This study uncovers a novel selection mechanism in Medicare Advantage driven by beneficiaries’ private health perceptions, revealing how MA firms exploit this in plan design to attract profitable enrollees, shedding light on the welfare consequences of imperfect risk adjustment.


This paper explores plan design and selection mechanisms under risk adjustment in Medicare Advantage (MA), unveiling a novel selection mechanism that leverages beneficiaries’ private health perceptions. In this government-subsidized market, firms’ primary revenue comes from risk-adjusted capitation payments. However, existing risk adjustment methods do not completely neutralize selection biases. Our findings suggest that individuals with optimistic health perceptions tend to be systematically overcompensated, and this heterogeneity in health perceptions drives plan choice. This incentivizes MA firms to design their offerings in ways that attract such individuals, thereby boosting profitability. Our analysis demonstrates how MA firms can feasibly engage in favorable selection on a large scale, even within a tightly regulated environment, elucidating the observed high profit margins, overpayments, and the prevalence of low-premium, low-generosity in MA plans. Employing a structural model, we quantify the impact of private information on plan choice and illustrate how firms exploit this in plan design. This approach provides a comprehensive framework for understanding both consumer and firm behavior in a subsidized insurance market, shedding light on the welfare consequences of imperfect risk adjustment. These findings provide essential insights for policymakers dedicated to improving market efficiency.

Figure: Distribution of Capitation Payments