Risk-adjustment is critical to the functioning of regulated health insurance markets. To date, estimation and evaluation of a risk-adjustment model has been based on statistical rather than economic objective functions. We develop a framework where the objective of risk-adjustment is to minimize the efficiency loss from service-level distortions due to adverse selection, and we use the framework to develop a welfare-grounded method for estimating risk-adjustment weights. We show that when the number of risk adjustor variables exceeds the number of decisions plans make about service allocations, incentives for service-level distortion can always be eliminated via a constrained least-squares regression. When the number of plan service-level allocation decisions exceeds the number of risk-adjusters, the optimal weights can be found by an OLS regression on a straightforward transformation of the data. We illustrate this method with the data used to estimate risk-adjustment payment weights in the Netherlands (N = 16.5 million).

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Keywords Health insurance, Risk adjustment, Adverse selection
Persistent URL hdl.handle.net/1765/112758
Journal Journal of Health Economics
Layton, T.J., McGuire, T.G., & van Kleef, R.C. (2018). Deriving risk adjustment payment weights to maximize efficiency of health insurance markets. Journal of Health Economics, 61, 93–110. Retrieved from http://hdl.handle.net/1765/112758