Deloitte China Healthcare Services Industry Analysis Report I: The Impact of Healthcare Reform Policies on Market Structure

China’s healthcare services market is vast and expanding rapidly, driven by factors such as population aging, urbanization, rising wealth, and the basic medical insurance system. The deepening of the new healthcare reforms has created opportunities for private capital to enter the healthcare services sector, while also profoundly reshaping the market landscape. Recently, Deloitte China’s Life Sciences and Healthcare Industry practice, in collaboration with the Deloitte Research & Insights Center, jointly compiled an analytical report on China’s healthcare services industry. This report examines the current status and future trends from various perspectives within the healthcare services sector and provides practical strategic recommendations for both private and public hospitals. VCBeat will present this report in three parts.

China’s healthcare services market is vast and has been expanding rapidly, driven by factors such as population aging, urbanization, rising wealth, and the basic medical insurance system. In 2013, China’s total health expenditure reached RMB 3.2 trillion, maintaining a compound annual growth rate (CAGR) of 17.2% over the preceding nine years. However, compared with the 7.7% level in high-income countries, China’s healthcare expenditure accounted for only 5.6% of its gross domestic product (GDP). Given the enormous base of population and consumption, it is evident that China’s healthcare services market still holds substantial room for future growth.

Meanwhile, healthcare reform policies are deepening. The government continues to increase investment to ensure universal access to basic medical and health services, while also encouraging social capital investment to enhance service quality and meet the public’s multi-level and diversified needs. The deepening of the new healthcare reform has created opportunities for social capital to enter the medical services industry, while profoundly reshaping the market landscape.

Private hospitals remain at a disadvantage compared to public hospitals, but they are entering a phase of rapid development under strong policy support. Institutional investors and industrial capital are flocking into the sector, leveraging financial resources to enable private hospitals to achieve resource integration and accelerate market expansion more quickly, thereby upgrading their management, medical technology, service quality, and scaled operations. However, rapid market expansion is often accompanied by higher risks, making prudent decision-making essential. We believe that private hospitals should comprehensively consider local economic development levels, supply and demand conditions, healthcare reform, and tax policies when determining their strategic positioning, and combine these factors with their own capabilities to identify appropriate medical service segments and entry modes.

In terms of growth drivers, we are optimistic about four service sectors. The first is high-end healthcare. High-end healthcare services will expand into lower-tier geographic markets, while previously popular specialties will see a shift in their target demographic from the general public to affluent populations. Additionally, services integrating healthcare with tourism are poised for growth. The second sector is specialized hospital chains. Niche specialties with strong service attributes and high replicability are expected to become investment hotspots. Meanwhile, as healthcare system reforms advance—particularly with increased mobility of medical professionals—private hospitals are likely to enter specialized fields with higher technical barriers. Third, in the realm of general hospitals, capital, talent, and management requirements create higher entry barriers; however, this also means that established hospitals with public recognition will enjoy solidified market positions and significant first-mover advantages. Consequently, various investors will prioritize strategic layouts in general hospitals. Furthermore, greater emphasis on quality of life and heightened health awareness will drive rapid development in the health services sector. The enthusiasm shown by both capital markets and traditional medical institutions toward telemedicine, mobile health, and wearable devices serves as compelling evidence of this trend.

Public hospitals continue to dominate China’s healthcare service system, accounting for approximately 90% of service volume while concentrating high-quality medical resources and talent. However, national healthcare and pharmaceutical reforms are compelling public hospitals to reshape their revenue mechanisms, enhance efficiency, and reduce costs, while simultaneously pushing them into the market, where they face potential outflows of patients and talent. In response to this new market landscape, we recommend that public hospitals focus on the following five areas: reforming performance management systems, improving patient experience, introducing marketing management to build stable and trusting relationships with patients, standardizing medical services and clinical processes, and enhancing hospital information systems.

Rapid Expansion of the Healthcare Services Market

China’s total health expenditure in 2013 amounted to RMB 3.2 trillion, 4.2 times that of 2004, with a compound annual growth rate (CAGR) of 17.2%. Despite the rapid growth in health expenditure, its share of GDP remained at only 5.6%, below the levels observed in high-income and upper-middle-income countries (Figure 2). If this proportion were to reach the 6.5%–7% target proposed by the National Health and Family Planning Commission in its “Healthy China 2020” Strategic Research Report by 2020, the size of China’s healthcare market would reach RMB 6.2–6.7 trillion.

