Prevention and Dynamic Risk Adjustment

Risk adjustment deters selection and helps to assure fair and efficient payments among health insurers or capitated provider groups. However, since conventional risk adjustment allocates funds among insurers or regions according to current population health status, it does not reward — indeed, it penalizes — provider preventive efforts that improve population health. This prevention penalty of risk adjustment will become increasingly salient as inter-related trends converge — aging societies, chronic disease epidemics, use of market-based incentives and wider adoption of conventional risk adjustment. We develop a theoretical model of selection and prevention demonstrating this problem with conventional risk adjustment and suggesting a simple alternative that restores incentives for optimal prevention. Dynamic risk adjustment combines conventional risk adjustment with pay-for-performance for prevention. JEL classification: I1