General Office of the State Council on Further Deepening the Reform of Basic Medical Insurance Payment Methods”—these documents clearly stipulated reform objectives, planned arrangements, and operational steps.

However, a unified top-level design has yet to be established for a series of rules, methods, and standards that require prior clarification, including the national standard version of the DRG grouper, coding rules and standard coding systems compatible with the grouper, whether weight calculation is based on cost or charge measurement rules, the selection of cost accounting methods, the maintenance mechanism of the DRG system, as well as fee schedules, weight calculations, health insurance negotiation rules, and data exchange protocols. This lack of standardization has left pilot regions uncertain when advancing DRG-based payment pilots. Furthermore, research institutions and grouper development teams have independently invested resources and research efforts, resulting in difficulties in unifying standards and inefficient duplication of resource allocation.

Meanwhile, in terms of organizational support, countries such as Germany and Australia established specialized agencies to lead the overall top-level design and implementation of DRG payment systems, such as InEK in Germany and IHPA in Australia. Prior to the establishment of China’s National Healthcare Security Administration, responsibilities for healthcare service payment or pricing were distributed among several departments, including the Ministry of Human Resources and Social Security, the National Health Commission, the National Development and Reform Commission, and the Ministry of Civil Affairs.

Following its establishment, the National Healthcare Security Administration (NHSA) consolidated into its mandate the New Rural Cooperative Medical Scheme previously under the National Health and Family Planning Commission; basic medical insurance for urban employees and urban residents, as well as maternity insurance, formerly administered by the Ministry of Human Resources and Social Security; drug and medical service price management from the National Development and Reform Commission; and medical assistance programs from the Ministry of Civil Affairs. Positioned as the primary purchaser of healthcare services, the NHSA is better equipped to exert a decisive influence on the development of the healthcare delivery system and the allocation of health resources. Therefore, rather than formulating its own department-level Diagnosis-Related Groups (DRGs) standards, the NHSA should focus on developing a unified, top-level national design framework.

It is not in conflict or contradiction with the DRG-related achievements and pilot programs previously led by the National Health Commission (NHC) before the establishment of the National Healthcare Security Administration (NHSA). This is because the NHC’s prior research findings and pilot initiatives on DRGs provide valuable references for the NHSA’s current construction of standard systems and exploration of payment mechanisms.

Liu Zhichen: As the purchaser of medical services, the National Healthcare Security Administration has implemented Diagnosis-Related Groups (DRG)-based payment, a pricing and reimbursement mechanism for healthcare procurement. In most foreign countries, this system is enforced mandatorily through specific legislation. Naturally, it is compulsory for hospitals as well, which will inevitably bring about profound changes in hospital management models.

As the pilot model is gradually rolled out and top-level national design is introduced, it is believed that the state will certainly promulgate corresponding laws, regulations, or policy frameworks to enforce compliance during future large-scale implementation. Healthcare institutions are advised to prepare in advance. Hospitals that fail to proactively adapt to this system may face the risk of exit. It is worth noting that during the implementation of DRG payment system reforms in the United States from 1987 to 1994, 454 hospitals went bankrupt, and 22,000 acute-care beds were closed. With increased financial liability risks for hospitals, corresponding changes in physicians’ clinical practices and hospital management models are imperative.

Liu Zhichen: I believe it is inaccurate to describe this as a “supplement.” The establishment of the National Healthcare Security Administration (NHSA) was intended to fulfill its role as the purchaser of healthcare services, with highly centralized authority over procurement, pricing, and payment.

DRG-based payment addresses pricing and reimbursement issues, while volume-based procurement addresses purchasing issues. The two are complementary.

As indicated by the preceding introduction to DRG-based payment, DRGs transform the reimbursement model for healthcare providers from fee-for-service to bundled payments based on diagnosis-related groups. Under this system, individual medical services no longer serve as revenue sources for healthcare institutions but instead become cost items, fundamentally altering their revenue models. This shift inevitably leads to profound changes in the procurement patterns for products such as pharmaceuticals and medical consumables.

Therefore, it is highly likely that volume-based procurement will not be limited to the initial “4+7” cities; more cities are expected to proactively join these initiatives, further driving down the procurement costs of pharmaceuticals and medical consumables.

Liu Zhichen: The payment rules of DRGs will bring about profound changes to the game rules not only for pharmaceutical companies, but also for consumables manufacturers, medical equipment manufacturers, and even all ecological enterprises that provide logistical services to medical institutions.

With the implementation of DRG-based payment, the transactional dynamics between the National Healthcare Security Administration, as the purchaser of medical services, and hospitals, as the providers, have undergone a disruptive shift. This will inevitably lead to transformative changes in their purchasing behaviors toward other product or service providers within the healthcare ecosystem.

