A demand-side view of risk adjustment

Perverse Incentives in the Medicare Prescription Drug Benefit

This paper analyzes some of the perverse incentives that may arise under the current Medicare prescription drug benefit design. In particular, risk adjustment for a standalone prescription drug benefit creates perverse incentives for prescription drug plans when making coverage decisions and/or for pharmaceutical companies when setting prices. This problem is new in that it does not arise with risk adjustment for other types of health care coverage. For this and other reasons, Medicare's drug benefit requires especially close regulatory oversight, now and in the future. We also consider a relatively minor change in financing the benefit that could lead to significant changes in how the benefit functions. In particular, if all plans were required to charge the same premium, there would be less diversity in quality, but also less need to regulate formulary composition, less budgetary uncertainty, and less upward pressure on drug prices.

Employer contribution methods and health insurance premiums: does managed competition work?

We derive a two-stage model in which health plans first compete to be selected by employers and subsequently compete to be chosen by employees. We identify the key determinants of competition and show that increasing competition at one stage often comes at the expense of competition at the other stage. Many economists and policymakers have argued that in order to increase competition among health plans, employers should offer multiple plans and structure premium contributions to make employees more price sensitive. While our theoretical model shows that following this policy prescription may not actually lead to lower premiums, our empirical analysis provides some support for this recommendation. We also find that if employers instead pay the full premium, premiums increase when they offer additional plans. These results have important implications for both employers and policymakers.

Having it all: national benefit equity and local payment parity in Medicare

The Medicare Payment Advisory Commission (MedPAC) has identified two important problems with the Medicare+Choice (M+C) program: nationwide geographic inequity in government-financed benefits, and unequal government payments for M+C plans versus fee-for-service (FFS) Medicare in the same market area. MedPAC concludes that both problems cannot be solved simultaneously. We argue that both problems could be solved if Congress discontinued its policy of underwriting the cost of FFS Medicare. Instead, Congress should define a national entitlement benefit package and have all health plans submit bids on the package in each market area. The government's premium contribution should be equal to the lowest bid submitted by a qualified health plan in each market area. The contribution could be adjusted for health risk, the special obligations of FFS Medicare, and welfare enhancements associated with FFS Medicare that are valued by both beneficiaries and taxpayers but unrelated to beneficiaries' health status.

Why don't private employers use risk adjustment? Conference overview

In spite of advice from some researchers, private employers do not use formal risk adjustment to pay health plans. A conference, “Private Employers and Risk Adjustment,” was held in February 2000 to consider the meaning of employers' actions. This overview introduces the papers written for that conference.

Formal risk adjustment by private employers

This paper explores explanations for why few private employers have adopted formal risk adjustment. The lack of data, challenges of using highly imperfect signals, and absence of market power are not compelling explanations. Alternative strategies that reduce selection problems are clearly important. The central argument is that U.S. health markets are not in equilibrium, but rather are changing rapidly. Since many agents-consumers, employers, health plans, and providers--do not currently demand formal risk adjustment, it is not surprising that adoption has been slow. Recent changes in health plan markets may change the demand and accelerate future adoption.

The prevalence of formal risk adjustment in health plan purchasing

This paper describes the prevalence of formal risk adjustment of payments made to health plans by Medicare, Medicaid, state governments, and private payers. In this paper, 'formal risk adjustment" is defined as the adjustment of premiums paid to health plans based on individual-level diagnostic or demographic information. We find that formal risk adjustment is used for about one-fifth of all enrollees in capitated health plans. While the Medicare and Medicaid programs rely on formal risk adjustment for virtually all their health plan enrollees, the practice is used for only about 1% of privately insured health plan enrollees. Ourfindings raise the question of why regulators have adopted formal risk adjustment, but private purchasers for the most part have not.

Private employers don't need formal risk adjustment

This paper lays down a set of hypotheses to explain why private employers do not use formal risk adjustment. The theme running through these hypotheses is simple: private employers don't need formal adjustment because they have better tools for dealing with adverse selection than formal risk adjustment provides. Open enrollment provisions, premium negotiations, and restricting employees' choices of health plans are mechanisms superior to formal risk adjustment for dealing with problems caused by adverse selection.

Designing employer health benefits for a heterogeneous workforce: risk adjustment and its alternatives

Many health economists recommend that employers provide employees with a risk-adjusted choice among competing health insurance plans. However, formal risk adjustment is rarely if ever used by employers. This paper examines a range of health benefit design options available to employers, focusing attention not only on risk adjustment but also on its alternatives. We argue that while formal risk adjustment is rare, employers commonly use strategies that accomplish some of the same objectives at less cost.