Economic Thinking of Value-based Medicine in China Health Reform

Published Feb 21, 2022

Inscription: On September 19, 2021, at the inauguration ceremony of the Chengze Garden Campus of Peking University National School of Development, a special forum on "Healthcare Reform and Healthy China" was held. This article is based on the speech of Professor Gordon G Liu, a Peking University BOYA Distinguished Professor at the National School of Development, and Dean of the PKU Institute for Global Health and Development.

As the core content of national health reform, the universal medical insurance is an important institutional arrangement to promote a healthy China and common prosperity. In recent years, the annual dynamic adjustment of the National Medical Insurance Catalog has involved the vital interests of thousands of families and enterprises with great social impact. Mr. BI Jingquan (former China CFDA commissioner) raised two major issues in the previous lecture: one is the pricing of drugs and medical services; the other is the reimbursement method and ratio. These are the two hardest things in the national medical insurance reform.

The dynamic adjustment of the National Medical Insurance Catalog mainly includes four steps, which are jointly completed by four expert groups.

First, an expert team mainly composed of clinicians and pharmacists conducts the first round of evaluation focusing on the comprehensive clinical value of the drugs and gives product recommendations for the selected drugs participating in the next evaluation.

Secondly, an expert group is composed of pharmacoeconomics researchers from major universities, hospitals, and research institutions. On top of the recommendations by the clinical expert team, they further evaluate the economic value of the selected drugs and the payment standard by medical insurance through cost-effectiveness and budgetary impact analysis.

Thirdly, a group of administrative personnel is teamed up from various local medical insurance departments to measure insurance budgetary impact. Specially, their responsibility is to measure the possible changes in the payment of medical insurance when the selected drugs are included in the medical insurance list.

Finally, the administrative team from the National Healthcare Security Administration (NHSA) consolidates all the reviews and estimates made by the above-mentioned expert groups to formulate a payment policy recommendation for each product selected. In the meantime, several medical insurance negotiation teams are then tasked to conduct the price negotiations directly with pharmaceutical companies. Drugs that can reach a final consensus for pricing and related conditions are to be listed in the newly updated national medical insurance adjustment catalog.

It can be seen that the adjustment of the entire medical insurance catalogue requires the close cooperation of several expert groups such as clinical, pharmacy, medical insurance, and pharmacoeconomics, which is indispensable. Due to the different professional characteristics of each expert group, the focus of the role of each group is clearly different. As Mr. HU Jinglin, Director of the National Healthcare Security Administration, said, "In the four links, the work of the pharmacoeconomics group is mainly based on empirical research data, so this group requires the highest scientific evidence." In other words, the expert reviews of front-line work such as medicine, pharmacy, and medical insurance can refer to rich practical experience to make judgments. Whereas the members of the pharmacoeconomics group have little clinal or administrative advantages to reply upon, so scientific evidence has become the top priority of their review work.

How can drugs and medical services be reasonably priced? This is an extremely complex issue worldwide. To answer this question from an economic perspective, I think we may go back to the relationship between the government, the market and the comparative advantages of their respective roles.

In recent decades, a popular concept advocated in the field of medical services at home and abroad is "value-based medicine". From the perspective of medical insurance, value medicine must answer the question of reasonable prices for drugs and services, so that medical insurance payment is "value for money". If the price of medicines and medical services is determined on value basis, should we first consider how to measure the value of services?

On August 31, 2021, the National Healthcare Security Administration officially issued the "Pilot Plan for Deepening the Reform of Medical Service Prices" (referred to as the "Pilot Plan"). This is an important document on setting the prices of medicines and medical services, which involves several key words about value medicine and the role of the market. The first part of the "Pilot Program" is "General Requirements", which clarifies the general ideas and reform goals.

 General idea: To standardize the management of medical service price items and establish a pricing unit system that conforms to the law of value.

