A new Health Policy Brief from Health Affairs and the Robert Wood Johnson Foundation looks at so-called risk adjustment—an approach that will be needed in insurance exchanges scheduled to open in 2014. When the exchanges created under the Affordable Care Act are up and running and millions of Americans are buying coverage through them, some new enrollees will be healthy, but many others may have preexisting or high-cost conditions. To remove incentives for insurance companies to seek only the healthiest enrollees, insurance plans will be compensated through risk adjustment.

This policy brief explains how risk adjustment works and the issues involved in putting it into practice. Topics covered in the brief include:

  • Why risk adjustment is needed. Since the 1990s, many policy makers have argued that structured insurance market competition could be an important way to lower health insurance costs. Appropriate payment, as determined by risk-adjustment calculations, is a key ingredient in the overall success of the innovations in the Affordable Care Act, because health plans will compete on the basis of quality and efficiency, not by avoiding high-cost patients.
  • What risk adjustment is and how it works. The brief explains how, in risk adjustment, a third party, such as the federal government or a state, collects and organizes data from insurance claims and clinical diagnoses for all enrollees in every participating health plan or provider organization in a particular market. Using what’s known as a risk-assessment tool or methodology, this entity then converts the data into a risk score for each person, and uses that score to determine whether the person is healthier or sicker than average and thus how payment to the plan should be adjusted as a result.
  • Backstops to risk adjustment.As a supplement to risk-adjusted payments to plans, two additional stop-gap measures will be in place during the first three years of the Affordable Care Act, in case the adjustments don’t work as expected. “Transitional reinsurance programs” will assess fees on insurers based on their relative market share; those funds will then be channeled to any plans that cover patients with extraordinarily high medical costs. “Risk corridors” constitute another mechanism of transferring funds from plans with below-average risks to those with above-average risks. Funds will be collected from insurance companies whose target costs projections are at least 3 percent lower than expected and channeled to insurers whose actual costs turn out to be at least 3 percent higher than projected.

About Health Policy Briefs

Health Policy Briefs are aimed at policy makers, congressional staffers, and others who need short, jargon-free explanations of health policy basics. The briefs, which are reviewed by experts in the field, include competing arguments on policy proposals and the relevant research supporting each perspective.

You can sign up for e-mail alerts about upcoming briefs. The briefs are also available from the RWJF Web site. Please feel free to forward to any of your colleagues who are tracking health issues. And after you’ve taken a look, we would welcome your feedback at hpbrief@healthaffairs.org.