The move to privatize Medicaid services is enabling a small group of managed-care companies to capitalize on the growing readiness among venture capitalists to invest in healthcare companies.
Catching a ride on the waves of the two surging trends are companies such as Americaid Community Care, based in Virginia Beach, Va. Formed in October 1994, Americaid has rounded up $24 million from venture capitalists to begin its operations as a managed-care company specializing in providing services to Medicaid beneficiaries.
The start-up HMO is now working to secure state Medicaid contracts and establish provider networks in Chicago; Newark, N.J.; Fort Worth, Texas; San Antonio; and other cities where it has identified high concentrations of Medicaid recipients and opportunities to partner with healthcare providers, said Jeffrey McWaters, Americaid chief executive officer.
"Today the government has 90% market share, and (the states) want to get out of the Medicaid business," McWaters said. "The states are interested in companies with our expertise. We're creating an urban HMO product."
Sage Givens, managing partner for San Francisco-based Acacia Venture Partners, led two rounds of financing for Americaid. "We think that the targeted Medicaid market is untapped," she said. "The market is wide open right now."
Industry observers estimate that 10 to 12 Medicaid HMOs have similarly secured financing from venture capitalists. One of the first to make a big splash was Philadelphia-based OakTree HealthPlan. By the end of 1993, OakTree had raised about $7 million from the Sprout Group, New York; Oak Investment Partners, Westport, Conn.; Marquette Venture Partners, Deerfield, Ill.; and Delphi Ventures, Menlo Park, Calif.
After about 18 months spent obtaining licenses and establishing a provider network, OakTree opened its doors and eventually signed up more than 30,000 enrollees. Then in April 1995, Norwalk, Conn.-based Oxford Health Plans acquired OakTree for $66 million.
As a result of the sale, the Sprout Group saw its initial investment of $3.5 million turn into a $45 million windfall, said Richard Kroon, managing partner of the Sprout Group, which is the venture capital affiliate of New York-based Donaldson, Lufkin & Jenrette.
Other venture capitalists also have picked up on the potential for such textbook success stories. "We saw Medicaid as virgin territory for HMOs," said James Hoover, general partner at Welsh, Carson, Anderson & Stowe in New York. "It presented an opportunity to build new plans."
Hoover's firm, along with the Texas-based Calver Fund, invested $30 million in May 1995 in Physicians Healthcare Plans. Today, Welsh, Carson is the largest shareholder of the Tampa, Fla.-based HMO, which has about 45,000 Medicaid enrollees and 10,000 commercial enrollees.
Such start-ups are beginning to nip at the heels of more established managed-care companies that have expanded to serve Medicaid beneficiaries.
For example, Minneapolis-based United HealthCare Corp. has enrolled more than 400,000 Medicaid beneficiaries in 11 states where it has acquired health plans with Medicaid enrollees or where its local plans have contracted directly with the states.
Despite a lack of existing infrastructure and seemingly incongruous goals of keeping Medicaid patients healthy and high-stakes venture capitalists happy, more entrepreneurs are likely to bet that the Medicaid managed-care market is big enough and lucrative enough for them to find a niche.
"That type of investor-driven start-up is emerging because states are putting enormous sums of Medicaid money on the table for the managed-care industry," observed Joel Menges, vice president at Lewin-VHI, a Fairfax, Va.-based research and consulting firm.
"Wall Street goes where the money is, and there are believed to be significant growth opportunities in the Medicaid managed-care market," Menges said.
The Medicaid population as a whole represents a market of more than 36 million enrollees with $157 billion in government money to spend each year. A growing number of these potential customers have been joining managed-care plans.
At the end of June 1995, 32.1% of Medicaid recipients were enrolled in managed-care plans compared with 9.5% in 1991, according to the Medicaid Managed Care Enrollment Report prepared by HCFA.
To keep up with the demand, more HMOs have been participating in federal programs. According to the 1995 National Directory of HMOs published by the Group Health Association of America, 32% of HMOs were providing care to Medicaid beneficiaries in 1994, compared with 19% in 1988.
All this activity attracted the attention of venture capitalists. In return for their investment in high-risk start-up companies hungry for capital and positioned to leverage new technologies or new approaches in a growing market, they receive an ownership stake in the company.
"In healthcare, healthcare services are the bright light for venture capitalists because of tremendous changes and the ability to achieve scale fast," said Rolf Selvig, marketing director at VentureOne Corp., a San Francisco-based research firm. "The healthcare companies have a need for the skills of the venture capitalists. They understand what is required to help a company grow at tremendously high rates."
According to VentureOne, venture capitalists sank $314.5 million into 61 deals involving healthcare services companies during 1995. The numbers represent a rebound from a dip in 1994 when 45 deals worth $241.1 million were completed.
Hoover speculated that more venture capitalists would be earmarking their money for specialized Medicaid HMOs if the regulatory landscape were easier to navigate.
In particular, Hoover said investors and entrepreneurs should not underestimate the challenge of meeting the so-called "75-25 test." Under federal regulations, an HMO serving the Medicaid population also must have at least 25% commercial enrollees.
"One shouldn't go into the business with the narrow view that they're going to be a large Medicaid HMO," he said. "One needs to address the requirement to succeed as a commercial HMO, or you could be digging yourself into a hole."
In addition, Hoover said, stakeholders should evaluate opportunities on a state-by-state basis and prepare for overnight regulatory changes at both the federal and state levels.
Neva Kaye, operations manager for the Medicaid managed-care resource center at the National Academy for State Health Policy in Portland, Maine, further advises for-profit start-up companies to look for states with new Medicaid managed-care programs and low HMO penetration, where competition from companies with longstanding contracts would be minimized. States such as Delaware, Georgia and Indiana, as well as the District of Columbia, might be appealing for those reasons, she said.
Despite the risks, some early measures of the financial performance of Medicaid HMOs may help investors rest a little easier. "Medicaid managed-care in the aggregate is not a bad business to be in," Menges said. "It's as good or better than serving the private sector."
According to Lewin-VHI, the average medical loss ratio for high-volume Medicaid HMOs is 80.5%. This means 80.5% of revenues is paid out to healthcare providers and 19.5% of revenues is left to cover administrative costs and count for profits. The average medical loss ratio for all HMOs is 83%, leaving 17% for administrative costs and profits.
However, Menges said that "what is going on beneath those numbers is not well-defined yet." He cautioned that the combination of Medicaid and venture capital could increase pressure on companies to produce high returns.
"Concerns are often raised that profit-driven, growth-driven corporations lack the needed commitment to serve the Medicaid population effectively," Menges explained. "There's not much room to save money on price due to the low underlying Medicaid reimbursement structure. The danger of Medicaid managed care is that in the worst-case scenario, the savings are realized through a redistribution of money through a series of capitation contracts that in and of themselves do not do anything to improve access or outcomes."
While the concept of an investor-driven managed-care company specializing in Medicaid may be relatively untested, some providers are willing to give them a chance.
Russell Tolman, president of Cook-Fort Worth Children's Medical Center, reviewed Americaid's proposal to win one of the Texas Medicaid contracts now up for grabs in his county's Medicaid managed-care demonstration project.
Tolman said he liked that Americaid is offering a special expertise in Medicaid services. He downplayed the profit-motivation issue.
"Every for-profit HMO runs that risk," Tolman said. "The existing Medicaid system has been patched together over several years. The vast majority of Medicaid patients have been taken care of in emergency rooms. Any system that provides a medical home for these individuals would be positive."