Reform goals: By 2025, the experience of deepening the pilot reform of medical service prices will be promoted nationwide, and the pricing mechanism for medical services with classified management, hospital participation, scientific determination, and dynamic adjustment will be mature and finalized, and the price leverage function will be fully utilized. The second part of the "Pilot Program" is to "establish a Target-Oriented Price Project Management Mechanism", which is further subdivided into three aspects.

Formulate the standards for the preparation of price items: According to the principle of service output-oriented, medical human resource consumption as the basis, and separation of technical labor services and material consumption, formulate national price item compilation standards.

Improve the national price item specification: To classify and integrate the current price item, improve the national medical service price item specification, unify the price item code, and gradually eliminate the differences between regions. Medical consumables are gradually separated from price items, play the role of market mechanism, and implement centralized procurement and "zero-markup" sales.

Optimize the management of new price items: To simplify the application process of new price items and promote the innovative development and clinical application of medical technology. To carry out innovative and economical evaluations for new price projects with high resource consumption and high price expectations.

Through the "Pilot Program", we can feel the importance of value-based medicine and its key points. Let's return to academic research from policy papers to see how value is understood from an economics perspective.

Value-based Medicine: What is it? why? what to do?

In economics, "value" is a concept that is associated with "utility". For consumers, the value of any product must include the utility that can satisfy their own needs, which is the essence of value. How to measure value? By far the most common way to measure the value of any good is the price individuals are willing to pay. Although there will always be a difference between price and subjective value, people have yet to find a better way than price.

In a competitive market, the price of a good depends on two aspects: one is the utility value (intrinsic value) of the item, such as the value of water to quench thirst and maintain life systems; the other is the exchange value (external value) of the item, such as the same water, the more water is available, the cheaper the water, and vice versa. Therefore, when using price to measure value, we need to consider both the utility value and the exchange value of a product.

Under the conditions of free exchange in a competitive market, buying and selling can only take place when the consumer believes that the value of the item is no less than its price, the so-called "value for money". Therefore, in the market of free exchange, the value of goods can’t be lower than the price, and the difference is the "consumer surplus".

At present, whether in developed or developing countries, value-based medicine has increasingly become a focus of improving the medical service system. Theoretically speaking, if medical services are paid fully by individuals for themselves, since everyone has own value judgment for the same medical service, the free-market exchange mechanism can help achieve the "value for money" with no need for assessing the price of value-based medicine. However, if medical services are paid for by third-party health insurance using public funds, the problem is not as simple as a free exchange based on individual utility preferences.

Since the beginning of the 21st century, many countries, including China, have established universal medical insurance through public finance, paying for most medical insurance services for the public. When public finances are used, under the resource constraints of the public budget, this significantly increases the conflict of interest between individual reference and public welfare. As a result, the value evaluation and pricing of medical services by third parties has become an important policy task. At the same time, due to factors such as fast innovation of medical technology, aging, income growth, etc., medical “inflation” continues to exceed the GDP growth worldwide, pressing the measure of “cost control” to become a common orientation of medical insurance policies in various countries.

Value-based Medicine and Market Price Mechanism

Concerning the rationality of cost control measures in managing the medical "inflation", Harvard economist David Cutler believes that people should turn the conversation from saving expenses and cutting costs to improving the value of medical services. As long as every dollar spent will bring greater value increment, even if the proportion of medical expenses is higher than the current proportion, it is worth the money, beyond reproach.

The price mechanism of value-based healthcare is not difficult to understand in concept, but it is not easy to implement into specific policies. Nevertheless, we can still try theoretical discussions to provide ideas for subsequent application practice. For the sake of discussion, let us first consider a fully competitive market. In this market, when market competition helps both the supply and demand sides reveal the value of the exchanged items, it implies that there would be substitutes available for customers to choose from when considering a product for demand, an important economic basis on which the market price mechanism can determine reasonable prices.