From the demand side, population aging, rising urbanization rates, lifestyle changes, wealth growth, and the advancement of universal health insurance coverage are all driving rapid expansion in the healthcare services market. However, supply has grown at a markedly slower pace relative to the surging demand for medical services: in 2013, the number of healthcare institutions was only 1.2 times that of 2004, while healthcare personnel and hospital beds increased by factors of 1.5 and 1.9, respectively.

Population Aging

China has a large population, and the pace of aging is accelerating. According to data from the Statistical Yearbook, the proportion of the elderly population in China has increased year by year, rising from 7.6% in 2004 to 9.7% in 2013, reaching 130 million people. The elderly have high incidence rates of diseases, prolonged treatment courses, and frequent comorbidities. Additionally, many seniors suffer from chronic conditions requiring long-term care and medication, making them a high-consumption group for medical services (Figure 3). Population aging will inevitably be accompanied by greater demand for medical services.

The Advancement of Urbanization

Driven by adjustments in the economic structure and national policy initiatives, China’s urbanization rate has been steadily rising, with the proportion of the urban population increasing from 41.7% in 2004 to 53.7% in 2013. Urbanization will boost household incomes, thereby increasing consumer demand for medical services. According to data from the National Bureau of Statistics in 2013, per capita consumption expenditure on healthcare among urban residents was 1.8 times that of rural residents. Furthermore, urbanization will lead to changes in residents’ lifestyles. Diseases predominantly prevalent among urban populations are showing an upward trend, which will also drive demand for specialized medical services.

Healthcare consumption demand is characterized by multi-tiered and diversified patterns.

Rising household incomes, wealth accumulation, and shifting health perceptions will continue to drive the diversification and stratification of healthcare consumption demand. Consumers are placing greater emphasis on privacy and are willing to pay a premium for high-quality service and specialized medical expertise, thereby fueling the growth of high-end healthcare. Increased attention to quality of life and greater health literacy have promoted the development of rehabilitative care. Diverse needs across different age groups have spurred the formation of specialized medical fields. Moreover, the paradigm shift from “seeking treatment only when ill” to a proactive focus on wellness has further stimulated the health services industry, expanding the scope of medical services from mere disease treatment to a diversified range of areas including health preservation, preventive care, and nursing. This trend toward multi-tiered and diversified healthcare consumption will drive vertical growth across the entire medical services industry, while the overall expansion of the market will be accompanied by further industry segmentation, propelling demand toward deeper and more specialized development.

Advancement of the Basic Medical Insurance System

In recent years, the basic medical security system has been continuously improved, with deepening coverage on the foundation of broad reach and basic protection. According to the National Development and Reform Commission (NDRC), in the first half of 2014, the enrollment rates for China’s three basic medical insurance schemes—urban employee basic medical insurance, urban resident basic medical insurance, and the New Rural Cooperative Medical Scheme (NRCMS)—remained stable at over 95%. Government subsidies for urban resident basic medical insurance and NRCMS were raised to RMB 280 per person annually, while the reimbursement rates for hospitalization expenses within the policy scope reached over 70% and approximately 75%, respectively. Meanwhile, the state has actively promoted critical illness insurance. In February 2014, the National Health and Family Planning Commission (NHFPC) issued the “Notice of the State Council’s Healthcare Reform Office on Accelerating the Promotion of Critical Illness Insurance for Urban and Rural Residents,” which stipulated that provinces not yet piloting critical illness insurance for urban and rural residents must launch pilot programs by the end of June 2014. The gradual advancement of the basic medical security system will continue to enhance the public’s ability to pay, thereby stimulating demand for medical services.

