Medicare uses an elaborate risk adjustment model incorporating individual demographic characteristics and medical conditions into 70 different hierarchical condition categories in order to decide how much to pay Medicare Advantage plans for each individual enrollee. The goal is to predict each enrollee’s medical expenses as accurately as possible and to pay a premium that reflects that expectation. These models will also be used in the new ObamaCare exchanges in order to “tax” plans with healthier enrollees and subsidize those with “sicker” enrollees. Private insurers have historically set their premiums using experience rating rather than risk adjustment.
So how well does risk adjustment work? According to the June 2012 MedPAC Report, the current model is a “much better predictor of a beneficiary’s costliness” than the previous model. The previous model explained “only about 1 percent” of an individual’s costliness. The current model predicts “about 11 percent.”