How profitable is risk selection? A comparison of four risk adjustment models

Abstract

To mitigate selection triggered by capitation payments, risk-adjustment models bring capitation payments closer on average to individuals' expected expenditure. We examine the maximum potential profit that plans could hypothetically gain by using their own private information to select low-cost enrollees when payments are made using four commonly used risk adjustment models. Simulations using a privately insured sample suggest that risk selection profits remain substantial. The magnitude of potential profit varies according to the risk adjustment model and the private information plans can employ to identify profitable enrollees.

Predictability and predictiveness in health care spending

“…Papers using various data sets and making use of these assumptions conclude that the "predictable" component of variance is about 15-25%. 3 Some papers have explored the importance of this degree of predictability and simulated health plan incentives to engage in selection of profitable enrollees (van Vliet, 1992;Newhouse, 1997;Shen and Ellis, 2002a). They all find that risk adjustment reduces but does not eliminate the profitability of risk selection.…”

Risk Selection in Natural-Disaster Insurance

“…Note that the …nal increase in the rate of reinsurance was the introduction of the unique rate of 50% by the reinsurer. 20 Finally, columns four and …ve indicate information on the …nancial evolution of the CCR, presenting the ceded premium income and the evolution of reserves of the public reinsurer.…”

Risk adjustment in health insurance and its long-term effectiveness

“…Second, Zweifel and Breuer argue that insurers who want to stay in business must have an eye on present values rather than one-period profits. This paper, then, follows the lead of Shen and Ellis (2002) by estimating expected profits attainable from risk selection, given the information available to the insurer. It therefore only models the classification of risk types, neglecting the problem of how to attract or deter types.…”

“…However, unlike Shen and Ellis (2002), the present analysis assesses the impact of risk adjustment if insurers" planning horizon exceeds one year. In an attempt to reflect longer planning horizons 3/21 (which agree with insurers" preference for long-run contracts and guaranteed renewability unless prevented by regulation (Pauly et al 1998)), the period of observation for expected profits is extended to five years in the body of the paper.…”