Healthcare Reform Policies Will Profoundly Reshape the Landscape of the Medical Services Market

In April 2009, the State Council issued the "Opinions of the Central Committee of the Communist Party of China and the State Council on Deepening the Reform of the Medical and Health Care System," firing the starting gun for a new round of medical and health care system reform in China. Centered on the core concept of providing basic medical care as a public good to all citizens, and adhering to the basic principles of ensuring basic coverage, strengthening primary care, and establishing robust mechanisms, this reform has promoted the coordinated development of medical services, medical insurance, and pharmaceuticals (the "Three-Medical Linkage"), achieving remarkable results over the past five years. A tiered diagnosis and treatment service system has been basically established, with ongoing efforts to build an orderly pattern of initial consultations at primary care facilities, tiered diagnosis and treatment, and two-way referrals. A framework for basic medical security covering all residents has initially taken shape, with continuously expanding coverage and depth of protection. Reforms to the medical insurance payment system are underway, with initial effects visible in controlling medical costs. Public hospital reform has entered a critical phase, with continuous advancements in institutional innovations centered on separating government administration from institution management, separating regulation from operation, and separating medical services from pharmaceutical sales. The reform of the medical and health care system will continue to deepen, enhancing quality to meet the multi-level and diversified needs of the public while ensuring the accessibility and affordability of basic medical services for all. The deepening of the new medical reform has brought opportunities for social capital to enter the medical service industry, while also embarking on the journey of institutional and systemic reforms for public hospitals.

From 2009 to 2015, healthcare reform policies primarily focused on establishing a primary healthcare service system and a basic medical insurance scheme, addressing issues of accessibility and affordability of medical services. Between 2016 and 2020, China’s healthcare reform policies are expected to shift their focus toward improving the quality of medical services.

Jiang Xiaorui, Partner, Deloitte Consulting

Tiered Diagnosis and Treatment Service System

China’s medical resources are unevenly distributed and heavily concentrated in large hospitals in major cities, leading patients to seek care at these facilities regardless of the severity of their conditions. As a result, large hospitals are overwhelmed, while urban community hospitals, rural hospitals, and health clinics remain underutilized. The tiered diagnosis and treatment system is designed to address the “dual difficulties” in accessing medical care by establishing a primary healthcare service network covering both urban and rural areas, thereby guiding patients to seek initial care at the grassroots level and promoting the rational allocation of medical resources. Its main measures fall into three categories: First, increasing investment in county-level hospitals to establish a rural medical and health service network with county-level hospitals as the lead and township health centers and village clinics as the foundation. Second, forming medical consortia and implementing mechanisms such as two-way referrals to facilitate the vertical flow of medical resources. Third, strengthening the workforce at the grassroots level by training general practitioners and enabling primary care physicians to receive training at large hospitals, thereby enhancing the service capacity and quality of grassroots medical institutions. Currently, China has basically established a primary healthcare service system; from 2007 to 2013, the number of primary healthcare institutions increased by nearly 37,000. According to the Plan and Implementation Scheme for Deepening the Reform of the Medical and Health System during the 12th Five-Year Plan Period, the focus of reform will be on improving the service capacity of primary healthcare institutions and establishing an orderly pattern of initial diagnosis at the grassroots level, tiered diagnosis and treatment, and two-way referrals. For instance, the Scheme proposes that by 2015, over 95% of primary healthcare institutions should meet standards, and efforts should be made to raise the proportion of patients treated within their own counties to approximately 90%.

The Construction of a Universal Health Insurance System

The construction of the medical insurance system involves two aspects. First, establishing a multi-tiered medical security system covering both urban and rural residents to address the payment issues for basic medical needs. The basic medical security system includes basic medical insurance for urban employees, basic medical insurance for urban residents, the New Rural Cooperative Medical Scheme, and medical assistance programs in both urban and rural areas, thereby covering employed and unemployed urban populations, rural populations, and financially disadvantaged groups in both urban and rural settings. On the basis of ensuring that basic medical needs are met, the development of diverse commercial insurance products is encouraged to satisfy the varied health needs of the public. The expansion of medical insurance coverage in terms of breadth and depth, along with the growth of commercial insurance, helps enhance the public’s ability to pay and stimulates demand for medical services. The second aspect is the reform of the medical insurance payment system, which, combined with the implementation of clinical pathways for diseases, helps constrain the growth of medical expenses. By tilting resources toward primary care facilities, the system guides patients to seek treatment at the grassroots level, promotes the formation of a tiered diagnosis and treatment system, and extends regulatory oversight to medical personnel in non-public medical institutions by including these institutions in the insurance network. Reforms in medical insurance payment methods will drive the transformation of profit models in designated medical insurance hospitals, prompting them to place greater emphasis on cost control and efficiency improvement under the constraints of insurance reimbursements.

