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

55 Pages Posted: 25 Apr 2011 Last revised: 6 May 2011

See all articles by Jason Brown

Jason Brown

Government of the United States of America - Department of the Treasury

Mark Duggan

University of Maryland - Department of Economics; National Bureau of Economic Research (NBER)

Ilyana Kuziemko

National Bureau of Economic Research (NBER)

William A Woolston

Stanford University - Department of Economics

Date Written: April 2011

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.

Suggested Citation

Brown, Jason and Duggan, Mark G. and Kuziemko, Ilyana and Woolston, William A, How Does Risk Selection Respond to Risk Adjustment? Evidence from the Medicare Advantage Program (April 2011). NBER Working Paper No. w16977. Available at SSRN: https://ssrn.com/abstract=1820089

Jason Brown

Government of the United States of America - Department of the Treasury ( email )

1500 Pennsylvania Ave., NW
Washington, DC 20220
United States

Mark G. Duggan

University of Maryland - Department of Economics ( email )

3115C Tydings Hall
College Park, MD 20742
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ilyana Kuziemko

National Bureau of Economic Research (NBER) ( email )

William A Woolston

Stanford University - Department of Economics ( email )

Landau Economics Building
579 Serra Mall
Stanford, CA 94305-6072
United States

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