The venture industry and America's largest state pension system came together this week when it was announced that CalPERS would allocate $700 million to invest in an area of healthcare that will increasingly become a topic of concern, but has thus far been ignored by venture capital. The new fund, created by former Bush administration health official Dr. David Brailer, will look at ways to reduce the cost of healthcare.

Brailer was the administration's national coordinator of health information technology. Brailer and CalPERS turned out to be a good match. The $240 billion pension system is the third largest health purchaser in the nation.

"Our staff struggle like all health benefit purchasers to keep cost increases at bay while trying to secure better health care for our 1.2 million members," CalPERS board President Rob Feckner said during the press conference announcing the new initiative. In looking at their own health insurance needs, Feckner and CalPERS Chief Executive Officer Fred Buenrostro discovered that there may be a way for them to increase the pension system's bottom line, while lowering the cost of healthcare.

Among the fields Health Evolution Partners would look to invest in are remote monitoring of patients, management of chronic diseases, telemedicine, predictive genomics to tailor drug doses and an Internet marketplace for non-emergency medical procedures.

Health Evolution Partners will also seek to invest in healthcare services, an area in which venture capital investment has been scarce. The lion's share of investment in the healthcare area goes to biotechnology and medical devices.

"Services have always made up a very small portion of the venture capital pie," says John Taylor, research and financial affairs executive at the National Venture Capital Association. "Typically, it is about 1% to 2%." Biotechnology and medical devices make up 40% of venture capital investment in the life sciences area. 

The decision was welcomed by venture capitalists in the healthcare space, who have long considered the sector to be an inefficient one.

"David is right on. If you look at where he wants to put capital, those are the best leverage points we have today," says Kevin Kemmerer, senior vice president in the technology group at private equity firm Safeguard Scientific. Kemmerer believes the best way to reduce healthcare costs is with enterprises that treat chronic diseases.

"[The company] is going to make sure that you are taking your medicine and regulate your condition, so you never have to go the hospital," he says.

Kemmerer also sees remote monitoring, an area Brailer named as a potential area of investment, as a cost saver.

"What if you could have more remote monitoring of patients, so they don't have to come into the hospital, but you can check the vitals remotely?" Kemmerer asks. Take away hospital visits and costs will be reduced, he believes.

Mark Brooks, a managing director at Scale Venture Partners broke down the U.S. healthcare system to show the parts of it where costs could be lowered.

"The healthcare system costs $2 trillion a year and $1.5 trillion of that is in the service sector," Brooks says. Venture firms could invest in companies seeking to reduce the amount of paperwork doctors have to file, Brooks says.

"With more claims filed electronically, you could reduce the number of back office personnel you have to employ," Brooks says.

One thing Taylor, Brooks and Kemmerer all agree on is that one major government agency must be reformed before any real reduction in healthcare costs could be realized.

"The biggest obstacle in the healthcare space is that the majority of payments are done through CMS [Center of Medicare and Medicaid Services] and until they change, the market can't change," says Kemmerer. He went on to explain that CMS is such a force in America's healthcare system because the rates it charges for hospital stays and doctor visits are the ones insurance companies use to set their own prices.

The federal government is also the largest purchaser of healthcare.

"A procedure or drug can be approved by the CMS, but if they won't pay for it, doctors can't provide it as an option to their patients," says Taylor. Non-approved procedures can still be used on patients, but more than half of the user base is wiped out when Medicare and Medicaid is eliminated as a source of revenue.

There is no panacea that will solve all the problems of the healthcare system. "People are going to get sick," Kemmerer says.

The healthcare system is not going away. "All you are trying to do is lower the cost of healthcare by eliminating the waste, the fat in the system," Kemmerer says.