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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, and William Woolston
American Economic Review. Oct 2014, Vol. 104, No. 10: Pages 3335-3364

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

Jason Brown1, Mark Duggan2, Ilyana Kuziemko3 and William Woolston4

1US Treasury, Office of Economic Policy, 1500 Pennsylvania Avenue NW, Washington, DC 20005 (e-mail: )

2Department of Economics, Stanford University, 579 Serra Mall, Stanford, CA 94304 (e-mail: )

3Department of Economics, Princeton University, 322 Wallace Hall, Princeton, NJ 08544 (e-mail: )

4J.P. Morgan Chase, 270 Park Avenue, New York, NY 10017 (e-mail: ).

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)