Does risk adjustment for Medicare patients reward caring for sick patients or liberal admission practices?

By January 2000, approximately one sixth of all Medicare beneficiaries were enrolled in HMOs. Medicare payments made on their behalf are projected to total $40 billion for 2000.1 Historically, capitated payments to health plans—currently averaging $5100 per patient—have been based on a percentage of average costs in fee-for-service Medicare. Until now, these payments have been adjusted only for certain demographic characteristics, particularly age and sex. For example, Medicare paid health plans about twice as much for each man in his early eighties as it paid for each woman in her late sixties. However, there was concern that adjusting for age and sex alone was not sufficient and that Medicare payments were not accurately reflecting expected health care costs of individual enrollees.2,3 Without using health status measures to adjust capitation payments, health plans were not paid more to care for sicker enrollees. Plans with sicker—and therefore more costly—enrollees were penalized, whereas those with enrollees who were healthier than average were rewarded. As of January 2000, Medicare has addressed this problem by implementing capitation payments that are risk-adjusted according to an enrollee’s clinical diagnosis, as identified from previous hospital admissions records. In this paper, I review this new approach and consider some of the problems with adjusting payments on the basis of previous admissions, particularly those for “discretionary” diagnoses. I also identify issues that policymakers will face in compensating plans for serving sicker patients without rewarding liberal admission practices. (A note about usage: Many authors have referred to the expanded range of health plans that can receive capitated Medicare payments as “M+C plans” [for Medicare+Choice], instead of “HMOs;” however, in this paper I simply use “health plans.”)