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How Does Risk Selection Respond to Risk Adjustment? New Evidence from the Medicare Advantage Program

Jason Brown, Mark Duggan, Ilyana Kuziemko, William A Woolston

American Economic Review · 2014 · 266 citations · 39 references

Open access

TL;DR

Governments increasingly base payments to health plans on enrollees' risk‑adjustment scores to combat adverse selection, but higher scores can also incentivize enrolling overpriced individuals whose costs fall below predictions due to increasing cost variance with mean. In 2004, Medicare began to risk‑adjust capitation payments to private Medicare Advantage plans to reduce selection‑driven overpayments. After risk adjustment, MA plans enrolled higher‑scoring individuals whose costs were lower than predicted, and the study found no net reduction in overpayments. JEL classifications: G22, H51, I13, I18.

Abstract

To combat adverse selection, governments increasingly base payments to health plans and providers on enrollees' scores from risk-adjustment formulae. In 2004, Medicare began to risk-adjust capitation payments to private Medicare Advantage (MA) plans to reduce selection-driven overpayments. But because the variance of medical costs increases with the predicted mean, incentivizing enrollment of individuals with higher scores can increase the scope for enrolling “overpriced” individuals with costs significantly below the formula's prediction. Indeed, after risk adjustment, MA plans enrolled individuals with higher scores but lower costs conditional on their score. We find no evidence that overpayments were on net reduced. (JEL G22, H51, I13, I18)