Taking medical heart stents as an example, there are many homogeneous competing products in the market. Assume that the equilibrium price of supply and demand at which the market clearing is 2,000 yuan. If the market price of stents is temporarily 4,000 yuan, although the seller has sufficient supply, many patients cannot afford or find not worth it, and there will be an oversupply. As long as market competition works, seller will force prices down until a price level where supply and demand equalize. Conversely, if the price of the heart stents is too low at 700 yuan, some of the supply will be withdrawn from the market because it can’t be profitable, resulting in a shortage of supply. In the same way, as long as there is market competition, the demand-side forces that are in short supply will push up the market price until supply and demand are balanced.

Some people may argue that with big data and superpower computing capacity, the pricing of administrative intervention may be accurately enough to reach a market clearing condition as well. This is a false argument simply because the market equilibrium price itself is not a static value, but a dynamic variable driven by both demand and supply forces. Unless the market "invisible hand" makes dynamic adjustments through incentive mechanisms for both demand and supply sides, no matter how powerful the measurement experts are, it is difficult to think of possible driving forces to move towards the equilibrium price. Even if a certain equilibrium level is accidentally hit, how can it be dynamically adjusted in response to changes in supply and demand? As far as real-world management is concerned, regardless of public or commercial medical insurance, the price adjustment is at least annual or even longer due to high administrative cost of frequent adjustment. Of course, in theory, one can assume to ignore the administrative costs so that the adjustment period of administrative pricing can be shortened to a monthly or even smaller unit. If this would be the case when administrative pricing may eventually achieve the same market equilibrium outcomes at extraordinary cost, why even bother administrative intervention in the first place?

How to Balance Market Competition and Unique Conditions

Of course, not all products can meet the requirements of the competitive market, such as patented innovative products. In fact, many clinical front-line diagnosis and treatment services do have some degree of uniqueness, making it more difficult to achieve the balance of supply and demand for maximum social welfare through market competition. Following health economics, the medical service market has two unique characteristics that need to be taken with caution. First, information asymmetry. Although there is information asymmetry between buyers and sellers of any goods, there may be a larger information gap between patients on demand side and clinicians on supply side, and it is more difficult to eliminate it in the short term through supplier-side competition. Second, the uncertainty of diagnosis and treatment effect. When the same medical technology is used for the same diseases, but the actual treatment effect may well vary from person to person depending on individual hard-to-measure conditions.

In this regard, to better advocate the payment concept of value for care, how should we consider some of the uniqueness of medical services and the advantages of market competition? For brainstorming, my initial thinking is to manage the market by category. The supply chain of the medical market is very long, including R&D, production, distribution, procurement, clinical and medical insurance. From the perspective of market competition, the supply market may be simply divided into a "dual" structure of upstream and downstream: the upstream part is the medical factor market; the downstream part is the medical clinical service market.

At the upstream end of medical factor market, the main body of suppliers is the production and distribution enterprises that provide medicines and equipment factors, and the main body of buyers is hospitals and clinics. In the upstream factor market, the drugs, devices or consumables approved by the State Food and Drug Administration have unified indications and specifications, and the degree of standardization is high. For approved indications, as long as there are related products to choose from, market competition will have a foundation to play roles. More importantly, since the patients as a main party has not "entered" yet in the upper-end factor market, there is no uncertainty characteristic of the above-mentioned medical services. Therefore, the medical institutions as the buyer and the pharmaceutical company as the supplier can well exchange the factor goods through the market mechanism, and the force of market competition will help achieve a win-win situation for both parties. For patented goods or new products, the situation is different, where the third-party pharmacoeconomic evaluation can play a central role on the basis of incremental value and cost of new technologies as compared to existing products, providing an economic foundation for price setting through insurance policy.

At the downstream end of clinical services, the role of medical institutions is switched from factor buyers to service suppliers in meeting the patient demand. With the patient-centered downstream market, clinical uncertainty due to patient heterogeneity has become the "main theme", making drugs for the same indication to face different clinical outcomes. Under such uncertain circumstances, what would be the value of clinical services? Following Dr. Trudeau, an American physician in the early 20th century, a medical oath is said that medicine is "sometimes a cure, often help, always a comfort". The essence of this statement is that the value of medical services is not only that doctors can sometimes cure the disease, but also help patients relieve symptoms, improve communications between doctors and patients, and offer professional counseling and supportive comfort as needed.

