Setting health plan premiums to ensure efficient quality in health care: minimum variance optimal risk adjustment

Risk adjustment refers to the practice of paying health plans a premium per person (or per family) based on a formula using risk adjusters, such as age or gender, and weights on those adjusters. One role of risk adjustment is to make sure plans have an incentive to accept all potential enrollees. Another role, at least as important in our view, is to lead health plans to choose the efficient level of quality of care for the various services they offer. Most of the research and policy literature on risk adjustment focuses on the first problem. This paper proposes a new way to calculate weights in a risk adjustment formula that contends with both problems. For a given set of adjusters, we identify the weights that minimize the variance in plan predictable health care costs that are not explained by risk adjustment (addressing the access problem), subject to the payments satisfying conditions for an optimal risk adjuster (making sure plans provide the efficient quality). We call the formula minimum variance optimal risk adjustment (MVORA). (C) 2002 Elsevier Science BV All rights reserved.