What Is Risk Adjustment in Health Insurance?
Discover how health insurance systems manage diverse enrollee health needs to foster competition and ensure broad access to care.
Risk adjustment in health insurance is a regulatory mechanism designed to address financial imbalances that arise when health plans cover populations with varying health needs. This system operates within specific health insurance markets, such as those established under the Affordable Care Act (ACA), to ensure a more equitable distribution of financial responsibility among insurers. Its objective is to mitigate financial disincentives for insurers enrolling individuals with higher expected healthcare costs. By implementing this system, regulators aim to promote a marketplace where insurers compete on the quality and efficiency of care, rather than on their ability to attract a healthier, less costly pool of enrollees. This supports broader access to coverage for all individuals.
The Purpose of Risk Adjustment
Risk adjustment fundamentally aims to solve “risk selection,” where health plans might try to attract healthier individuals and avoid those with pre-existing conditions or higher healthcare needs. Without this mechanism, insurers could gain a competitive advantage by enrolling a disproportionately healthy population, leading to an unbalanced marketplace. This imbalance could result in higher premiums for plans serving sicker populations, making coverage unaffordable for those who need it most.
The system creates a more level playing field for health insurers within the same market. It ensures plans are not penalized for accepting individuals who require more extensive medical services. By compensating plans that enroll individuals with higher projected healthcare expenses, risk adjustment encourages comprehensive coverage offerings. This mechanism stabilizes premiums for consumers and mitigates the financial risk of covering high-risk populations, preventing dramatic premium increases. Ultimately, risk adjustment supports broader access to affordable coverage, ensuring insurers can financially sustain covering a diverse range of enrollees.
How Risk Scores Are Determined
Risk adjustment assigns a “risk score” to each enrollee, representing their predicted future healthcare costs relative to an average population. A higher risk score indicates greater expected healthcare expenses. These scores are recalculated annually to reflect changes in health status.
Risk score calculation incorporates demographic information, such as age, sex, and sometimes geographic location. For example, older individuals may have higher predicted costs due to general health trends.
A significant portion of the risk score comes from health status information, primarily diagnosis codes obtained from medical claims. These codes, such as those from the International Classification of Diseases (ICD-10-CM), are submitted by healthcare providers for services rendered. These diagnosis codes reflect an individual’s chronic conditions, acute illnesses, and overall health severity.
These data points are fed into statistical models to predict an individual’s expected healthcare costs. In the United States, a prominent example is the Department of Health and Human Services (HHS) Hierarchical Condition Category (HCC) model. This model groups related diagnosis codes into categories that share similar cost patterns. Each Hierarchical Condition Category (HCC) is assigned a specific value, which combines with demographic factors to produce a comprehensive risk adjustment factor (RAF) score. This RAF score quantifies the expected cost of care for a patient, reflecting the complexity and severity of their health conditions.
The Financial Transfers
The calculated risk scores directly influence financial adjustments among health plans. These adjustments are not payments to or from individuals but represent financial transfers that occur between health insurers. The mechanism ensures that plans with healthier enrollees, who have lower average risk scores, contribute funds into a central pool.
Conversely, health plans that have enrolled sicker individuals, characterized by higher average risk scores, receive payments from this central pool. This system effectively redistributes aggregate premium revenue among plans within a state or market. For example, if a plan’s average enrollee risk score is below the market average, it will typically make a payment, while a plan with an average score above the market average will receive funds.
The ultimate goal of these financial transfers is to compensate plans for taking on higher-cost members, thereby neutralizing the financial disincentive to enroll individuals with complex health needs. This mitigation allows health insurers to set premiums based on the average expected health costs of their entire enrollee pool, rather than inflating premiums to cover potential high-cost individuals.
These transfers are designed to be budget-neutral within each state and market, meaning the total payments made by lower-risk plans equal the total payments received by higher-risk plans. This self-balancing system ensures the overall financial burden of covering a diverse population is shared among all participating insurers.