Value-based Pricing: A Patient-Centric Competitive Mechanism

Due to the individual differences and uncertainties of clinical services, market competition based on service items lacks a comparable value basis, and the resulting market price is difficult to reflect the service value. In this regard, does it necessarily mean the "failure" of market competition, and would it be a better choice to have administrative pricing intervention instead? Regarding this issue, Professor Michael Porter of Harvard Business School believes that the root of the problem should not lie in the competition itself, but in determining whether the competition-oriented service unit is properly selected. In a simple hierarchy of basis for service payment, the highest unit is patient health, followed by capitation, DRG or disease, and the lowest unit is diagnosis and treatment items such as drugs. In the case of the two end units, if the payment unit is the degree of patient health, the goal orientation of service competition may lead to health promotion. In contrast, if the payment unit is at the quantity of prescription drugs delivered, the competing forces may lead to the outcomes of overmedication.

How can we choose an appropriate competitive unit? For illustration, we may divide the clinical service market into general primary care and specialty care areas. Following the mainstream medical practice models, the service platform of the former is mainly through the most accessible community clinics for outpatient services, while the latter is provided mainly through general hospitals and other specialty institutions.

For primary care and health management. General speaking, primary care mainly focuses on the supply of outpatient services and health management for community residents. Health management helps promote healthy dietary culture, healthy behavior, and ecological environment, all of which can highly affect the level of population health which can change the demand dynamics for subsequent medical services. For community residents, a distinguished feature of health management and much primary care is that almost everyone needs it, offering some characteristics of large samples, random distribution, and little selection bias. Such characteristics provides good conditions for the role of market competitions in population health-oriented contractual settings between medical insurers and service suppliers. Because of the large population as a contractual basis to support pay-for-outcome approach, the service providers may carry out efficient and health-led competitions leading to win-win outcomes for residents, medical insurance, and service entities.

For specialty care and inpatient services, on the other hand, they are mostly provided at general hospitals and specialty care facilities. Compared with the large population-based demand for health management and primary care, while the patient size of inpatient and specialty care is much smaller, the costs would be significantly higher for each individual, and the demand would be very selective to high risk groups. In view of the above characteristics of inpatient and specialty care services, it is more feasible and manageable to pay for the performance at disease level. In fact, following medical practices in many developed countries, such services are mostly paid on the basis of the "Disease Diagnosis Related Group" (DRG) confirmed when a patient is discharged from the hospital. The DRG system originated in the United States, and has been widely adopted in countries around the world. China has also been widely promoted in recent years. Because DRG has a high degree of systematic definition and standardization of inpatient diseases, market conditions may also be established to a certain extent for hospitals to compete for services based on DRG units.

My final point is on the role of public scrutiny. From a system development perspective, no service contract can be perfect in general, and there are actually many problems with the DRG-based service payment models in particular. Among others, a typical problem is the upward adjustment of DRG conditions, the so-called "up-coding" issue; the second is the service discount to the extent that no problem may be clinically observable at individual level when discharged. At the population level, however, such discounted services may lead to observable adverse effects, which may be reflected in population indicators such as readmission rates, mortality, and total cost per capita. In view of this, insurance institutions can conduct big-data analysis and performance tracking of leading health indicators of the serviced population. More importantly, such information can be published publicly on regular basis, enabling the public to "vote with their feet" to help scrutinize the service quality. A good example occurred at the end of the last century, when the mortality rate of some hospitals in New York State remained persistently higher than that of other hospitals. The traditional hospital management methods were used to improve, but little success was achieved until the state government published the health outcomes to the public, leading to a significant drop in hospital mortality. In sum, giving full play to the "voting with your feet" function of public scrutiny is an important supplement to the reform of modern hospital management and payment methods, and its role can be hardly overestimated.

This article is edited from the original Chinese article which is available here.

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