Incorporating Prescription Drug Utilization Information Into the Marketplace Risk Adjustment Model Improves Payment Accuracy and Reduces Adverse Selection Incentives

Beginning with the 2018 benefit year, the Centers for Medicare and Medicaid Services started incorporating select prescription drug utilization information into the Marketplace risk adjustment model. There has been little evidence about the impact of this change on payment accuracy and the mechanisms through which it may occur. Using commercial claims in 2017 from a large national health insurer, we find that the policy change improves payment accuracy in our sample and would help mitigate insurers’ selection incentives for some enrollees through two channels: imputing missing diagnoses and varying risk scores to better capture the heterogeneity in expenditures among patients with certain health conditions. However, while improving payment accuracy overall, there are potential perverse incentives that could distort treatment choice for marginal patients. Additionally, overcompensation and undercompensation persists for certain patient subgroups, suggesting an opportunity to further refine and improve the model.