Strategic Cross Subsidization in Healthcare Capitation Programs: Evidence from Medicare Advantage

Abstract

Problem definition: This study identifies a resource misallocation problem in Medicare Advantage (MA), the U.S.'s largest healthcare capitation program, which may result in discrepancies between patients' health status and the healthcare resources allocated to them.

Methodology/results: Utilizing a large commercial insurance database with claims from over 2 million MA enrollees, this research investigates the allocation of MA capitation payments. The findings reveal that MA inadvertently encourages health plans to reallocate portions of the capitation payments intended for one group of patients to another group of patients, a practice known as strategic cross subsidization. By exploiting an exogenous policy shock on MA capitation payments through a Difference-in-Difference (DID) design, we identify, for the first time in the literature, this cross subsidization practice. Additionally, we show that the strategic cross subsidization practice is associated with the risk selection problem in MA, where low-risk patients are more likely to enroll in MA compared to high-risk patients.

Managerial implications: This research uncovers a previously undocumented healthcare resource misallocation problem, i.e., strategic cross subsidization. U.S. law explicitly prohibits this practice due to its exacerbated effect on the undesired risk selection problem and healthcare inequality in capitation programs. To alleviate the identified strategic cross subsidization behavior, increased transparency in MA claims data and heightened attention from healthcare payers and policymakers are needed.

Note:
Funding declaration: None to declare.

Conflict of Interests: None to declare.

Keywords: healthcare markets, capitation payment models, health plans, risk selection, Medicare Advantage

JEL Classification: H51, I13, I18