Risk Adjustment Arrives for Commercial Health Insurance

Health & Human Services’ new risk adjustment program for small-group and individual health insurers will partly protect carriers from some of the cost of adverse selection. But our actuarial analysis shows that the program also creates new risks.

It tends to overpay for high-risk patients and underpay for low-risk. The cost to an insurer with even five percent fewer high-risk members than its competitors can be as much 8 percent of premiums. To prosper in this new environment, insurers need to go beyond basic tactics like appropriate risk coding. They need to start tailoring product, network design, and health management programs to selected risk segments.

How the New Risk Adjuster is Different

The risk adjustor for the small-group and individual markets (known as HHS-HCC) is different in several important ways from the Medicare risk adjustor (CMS-HCC). But perhaps the most significant difference is in the market itself: Only about 20 percent of consumers in the commercial market have risk factors, compared to about 60 percent in the Medicare market. Their most significant risks won’t necessarily be the top risks in Medicare. And they may prove difficult to efficiently identify, diagnose, and code.

1What do insurers need to know about the HHS risk adjustor?

There are a couple of things that might not be obvious. One is that the program uses a closed design: The all the money involved moves back and forth between insurers with high and low risk scores. In the Medicare program, if overall risk is higher or lower than expected, they can adjust. In the commercial program, they can’t. And insurers need to know that the system overpays a bit for high-risk members and underpays a bit for low-risk members.
2What does that mean for insurers?

It means that low-risk members are financially risky for the insurance company. In our analysis, if a health plan with low market share attracted five percent fewer patients with risk factors than its competitors, it could face a margin loss of 7.7 percent of premiums. Obviously that’s enough to make the difference between profitability and loss, or even exiting the market. And there are a lot more low-risk members in commercial than in Medicare Advantage.
3Why does that matter?

The key to winning in a risk-adjusted environment is to make sure that you’re coding risk properly, and managing the risk you get. A high-risk patient that you haven’t diagnosed and coded is considered low-risk in the risk adjustment calculation—so instead of gaining you money he costs you. But with a relatively healthier pool of patients, it will be harder to identify and manage the high-risk few. In Medicare, it makes financial sense to do home visits and chart reviews. In commercial, insurers are going to have to find something more cost-effective.