(UPDATED: See below.)

hep-logo.gifThree months ago, the California Public Employees’ Retirement Fund committed $700 million to a newly formed San Francisco private-equity firm called Health Evolution Partners, promising that the resulting investments would aim to improve healthcare efficiency and to bring down soaring medical costs. At the time, however, the partners were purposefully vague about exactly how they planned to proceed. (See our coverage here.)

Today, HEP began to outline exactly how it intends to begin transforming the healthcare system. In a speech in New York, HEP founder David Brailer, formerly national coordinator for health information technology in the Bush administration, said the fund will devote $500 million to direct investments in late-stage healthcare companies, reserving the remaining $200 million for startup investments in partnership with a syndicate of existing venture investors. In an interview with VentureBeat Life Sciences, Brailer didn’t identify any members of that venture syndicate, but said HEP would likely announce its first partner this year.

Brailer said HEP’s investments in later-stage companies will likely be in the $10 million to $80 million range, although in practice, he said, the range will likely be “tighter.” The fund doesn’t intend to make direct investments in startup firms at first, and instead plans to invest up to $100 million in venture funds raised by its syndicate partners. Over time, HEP may also co-invest another $100 million alongside its partners.

HEP plans to target its investments to companies whose services, technologies or IT strategies hold the potential to upend established healthcare practices in ways that reduce spending. “This is about getting more value out of existing spending, not increasing spending,” Brailer said.

Brailer said HEP would assess potential investments by assigning companies a “health value” score that would be calculated by a coalition of organizations “anchored” by HEP. That metric will score three main parameters — whether a company can produce cost efficiencies that won’t simply be absorbed by another component of the healthcare system; whether it is improving the efficiency of medical treatments by boosting patient compliance or by targeting treatments more precisely to the patients likely to benefit; and whether its business emphasizes giving consumers more power to make decisions about their own healthcare.

HEP plans to make those scores public for companies in its portfolio, and eventually hopes to encourage major healthcare buyers to require companies to disclose their scores as well. Brailer stressed that while high health-value scores will influence HEP’s investments, the fund still intends to emphasize traditional measures of financial performance.

Although Brailer said HEP would be open to investing in a variety of healthcare-related sectors, he said the largest efficiency opportunities appeared to lie in healthcare services, information, devices and diagnostics. Diagnostic tests, for instance, might indicate whether patients will really benefit from expensive cancer chemotherapy, potentially saving money by restricting the treatment for those most likely to respond. Some medical devices might substitute for surgery or expensive, long-term drug treatment. Information systems could make doctors more efficient and “disrupt” existing wasteful processes, Brailer suggests.

HEP doesn’t seem likely to show much interest in biotech or pharmaceuticals, however. Brailer said he considers those industries “overcapitalized” and questioned whether the heathcare system is really benefiting from a steady onslaught of pricey new drugs. “Over time, we may be asking a lot of questions about these drugs.”

Of course, another term for what HEP hopes to encourage is “healthcare rationing,” albeit a version driven by market forces and — one hopes — solid medical evidence. It’s hard not to be encouraged by an effort of this scale that aims to actually reverse the seemingly endless spiral of medical costs, which as I’ve described earlier, has no shortage of dire consequences for the average American worker. But it will be interesting to see if this sort of rationing draws anywhere near the sort of opprobrium as previous free-market efforts to rein in healthcare spending — such as, for instance, the practices of HMOs during the 1980s and 1990s.

HEP’s press release on the subject is here; a PDF background document on its strategy is here.

UPDATED: Added links to HEP’s press materials and revised slightly throughout.