How Will Risk Adjustment Work Under the Health Care Reform?

by James Kwak

I think I know what it is, and if I’m right it’s very important to health care reform, but it hasn’t gotten a lot of attention.

Risk adjustment is the solution to the following problem. Imagine you tell all the health insurers that they have to accept the healthy and the sick, and they have to charge each the same insurance premium. You may not have to imagine for much longer; this is at the core of all the proposed health care reform bills. (In the Finance Committee bill you can discriminate based on a small number of factors, like age and tobacco usage, but that’s it.)

If you’re a profit-maximizing insurer, what do you do? You try to cherry-pick the healthy, since the revenues will be the same as for the sick and the costs will be lower. If you can do this successfully — say, by only advertising in gyms and in Runner’s World, or maybe by offering additional benefits that only the healthy will want — then you can dump the sick on someone else. That someone else will eventually (after all the private insurers get smart or go out of business) be the public option or the non-profit cooperative, whichever we end up with, which will end up losing money; the net effect is a transfer from taxpayers to private insurers. Now, the fact that insurers participating on exchanges have to take everyone should mitigate this problem, but it won’t go away. In effect, insurers will compete by marketing in ways that attract the healthy and hide from the sick, instead of competing to offer better health care at lower cost.

Risk adjustment is a transfer mechanism whereby money flows in the reverse direction, from insurers with healthy customers to insurers with sick customers. It requires some means of calculating the expected healthiness of a pool of people and the fair transfer payment. You can’t (I don’t think) base your transfers on actual healthiness, because then you are penalizing insurers that are actually good at making people more healthy. So the transfers need to be based on some measure of how sick the customers were when the insurers got them at the beginning of the year.

I haven’t found much on the blogs (maybe I’m reading the wrong blogs); when I searched Ezra Klein, my first resource on health care, for “adjustment,” I only came up with these three posts. What I really want to know is how risk adjustment will work under our proposed health care reform. But in the Baucus Bill, this is all I found:

“Risk-adjustment. All plans in the individual and small group markets would be subject to the same system of risk-adjustment. Risk-adjustment will be applied within rating areas (described below).

“The Secretary would be required to pre-qualify entities capable of conducting risk-adjustment and the states would have the option to pick among those entities. The entities pre-qualified by the Secretary cannot be owned or operated by insurance carriers. The Secretary of HHS would define qualified risk-adjustment models which can be used by states. States can also choose to develop their own risk-adjustment model but it must produce similar results and not increase Federal costs. After risk-adjustment is applied, reinsurance and risk corridors (described below) would apply.”

So it seems like the government will designate certain organizations that are allowed to do the risk adjustment calculations, and states can pick between them. (This reminds me of nationally recognized statistical rating organizations, but that’s perhaps an overreaction.)

There is also a reinsurance mechanism under which all insurers in a state have to pay an amount proportional to their insurance premiums into a reinsurance fund, which then pays out to insurers based on how many high-risk customers they have. That is probably a good thing, but it only applies for three years (2013-2015), and it doesn’t eliminate the incentive to cherry-pick; since contributions into the fund do not come from insurers with disproportionately healthy customers, you are still better off attracting the sick.

The overall goal here is to channel private-sector competition in a socially beneficial way. It does seem simpler to just have a single payer and be done with it (then you don’t need any of these rules), but the basis of our proposed system is getting insurers to compete in some ways (lower administrative costs, lower medical costs through intelligent use of negotiated payment schedules) and not in other ways (cherry-picking). As far as I can tell, the bill points in the right direction, but it still seems terribly vague to me. Am I just missing something that’s in a different part of the bill?

Comments

[John Lounsbury:]

James - - -

You are not missing much. There is a lot missing in what is being proposed that could focus on (1) coverage for everyone and (2) reducing costs. I have written several pieces on this topic. My surprising conclusion is that one very credible solution involves more direct government involvement AND more individual responsibility for each paying directly for their own health care expenses.

The health care system we have today, and the one that is apparently being perpetuated, is not an insurance system. It is a pre-paid health care process. Real insurance protects against unusual events, not everyday visits to the doctor. If we had an insurance system, insurance benefits would pay for medical expenses only above customary and usual annual expenses, say 10% or 15% of AGI. Up to that point, individuals would pay out of pocket.

This would produce a dramatic reduction in health care expenses. Much of the 30-35% of health care dollars that today go to administrative costs and unnecessary tests and treatments would be saved.

There are a lot of details like how to subsidize those in or near poverty, and how to subsidize insurance premiums for the same group. But going back to doctor/patient decisions determining everyday medical procedures is something that is fundamentally needed, in my opinion.

Finally, if doctors were compensated based on results rather than procedures, a lot of unnecessary expense could be eliminated. We would have to guard against adverse selection by doctors (cherry picking healthy patients and rejecting those with complicated conditions), just like we have to deal with insurance companies with similar practices today. I think this would be a more manageable problem with doctors than insurance companies.

These are just more thoughts related to risk-adjustment.

Oct 14 05:44 PM

[Reformwatcher:]

The risk-adjustment description in the Baucus Mark (it's not actually a bill yet) is vague, but there is a thriving industry in risk-adjustment mechanisms that could be put to use right away. The concept they all have in common is that an individual's relative risk level can be "scored" by using information about his/her medical services utilization to assign medical conditions and severity levels. Each insurer's block of business can then be "scored," and premiums can be shuffled around in a zero-sum game. As long as the total premiums are adequate, this zero-sum game will keep all the insurers solvent. The adjustments are not perfect, but the intent is to make the insurers neutral about signing up sick v. healthy customers.

The 2013-2015 reinsurance mechanism is intended to keep the first few years of community-rated (non-underwritten) individual insurance from becoming totally chaotic. With the relatively weak individual coverage mandate in the Baucus Mark, individual insurers will be selling policies to lots of people who are already sick without being able to balance that with enough policies to healthy people. Therefore the average premiums will be inadequate. The reinsurance mechanism (funded by assessments from all health plans, including group insured plans and self-funded plans) is intended to raise enough money to compensate individual insurers for some of the high costs of these newly-insured sick people.

Oct 16 04:49 PM

[User 67440:]

In broad terms, workers' compensation insurers incur greater expense for medical care of injured workers than they do for permanently adjudicated disability indemnity. In essence, the workers' compensation systems have become de facto health insurers. A significant portion of claims (e.g. lower back injury) could and would be treated under health insurance if the workers had such coverage and were otherwise disposed to get back to work.

Medicare and Social Security Disability bureaucrats have become much more aggressive in seeking set asides from long term workers' compensation awards and it seems likely that more scrutiny of the stand alone, expensive and sometimes duplicative workers' compensation systems will be in order. With the proposed health care changes reaching to a near national insurance scheme what impact do you see on workers' compensation systems? Will a national health insurance scheme cause a shift away from medical care delivery under workers' compensation?

Oct 18 10:38 AM

[mark Tierney:]

Risk adjustment is the key to health care reform. A Plan's decision to participate in the exchange will be 100% dependent on their opinion of the quality and accuracy of the risk adjustment methodology. While the science around risk adjustment has advanced a great deal over the past decade it remains complicated with issues around; data access, data confidentiality, technical application and timeliness. I too find it hard to understand how little attention has been paid by those drafting the legislation to this critical element in the health care reform puzzle.

Nov 13 03:24 PM