For example, a German expert mentioned in a lecture that before the implementation of DRG-based payment reform in Germany, every healthcare institution on a single street had purchased numerous pieces of large-scale medical equipment. However, after the adoption of DRG-based payments, major hospitals significantly reduced their procurement of such equipment by outsourcing services to cut costs. Some hospitals even outsourced logistical support services, such as laundry facilities.

Therefore, the transformation brought about by the implementation of DRG-based payment should not be viewed solely from a data perspective. It is crucial to understand the profound and disruptive changes underlying the shift in operational rules, and to take swift proactive measures to adapt early, thereby securing a competitive advantage in future reforms.

Liu Zhichen: The gradual expansion of DRG payment pilots will trigger a strategic restructuring of the ecosystem in the broader healthcare sector.

First, healthcare institutions will undergo profound transformations in their strategic positioning and management models.

From a strategic positioning perspective, the cost-centric management model will reshape the interest distribution within the healthcare ecosystem. Large hospitals may increasingly focus on specialized treatment for complex and refractory diseases, while small and medium-sized hospitals will transition toward health management or rehabilitation services, establishing differentiated complementarity and collaborative synergy with large hospitals. Meanwhile, hospitals that fail to proactively adapt to these new rules will be eliminated, whereas some private-capital healthcare institutions may gradually expand and strengthen their market presence due to their greater emphasis on cost control.

From the perspective of changes in management models, taking Germany as an example, the introduction of DRG-based payment reform has brought about profound transformations in hospital management. These changes include the comprehensive adoption of hospital financial budgeting aligned with DRGs, the introduction of new performance planning oriented toward DRGs, restructuring of financial frameworks, improvement and strengthening of financial control departments, establishment of medical operations control departments, formation of DRG collaborative working groups within each department, and upgrades to hospital information systems. Overall, both external collaborations and internal management of healthcare institutions will undergo strategic restructuring centered on cost control.

Secondly, profound changes will also take place in the payment systems, procurement and pricing mechanisms, and regulatory models of the medical insurance authorities.

Following the implementation of DRG-based payment, healthcare security authorities will shift from process-oriented management to objective-oriented management. Regulatory focus will transition from overseeing the rationality of examinations, medication, and treatment, monitoring healthcare fund fraud, and controlling unreasonable costs at medical institutions, to adopting an objective-driven approach that defines institutional responsibilities through regulatory frameworks. This includes strengthening oversight of clinical practice standards, the quality of front-page medical record data, the quality and safety of medical services, the level and efficiency of medical service delivery, and the prevention of under-treatment.

Meanwhile, the calculation and negotiation processes underlying DRG payment pricing differ significantly from the previous fee-for-service model, which will inevitably bring about disruptive changes to both the health insurance payment system and the pricing mechanism. Furthermore, in light of the aforementioned impact on the healthcare factor market, the health insurance procurement system is bound to undergo corresponding changes.

Third, the influence of health regulatory authorities. Any reform in payment methods has both advantages and limitations. Some adverse effects of DRGs include issues with upcoding, deterioration or insufficiency of healthcare service quality, patient shifting, and cost shifting. In light of potential problems arising from service quality and data quality, the National Health Commission, as the primary regulator of medical institutions, needs to strengthen future oversight of hospital data quality and healthcare service quality, so as to minimize or control the potential adverse impacts of DRG-based payment.

Fourth, the impact on commercial health insurance. The scale of commercial health insurance in China has remained relatively small, accounting for a very limited proportion of total national health expenditure. This is largely attributable to the lack of reliable data for precise actuarial calculations and pricing. I once conducted an in-depth analysis of DRG cost and cost-accounting data for a major Chinese city, revealing that costs for the same single disease entity could vary by dozens of times, indicating significant irregularities in medical service practices. With the implementation of DRG-based payment, unified pricing is applied within each DRG group. This enables commercial health insurers to conduct actuarial assessments and develop insurance products accordingly, while also providing a basis for cost containment. These developments will bring substantial benefits to the growth of commercial health insurance companies.

Fifth, the impact on vendors in the factor market. The factor market referred to here includes manufacturers of pharmaceuticals, medical consumables, medical equipment, and hospital logistics services, among others. Based on the aforementioned analysis of changes in purchasing behavior by healthcare institutions, the implementation of DRG-based payment will be unfavorable to the development of these vendors. It is recommended that companies in these sectors take proactive measures and formulate response strategies in advance to secure a competitive advantage in future market competition.