Abstract

Risk adjustment aims to equalize the profitability of diverse patient groups to prevent insurers from favoring inherently more profitable populations. However, evidence suggests that this system, widely implemented in Medicare Advantage (MA) markets, does not completely eliminate variations in profitability—a nature of the existing risk adjustment mechanisms. Low spenders remain more profitable than high spenders. Individuals possess private health perceptions, which influences heterogeneous preferences for plan generosity. MA firms strategically leverage this by designing plans that encourage self-selection to maximize profits. This framwork explains plan design trends and overpayment issue in MA. Counterfactual simulation shows that an additional generosity-specific capitation adjustment, designed to ensure equal profitability, would cost the government $1 billion (a 0.2% increase) but result in a $7 billion boost in social welfare.

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Keywords

private information, self-selection, product design, risk adjustment

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JEL Classification

• L11 Production, Pricing, and Market Structure
• I13 Health Insurance, Public and Private
• I18 Government Policy, Regulation, Public Health
• D22 Firm Behavior: Empirical Analysis
• D82 Asymmetric and Private Information, Mechanism Design

Figure: Spending vs. Capitation, by Spending Deciles

Figure: Profit without Premium by Plan Generosity