Tradeoffs in the Design of Health Plan Payment Systems: Fit, Power and Balance

Michael Geruso, Thomas G. McGuire

NBER Working Paper No. 20359
Issued in July 2014
NBER Program(s):   AG   HC   PE

In many markets, including the new U.S. Exchanges, health insurance plans are paid by risk-adjusted capitation, in some markets combined with reinsurance and other payment mechanisms. This paper proposes three metrics for analyzing the insurer incentives embedded in these complex payment systems. We discuss fit, power and balance, each of which addresses a distinct market failure in health insurance. We implement these metrics in a study of Exchange payment systems with data similar to that used to develop the Exchange risk adjustment scheme and quantify the empirical tradeoffs among the metrics. We show that an essential tradeoff arises between the goals of limiting costs and limiting cream skimming because risk adjustment, which is aimed at discouraging cream-skimming, is in fact tied to costs. We find that a simple reinsurance system scores better on fit, power and balance than the risk adjustment scheme in use in the Exchanges.

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This paper was revised on February 27, 2015

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Document Object Identifier (DOI): 10.3386/w20359

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