Does Health-Based Prospective Risk Adjustment Adequately Compensate for Individuals Diagnosed With a New Chronic Disease?

Many regulated health insurance markets use prospective risk adjustment (RA) to mitigate risk selection incentives for insurers. However, prospective RA might underpay insurers for people diagnosed with a new chronic disease. By tracking spending and RA payments over the period t−2 to t+2 for individuals diagnosed with a new chronic disease in year t, we find a substantial payment gap in year t and, to a lesser extent, in prior and/or subsequent years. The extent to which these gaps stimulate selection incentives for insurers depends on the possibilities for insurers to distort consumers’ choice of insurance products. Possibilities which—in turn—depend on whether and when consumers respond to the onset of the chronic disease when choosing an insurance product. By analyzing “insurer switching” in the period t−2 to t+2 we find that—on average—people first diagnosed with a chronic disease are more likely to switch insurer than others.