Risk-adjusted Capitation Primer

Managed care organizations (MCOs) are paid by Medicare, Medicaid and private companies to provide insurance functions (e.g., claims payment) and preventive healthcare interventions designed to improve patient health outcomes. MCOs, in turn, pay providers for the direct delivery of healthcare to members enrolled in their plans. Typically, MCOs receive per-member-per-month prospective payments for the health care management of their enrolled members, called capitation. To make a profit, a MCO must manage the health services of their population in ways that keep the actual healthcare costs below the capitation payment, on average.

While promoting cost-efficiency, capitation payment encourages MCOs to attract members whose likely costs are below the capitation rate. MCOs can behave in ways that lower the likelihood of attracting the unprofitable members - through benefit design, provider network composition, selective marketing, or other methods. These prohibited activities are called risk selection (“cherry picking”) and discriminatory disenrollment (“dumping”).

To mitigate cherry picking and dumping, payors have begun to adjust the payments made to MCOs based on patient diagnosis, so that more is paid to MCOs for the enrollment of sicker individuals than for healthier ones. Conventionally, these capitated payments can be “risk-adjusted” to account for certain factors that predict future healthcare costs, such as demographics (age, gender, geography), diagnoses, and pharmaceutical utilization.

With risk-adjusted capitation payments, more is paid to MCOs for the enrollment of sicker individuals than for healthier ones. The more accurately the risk adjustment payment model predicts the future healthcare costs of a member, the less incentive the MCO has to cherry pick or dump members. Sicker members mean higher capitation payments for the MCO.

Predictive power of risk adjustment methodologies continues to improve, but comparisons in the literature investigating Medicaid recipient populations show that the predictive power (R²) of the risk adjustment models ranges from 0.11 to 0.18 (Kronick, Gilmer, Dreyfus, & L. Lee, 2000) and from 0.15 to 0.23 (Gilmer, Kronick, Fishman, & Ganiats, 2001). While risk adjustment does not explain much of the variability in future healthcare expenditures, it is still sufficient for many government payors, such as Medicare, to pay MCOs for managing beneficiaries’ care. (It should be noted that perfect prediction of future health expenditures is not the goal. If future healthcare utilization was known, then insurance would not be necessary.)

Notwithstanding improvements risk adjustment accuracy, about 80% of the future health care costs are unexplained using risk adjustment. This remaining risk leads MCOs to engage in risk selection behaviors. While risk adjustment is a significant improvement over average cost capitation, the incentive to attract healthy enrollees and avoid the sick ones still exists. Are risk-adjusted payments better than nothing, though?

Medicare Advantage Star Bonuses

On November 10, 2010, the Centers for Medicare and Medicaid Services (CMS) released a Fact Sheet on the “stars” quality bonus payments for Medicare Advantage (MA) plans. Beginning in 2012, quality bonuses are paid to MA plans that earn 3 or more stars*. Five-star plans will receive a higher quality bonus payment than 4-star plans … 4-star higher than 3.5-star plans … 3.5-star higher than 3-star plans. Plans with less than 3 stars get no bonus and are eventually labeled as “low performers” on the web-based Medicare Plan Finder tool.

The regulations are different than methodology prescribed in the Patient Protection and Affordable Care Act and the Health Care Education and Reconciliation Act of 2010 (ACA). CMS will test an alternative method for bonus payments to understand whether providing scaled bonuses will lead to more rapid and larger year-to-year quality improvements compared to the ACA bonus structure. Essentially, there are two major changes:

1. Four rating levels (3-star, 3.5-star, 4-star, and 5-star plans) instead of two under ACA law (only 4-star and 5-star plans).
2. Increases bonus payments (e.g. 1.5% to 5% for 5-star plans in 2012).

I have two thoughts on the changes to the stars bonus system presented by CMS.

First, I applaud the increase in percentage of bonuses applied to the payment benchmarks. CMS has raised the bonus level for 5-star plans to the maximum allowed by previous federal regulation that applies to state payments to health plans (42 CFR 438.6(c)(5)(iii)). As suggested by Rosenthal, et al. (2006) in their work on provider performance payments, small bonus payments not be enough to effect results in incentive-based contracts (Rosenthal, 2006).

Second, I scratch my head at the inclusion on 3-star health plans bonus payments. While ACA provides NO BONUS for 3-star plans, the new star system gives them 3% starting in 2012. CMS defines 3-stars as “average performance.” This means that even average plans are rewarded. Using 14 months performance history, among the 560 MA plans 84.6% would receive at least a 3% bonus on the benchmark in qualifying counties. This reminds me of giving medals to all of the kids that participate in a competition.

Is CMS rewarding mediocrity? Will this create a sense of entitlement among MA plans? Will it strengthen CMS’ ability to distinguish between high and low performers? Thoughts?

* The quality assessment categories are:

• Staying Healthy: Screenings, Tests and Vaccines
• Managing Chronic (Long-Lasting) Conditions
• Ratings of Health Plan Responsiveness and Care
• Health Plan Member Complaints and Appeals
• Health Plan Telephone Customer Service