The Centers for Medicare and Medicaid Services (CMS) are revising the rules on how to reimburse Medicare and Medicaid inpatient medical expenses, a move that could make it costly for doctors and hospitals to use innovative medical devices. VCs fear the new rules may prevent their startups from earning sales and going public.
The reimbursement rule changes are designed to cut the taxpayer costs associated with Medicare and Medicaid, an increasingly pressing problem as the population ages and baby boomers head into retirement. The CMS helps determine what medical devices and procedures give patients the most bang for the taxpayer’s buck.
“It’s based on keeping down budgets, not necessarily giving people the best care,” says Rob Kuhling, a general partner at Onset Ventures. “You want to look at long term benefits in health care, but payers look at short-term costs.”
Kuhling and other med tech investors have more than just a passing interest in the proposed rule changes. Venture firms pumped $617 million into 58 medical device startups during the second quarter of 2006, which accounted for about 9% of all venture activity during the period, according to Dow Jones VentureOne. Kuhling is afraid VCs will forgo investments in innovative companies that build devices that significantly improves patient outcomes but are more expensive than a “good enough” alternative.
One example is Charité, an artificial disk made by DePuy Orthopaedics in Warsaw, Ind., that could be used to supplant spinal fusion in some patients. Spinal fusion can greatly reduce a patient’s range of motion, but implanting a Charité disk can be expensive. CMS ruled that the device did not improve Medicare and Medicaid patient health enough to justify the additional cost, says Kuhling, who has not invested in DePuy, which is a Johnson & Johnson spinout. DePuy has published a 24-page set of guidelines to help patients get the device covered by their insurers and encourages them to write to their senators and representatives.
While DePuy is working to make improvements to an existing treatment, startups such as Neuronetics are trying completely different approaches to treating diseases. Neuronetics is building a medical device that doctors can use in their offices to treat patients who suffer from depression. The device uses magnets to stimulate parts of the brain. It’s a painless procedure that doesn’t have some of the side effects associated with antidepressants.
But what the company does won’t be covered by CMS, at least not initially, Kuhling says. The new treatment is too different from existing devices and procedures. But Onset, along with InterWest Partners, Quaker BioVentures and Three Arch Partners put more than $75 million behind the company in three rounds. Kuhling says he thinks the company’s device will eventually win approval from CMS, but keeping it going until then will be expensive—especially without a robust public market to turn to.
The IPO aftermarket has not been kind to med tech companies this year. Four medical device companies have gone public this year, raising more than $225 million from their offerings. Each of the four was trading below its offering price last week. Northstar Neuroscience (Nasdaq: NSTR) opened at $15 on May 5, and was trading below $12 a share last week; Viscusi (Nasdaq: EICU) opened at $16 on April 4 and was down to just over $12; Iomai Corp. (Nasdaq: IOMI) opened at $7 on Feb. 1 and was down to $3.85; and Cardica Inc. (Nasdaq: CRDC) opened at $10 on Feb. 2 and was down to $4.50 last week.
CMS has responded to some technologist’s complaints about the lack of funds for innovative treatments. The organization provides temporary add-on payments for technologies that are less than three years old and substantially improve clinical outcomes for the Medicare community. One such beneficiary of these add-on payments is St. Francis Medical Technologies, maker of the X STOP Interspinous Process Decompression System. The X Stop device relieves pain, numbness and weakness caused when spinal nerves are compressed. St. Francis Medical has raised $28 million from Essex Woodlands Health Ventures, U.S. Venture Partners and Versant Ventures.
Other investors are less worried. “I don’t think the CMS reimbursement schedule for one or two products is going to affect the overall market for medical devices,” says John Lonergan, founder of Mach Ventures. He says that most procedures and medical devices will still be covered and that doctors and hospitals will still use them, even at reduced rates. Lonergan is currently raising $150 million for an early stage fund focused on medical device startups and hasn’t had any trouble securing LP interest. He expects to have a first close later this fall.
“Devices improve patient outcomes, reduce chronic pharma prescriptions and replace expensive surgery,” he says. “These factors won’t go away.”