Psilos Spells Out Hot Areas for Health Technology Investing

The water’s fine in the healthcare-and-technology market, and institutional investors should come on in. That’s the message from Psilos Group, a healthcare-focused venture firm based in New York City and Corte Madera, CA, in an outlook report on healthcare economics released today.

It’s the fifth annual edition of the report, and it points to four categories where the firm thinks venture investors and their limited partners should be looking for new opportunities: the rise of private health exchanges, new insurance programs designed to appeal directly to consumers, technologies for making healthcare organizations more efficient, and tools that eliminate error and waste in hospitals.

“When we began this in 2008, a lot of people didn’t really understand what was going on in the healthcare space, or what the opportunities were going to be, or why we have a philsophy of investing in products that reduce costs and improve quality,” says Al Waxman, co-founder and senior managing member at Psilos. “In fact, a number of people looked at me quizzically and said, ‘Yeah, I believe in the Easter Bunny too.’ But today, it’s almost conventional wisdom that this is a great place to invest.”

Psilos was founded in 1998, has $600 million under management, and is investing out of its third fund. It’s one of a small handful of venture firms specifically focused on the healthcare arena, which hasn’t traditionally been seen as a home for fast-growing companies.

But Psilos has had some big exits recently, notably the $435 million acquisition last May of Extend Health, a private Medicare exchange based in Richardson, TX, by professional services company Towers Watson. The firm is also a backer of SeeChange Health, a Studio City, CA-based provider of “value-based” health insurance plans that seek to reduce costs for employers by offering patients preventative services that could reduce the rate of chronic, expensive diseases like diabetes.

In the report, Psilos partners predict that the reforms built into the 2010 Patient Protection and Affordable Care Act, aka Obamacare, will prompt the creation of many more companies like Extend and SeeChange. To help connect the 32 million people who will be eligible for government-subsidized health insurance beginning in 2014 with actual medical services, scores of new insurance exchanges will be set up around the country, brokering deals between health plans and individual patients. Waxman thinks the exchanges will also attract millions of people currently covered by employer-provided insurance, as companies realize it’s more cost-effective to hand employees the money for premiums and let them choose their own plans. (General Motors, for example, said it saved $300 million a year after hiring Extend Health to help retirees handle their own Medicare enrollment.)

“The private exchanges will get commissions for helping somebody to buy insurance in a way that is most suitable to them,” says Waxman. “I think that is a good system. You are going to have a huge number of people in this space.”

But to stay competitive, both the exchanges and the insurance plans will need to invest in the best new information technology, which leads to another of Psilos’s recommended investing categories. The company says insurance companies are struggling with decades-old software that isn’t ready for the changes coming under Obamacare, including pay-for-performance reimbursement.

“If 50,000 people were to show up at United Healthcare tomorrow and say, ‘I want to buy this kind of health plan,’ it would take them 9 months to do the software changes to administer new types of benefits,” Waxman says. “That’s not reasonable. It should take a couple of weeks.”

Burlington, MA-based HealthEdge, a Psilos-backed company founded in 2006 to help big health plans overhaul their claims processing systems and other software, is now one of the fastest-growing healthcare technology firms in the country, Waxman says. “I am sure other people will become interested in the health enterprise software area,” he says.

Waxman says the Psilos report is aimed mainly at institutional investors and other deep-pocketed potential LPs who are trying to figure out whether, when, and how to invest in the healthcare business. Under SEC rules, Psilos isn’t allowed to say whether it’s begun raising a fourth fund, but it wouldn’t be unreasonable to expect that at some point. “Given what we think are the opportunities going forward, we are actively exploring what we might do,” Waxman says.

But why would investors put their money into nascent businesses like insurance exchanges and health enterprise software makers now, rather than just waiting a couple of years to see how the reforms under Obamacare alter the economics of the business?

“I think you would see that the people who invested with us even before the healthcare reforms are prospering, because we were very good prognosticators,” Waxman says. “There is going to be a fundamental transformation of the healthcare industry, and it is going to be dependent on technology. We are very good selectors of that.”

Wade Roush is a freelance science and technology journalist and the producer and host of the podcast Soonish. Follow @soonishpodcast

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