Risk Adjustment | Importance of Risk Adjustment in Health

January 17, 2023

Risk Adjustment is a concept that has been used across healthcare for some time now to customize the payments made by Medicare. It has proven to be an effective tool in helping to identify under or overpayments relative to specific treatment or conditions. The idea behind risk adjustment is relatively simple. 

An alternative to using payments that ignore critical factors, such as readmissions, illness severity, and other hard-to-group issues, is to use targeted costs adjusted for risk or severity of conditions expected among different groups receiving care. 

These risk scores can be the basis for enrollment in Medicare Advantage plans, Medicare and Medicaid programs. The actual risk adjustment process involves making payments based upon certain attributes specific to each patient.

Understanding Risk Adjustment

Risk adjustment levels the playing field among health plan members by integrating existing and newly discovered health data. According to the Centers for Medicare and Medicaid Services (CMS), risk adjustment predicts future health care expenditures based on diagnoses and demographics. 

Risk adjustment adjusts all insurers' payments based on an estimate of the cost of the patient's care.

Through the risk adjustment program, insurers with low-risk enrollees transfer funds to insurers with high-risk enrollees. 

Medicaid-managed care plans in 33 states use risk adjustment, balancing insurers with high-risk enrollees against those with lower-risk enrollees, ensuring budget neutrality, and ensuring state funds are used correctly. 

As a result, risk adjustment provides insurers with financial assistance by spreading the risk among insurers who offer coverage for enrollees with higher healthcare costs.

Why is Risk Adjustment Important?

The purpose of the risk adjustment is to ensure that insurance companies receive the appropriate revenue or compensation for covering the medical costs of those they insure. 

As part of the Affordable Care Act (ACA), which has broad support, insurers of individual health coverage may not charge more for the same product based on health status (also known as community rating). 

In addition, health status cannot serve as a basis for denying coverage (known as guaranteed accessibility to coverage).

The rates set by a particular insurer may be too high or too low without risk adjustment. Also, risk adjustment prevents insurers from discouraging sick patients from enrolling since they are compensated more for risk adjustment for sicker patients.

How Does Risk Adjustment in Healthcare Work?

State governments are free to administer their risk adjustment methodology in the individual market; however, at present, all states have deferred to the HHS administration. 

The risk adjustment transfers are intended to be financially balanced, meaning that the money paid in by insurers equals money paid out. All participating insurers pay a user fee to cover the programs' administrative expenses.

Insurers make payments to one another by calculating the average health status of their enrolled members, using factors such as premiums, actuarial values, and months of participation. Data for funds' transfers are subjected to HHS’s rigorous data validation process once a year.

In Medicaid-managed care states with risk-adjusted plans, state actuaries create a unique risk adjustment model. 

According to insurer data, capitation payments depend on health status and state-specific variables, such as whether an individual became eligible for Medicaid.

How are Health Risks Calculated?

Variables in the health risk formula include age, gender, previous medical history, acute and chronic conditions documented annually in a member's chart. This formula determines members’ risk scores.

For chronic and acute conditions to be captured, encounter/claim data must be accurate, complete, and timely. 

  • Diagnostic sources: Only diagnoses from inpatients, outpatients, hospitals, and physicians will factor into CMS. Other data will be excluded.
  • Demographics: The risk score depends on age, gender, geographic region, eligibility for Original Medicare, disability, and Medicaid status.

Basic Approach to Risk Adjustment

  • Providers file claims that include diagnosis codes
  • Diagnosis codes determine beneficiary risk scores
  • Payment or reimbursement is risk-adjusted based on risk scores

Hierarchical Condition Categories (HCCs)

As part of its methodology for adjusting payments to health plans, the Center for Medicare and Medicaid Services (CMS) depends on accurately identifying diagnosis codes associated with HCCs (Hierarchical Condition Categories). 

Risk-adjusted payments allow CMS to make accurate payments to health plans for enrollees whose medical costs may differ from expected.

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