Public Hospital Reform

Public hospitals represent the most critical and contentious challenge in China’s healthcare reform. The practice of “subsidizing medical services with drug profits” has created a distorted compensation mechanism for public hospitals, undermining their public-welfare orientation. Excessive hospital scale has led to inefficient allocation of medical resources and has crowded out private hospitals. Ambiguous management responsibilities have further weakened governmental oversight. The reform of public hospitals is guided by the overarching principles of “upholding public welfare and incentivizing initiative,” with its tasks primarily focusing on two key areas.

• Explore mechanisms for separating government administration from institutional operations, and regulatory functions from management responsibilities.To achieve this, it is necessary not only to transform government functions by disentangling government agencies from the day-to-day operations of public hospitals, but also to improve the corporate governance structure of public hospitals so that they can assume specific management responsibilities. The primary models include the transfer of operational rights (such as trusteeship by government-affiliated institutions, large public hospitals, or private enterprises) and the transfer of ownership (such as management buyouts and joint-stock cooperative systems).

• Adjust the revenue structure of public hospitals to address the issue of "subsidizing medical services with drug profits."In accordance with relevant healthcare reform policies, the revenue “gap” resulting from the elimination of drug markups will be addressed through increased government subsidies, pharmaceutical care service fees, and technical service fees. According to data from the Health Yearbook, although the proportion of drug sales revenue in the total income of general hospitals in China has shown a downward trend, it remained as high as 39.7% in 2012, highlighting the challenges associated with this reform. Meanwhile, the increase in government fiscal input also necessitates strengthened oversight of the governance and operational mechanisms of public hospitals to enhance the effectiveness of such funding.

In the "Key Tasks for Deepening the Reform of the Medical and Health Care System in 2014," released by the General Office of the State Council in May 2014, promoting the reform of public hospitals was placed as a top priority, with mandatory deadlines specified for each task, demonstrating that China’s medical reform began to advance vigorously into deeper waters. The "Tasks" pointed out that the reform of county-level public hospitals is the highest priority within public hospital reform, with an additional 700 pilot counties (cities) to be added, covering more than 50% of counties (cities) and a rural population of 500 million. The elimination of drug markups in county-level hospitals will inevitably increase the demand for fiscal subsidies, potentially accelerating local governments’ promotion of the restructuring and trusteeship of public hospitals, thereby opening a window for social capital to enter the healthcare services industry. In addition, the "Tasks" emphasized the planning and layout of public hospitals, proposing that, in principle, the scale of public hospitals should no longer be expanded, thus leaving room for privately run medical institutions.

Diversified Healthcare Provision

China’s medical supply lags significantly behind demand, while the operational efficiency of public hospitals remains low, resulting in an imbalance between medical supply and demand. The fundamental direction of diversified healthcare provision is for public hospitals to return to their non-profit nature and meet basic medical needs, while social capital is introduced to supplement medical services and address diverse demands. The participation of social capital not only increases supply but also stimulates market competition, thereby compelling public hospitals to improve efficiency and service quality. Since 2009, the state has repeatedly issued policies supporting socially funded healthcare, with increasing intensity. In the key tasks of the 2014 healthcare system reform, the government again made arrangements to relax market entry conditions, optimize the policy environment for healthcare provision, and promote physicians’ multi-site practice, with various localities gradually implementing these measures in their detailed rules. For instance, Beijing has not only removed the cap on the number of locations for physicians’ multi-site practice but also eliminated the requirement for hospital approval in the application process. The Ministry of Commerce issued a notice allowing foreign investors to establish wholly foreign-owned hospitals in seven provinces and municipalities, including Beijing, Tianjin, Shanghai, and Jiangsu. As various requirements are further implemented in local detailed rules in the future, the development of private hospitals will continue to accelerate.

Municipal and district governments should leverage their platforms to integrate regional public and private medical resources, as well as related peripheral services such as healthcare logistics, health screenings, and research and development (R&D), thereby fostering a “medical ecosystem” that maximizes the synergistic effects of limited resources. Alternatively, this resource integration task can be undertaken by commercial entities, which can utilize upstream and downstream supply chain partnerships and online consumer platforms to achieve the goal of building an ecosystem by integrating asset-heavy operations through an asset-light model.

Wu Ping, National Leader of Deloitte China's Life Sciences and Health Care Industry

Remaining Report Topics:
II. Current Status and Trends in the Development of Private Hospitals and Clinics
III. Development Status of Public Hospitals and Community Hospitals

Stay tuned...

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