Understanding China's Dual-Track DRG DIP Provider Payment Reform

China has undergone a significant transformation in its healthcare system in recent years. One central area of reform has been the payment system for public hospitals. Many misaligned incentives, particularly a fee-for-service (FFS) model, drove Chinese hospitals and physicians to overprescribe expensive drugs and imaging services, leading to a double-digit escalation of health expenditure for more than two decades.

In response to growing concerns about soaring out-of-pocket expenses for Chinese patients and the long-term sustainability of public insurance funds, the Chinese government has been piloting alternative payment methods to rein in medical costs at public hospitals since 2009. In 2019, the National Healthcare Security Administration (NHSA) officially launched the national Diagnosis Related Group (DRG) pilot program, and in 2021, the national Diagnosis Intervention Packet (DIP) pilot program. As of early 2022, the actual payment of DRG pilot cities has covered more than 900 medical institutions, with a coverage rate of 43.5% for tertiary hospitals. In a November 2021 policy directive, “Three-Year Action Plan for DRG/DIP Payment Reform,” the NHSA envisions that the twin payment mechanisms will scale up to the entire country by the end of 2025.

These reforms have significant implications for the healthcare industry and its key stakeholders in China.

In the first part of this comprehensive series, we will delve into the unique challenges that the implementation of Diagnosis Related Group (DRG) faces in China, the key differentiators between the DRG and Diagnosis Intervention Packet (DIP) systems, and the rationale behind China's decision to adopt a twin-payment method instead of a single DRG rollout.

Part two will examine how the payment reform aligns with China’s broader healthcare goals and its immediate and long-term impact on public hospitals, commercial health insurers, and innovative drug and device manufacturers.

DRG Background

What is a DRG system?

First introduced in the US in 1983 to control hospital spending under the Medicare program, DRGs classify inpatients into groups that are clinically coherent and financially similar based on their principal and secondary diagnoses, the procedures performed, and other factors that may affect the cost of care such as age, sex, the presence of co-morbidities and complications.

Each DRG group is then assigned a weight representing the average cost of treating a patient in that group relative to the average cost of treating all patients. This weight is used to calculate a pre-determined payment amount hospitals will receive for treating a patient in that DRG, regardless of the actual cost incurred by hospitals. Thus, the DRG model shifts the financial risk to hospitals and encourages the efficient use of medical resources.

Pre-requisites for implementing an effective DRG system

Three factors influence the quality of a DRG system implementation.

First, the availability of quality clinical and cost data. To approximate DRG payments to the actual costs of care, quality clinical and cost data for a broad spectrum of services must be collected across a large sample size of hospitals. This makes standardized treatment patterns and adequate electronic medical record (EMR) systems critical to establishing DRGs.

Second, building the right incentives into the DRG system is crucial in inducing the desired provider behavior. For instance, DRG payments must cover all costs, including adequate compensation for physicians and nurses. Otherwise, hospitals and doctors will find other avenues to charge patients for services not covered under DRG payments.

Third, an effective governance structure must be in place to monitor how providers respond to the system incentives and spot unexpected provider behavior, often supported by a robust digital infrastructure and analytical capabilities.

Challenges for DRG Implementation in China

The establishment of NHSA in 2018 has put into place a powerful regulatory apparatus overseeing China’s provider payment reform. In contrast to the earlier reform pilots in the last decade, NHSA now owns a powerful information system – connected to its local offices and all social medical insurance designated hospitals. This big data platform enables policymakers to monitor local implementation for learning and evaluation closely.

Despite this strong governance apparatus, China faces two challenges to a national-wide DRG rollout.

First, sizeable regional diversity limits the availability of quality clinical and cost data.

The income disparity across different regions in China implies significant variations in treatment patterns, care quality, EMR system penetration, and cost of living across China. For instance, by 2018, the penetration rate of EMR at Chinese hospitals is less than 40%. This makes collecting quality clinical and cost data across a diverse large sample of hospitals over a long period difficult.

In comparison, when the US started the DRG implementation in 1983, there were 20 years of Medicare cost data, representing 40 percent of the country’s healthcare expenditures.

Second, legacy medical services pricing issues remain.

Public hospitals in China mainly rely on three sources of income: payments through basic medical insurance, co-payment by patients, and state subsidies. However, prices for medical services are set by provincial governments based on hospital expenses, mainly pharmaceuticals, medical consumables, and labor costs, with drugs and medical consumables accounting for the lion’s share.

Most hospitals’ revenue barely meets their expenses, mainly due to underestimation of labor costs. Inadequate physician compensation is one of the main factors that has led doctors to overprescribe expensive pharmaceuticals and imaging procedures to generate additional income under the fee-for-service model.

DRG payments must factor into adequate physician compensation to effectively deter this wasteful behavior. Otherwise, hospitals and doctors will find other ways to charge patients for services not covered under the DRGs.

The dual-track payment systems DRG and DIP

In 2020, policymakers concluded that full implementation of the DRG system across China was not feasible based on an interim evaluation of the DRG pilot.

At this juncture, DIP, an alternative case-based payment mechanism combined with regional global budget control for inpatient services, emerged from local experiments first in Guangdong Province. DIP differs from DRG as follows:

1. Simpler Patient Classification. DIP classifies inpatients based on the principal diagnosis codes and the principal procedure codes. Unlike DRG, it does not consider demographic factors such as age or sex. This means DIP has lower data quality and quantity requirements than DRG and is more suitable for less developed regions in China.
2. Larger Number of Groups. DIP creates approximately 13000 DIP groups. In contrast, the number of DRG groups is typically in the hundreds. Due to China’s sizeable regional diversity, the DIP system will better mirror the actual clinical practices and associated resource consumption in China than DRG.
3. Ex-Post Payment Combined with Regional Global Budget Control. Unlike the DRG mechanism, where payment for each inpatient case is fixed, the DIP payment scheme includes a price adjustment mechanism. Each DIP group is assigned a fixed number of points reflecting its prefecture-wide resource utilization relative to different groups. However, the monetary value for each point is floating, depending on the pre-determined prefecture medical insurance budget and the point sum of all inpatient cases. Therefore, the annual reimbursement for each hospital is determined ex-post, dependent on its own service volume, the service volume rendered by other hospitals, and the regional medical insurance budget.

In essence, the DIP provider payment system is less technically demanding than the DRG system and can be more easily expanded. The DIP system can better represent actual clinical practices and resource utilization in a large and diverse country like China through a much larger number of DIP groups combined with a price adjustment mechanism. At the same time, pegging price adjustments to the regional global budget helps safeguard the social medical insurance funds.

Implementing DRG and DIP reforms simultaneously in China is a pragmatic and innovative approach that acknowledges the significant disparities in financial, clinical, technological, and managerial capabilities across different regions' health systems. However, the effectiveness of these payment reforms may be limited until China’s physicians receive fair compensation for their services.

In our next article, we will examine how the payment reform aligns with China’s broader healthcare goals and its profound impact on public hospitals, commercial health insurers, and innovative biopharmaceutical and device firms in the near and long term.

References:

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