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

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  • Jason Brown
  • Mark Duggan
  • Ilyana Kuziemko
  • William Woolston

Abstract

Governments often contract with private firms to provide public services such as health care and education. To decrease firms' incentives to selectively enroll low-cost individuals, governments frequently "risk-adjust" payments to firms based on enrollees' characteristics. We model how risk adjustment affects selection and differential payments---the government's payments to a firm for covering an individual minus the counterfactual cost had the government directly covered her. We show that firms reduce selection along dimensions included in the risk-adjustment formula, while increasing selection along excluded dimensions. These responses can actually increase differential payments relative to pre-risk-adjustment levels and thus risk adjustment can raise the total cost to the government of providing the public service. We confirm both selection predictions using individual-level data from Medicare, which in 2004 began risk-adjusting payments to private Medicare Advantage plans. We find that differential payments actually rise after risk adjustment and estimate that they totaled $30 billion in 2006, or nearly eight percent of total Medicare spending.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16977.

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Date of creation: Apr 2011
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Handle: RePEc:nbr:nberwo:16977

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  1. Van de ven, Wynand P.M.M. & Ellis, Randall P., 2000. "Risk adjustment in competitive health plan markets," Handbook of Health Economics, in: A. J. Culyer & J. P. Newhouse (ed.), Handbook of Health Economics, edition 1, volume 1, chapter 14, pages 755-845 Elsevier.
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Cited by:
  1. Raj Chetty & Amy Finkelstein, 2012. "Social Insurance: Connecting Theory to Data," NBER Working Papers 18433, National Bureau of Economic Research, Inc.

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