TY - JOUR AU - Brown,Jason AU - Duggan,Mark AU - Kuziemko,Ilyana AU - Woolston,William TI - How does Risk Selection Respond to Risk Adjustment? Evidence from the Medicare Advantage Program JF - National Bureau of Economic Research Working Paper Series VL - No. 16977 PY - 2011 Y2 - April 2011 UR - http://www.nber.org/papers/w16977 L1 - http://www.nber.org/papers/w16977.pdf N1 - Author contact info: Jason Brown U.S. Department of the Treasury 1500 Pennsylvania Ave, NW Washington, D.C. 20220 E-Mail: Jason.Brown@do.treas.gov Mark Duggan The Wharton School University of Pennsylvania 1452 Steinberg Hall-Dietrich Hall 3620 Locust Walk Philadelphia, PA 19104 Tel: 215-898-0928 Fax: 215-898-7635 E-Mail: mduggan@wharton.upenn.edu Ilyana Kuziemko 361 Wallace Hall Princeton University Princeton, NJ 08544 Tel: 609/258-6917 Fax: 609/258-5974 E-Mail: kuziemko@princeton.edu William Woolston Department of Economics Stanford University 579 Serra Mall Stanford, CA 94305 E-Mail: william.woolston@stanford.edu AB - Governments often contract with private firms to provide public services such as health care and education. To decrease firms' incentives to selectively enroll low-cost individuals, governments frequently "risk-adjust" payments to firms based on enrollees' characteristics. We model how risk adjustment affects selection and differential payments---the government's payments to a firm for covering an individual minus the counterfactual cost had the government directly covered her. We show that firms reduce selection along dimensions included in the risk-adjustment formula, while increasing selection along excluded dimensions. These responses can actually increase differential payments relative to pre-risk-adjustment levels and thus risk adjustment can raise the total cost to the government of providing the public service. We confirm both selection predictions using individual-level data from Medicare, which in 2004 began risk-adjusting payments to private Medicare Advantage plans. We find that differential payments actually rise after risk adjustment and estimate that they totaled $30 billion in 2006, or nearly eight percent of total Medicare spending. ER -