The Structure of Risk Adjustment for Private Plans in Medicare

Medicare bases its risk adjustment method for Medicare Advantage (MA) plan payment on the relative costs of treating various diagnoses in traditional Medicare. However, there are many reasons to doubt that the relative cost of treating different diagnoses is similar between MA plans and traditional Medicare, including the varying applicability of care management methods to different diagnoses and the varying degrees of market power among suppliers of services to plans.

Researchers recently used internal cost data from a large health plan to compare its cost of treating various diagnoses with Medicare’s reimbursement. The research, published in the June issue of the American Journal of Managed Care, found substantial variability across diagnoses, implying that the current risk adjustment system creates incentives for MA plans to favor beneficiaries with certain diagnoses, but it found no consistent relationship between the costliness of the diagnosis and the difference between reimbursement and cost.

For a quarter of a century, Medicare has risk adjusted its payments to private plans that accept at-risk contracts and participate in Part C of the Medicare program, now known as MA. Risk adjustment means Medicare pays plans more for enrollees who are expected to use more services and less for enrollees who are expected to use fewer services, thereby better matching enrollee reimbursement to expected use and, most important, minimizing plan incentives to select against the sick. For example, Medicare pays more for a beneficiary with cancer than for a beneficiary with no chronic disease.

“Medicare’s initial risk adjustment system, introduced in 1985, accounted for only the enrollee’s age, sex, county of residence, institutional status, Medicaid eligibility (for the noninstitutionalized), and whether a working beneficiary had employment-based insurance that was primary,” the authors wrote. Although Medicare paid plans more for enrolling older beneficiaries than younger beneficiaries, reflecting their greater medical spending, the risk adjustment system at that time included no direct measures of health status.

“Without adequate risk adjustment, a plan could make money by attracting low-cost healthy beneficiaries with a tightly managed low-premium product, whereas a plan enrolling high-cost beneficiaries would not be paid commensurately more and could lose money,” according to the article.

According to the researchers, the Centers for Medicare and Medicaid Services—Hierarchical Condition Categories (CMS-HCC) system that Medicare uses to reimburse health plans establishes relative prices for different diagnoses based on fee-for-service system data. This makes the implicit assumption that health plans reduce costs equiproportionately across diagnoses.

This article tests that assumption. “We overwhelmingly reject that the relative cost of diagnoses in the health plans in our sample is the same as that in the CMS-HCC. The magnitude of the errors is large, exceeding 100% for some HCCs. This is particularly true for uncommon conditions for which certain providers have substantial market power but Medicare uses lower administered prices,” the authors concluded.

SourceThe Structure of Risk Adjustment for Private Plans in Medicare [The American Journal of Managed Care]