Risk Adjustment in the Private Health Insurance Market
link to page 1 
Updated October 3, 2018
Risk Adjustment in the Private Health Insurance Market
Section 1343 of the Patient Protection and Affordable Care
services—purchase health insurance. However, that
Act (ACA; P.L. 111-148, as amended) established a
remains a possibility, and an insurer may experience losses
permanent risk adjustment program that is designed to
if it enrolls a disproportionate share of high-risk enrollees
assess charges to private health plans in a state that have
with high health care costs.
relatively healthier enrollees and to use collected charges to
make payments to private health plans in the same state that
Under current law, absent a risk adjustment mechanism, a
have relatively sicker enrollees. The risk adjustment
plan that enrolls a larger proportion of sicker (i.e., high-
program aims to reduce the incentives insurers may have to
risk) enrollees than other plans in the market would need to
avoid enrolling individuals who are at risk of high health
charge a more costly average premium (across all enrollees)
care costs. All non-grandfathered, individual (non-group)
to be financially viable. Under the risk adjustment program,
market and small-group market health plans, both inside
an insurer can set premiums for plans with sicker-than-
and outside of the exchanges, participate in this program.
average (i.e., high-risk) enrollees lower than the expected
cost of claims because it will receive a risk adjustment
This In Focus briefly describes risks the ACA’s risk
transfer payment to make up some or all of the difference.
adjustment program is expected to mitigate and provides an
Conversely, an insurer of a plan with healthier-than-average
overview of the program. More information about the risk
(i.e., low-risk) enrollees will set premiums higher than what
adjustment program is available in CRS Report R45334,
is needed to cover their anticipated claims cost because part
The Patient Protection and Affordable Care Act’s (ACA’s)
of that premium will be a risk adjustment charge owed to
Risk Adjustment Program: Frequently Asked Questions.
other insurers. The risk adjustment program is intended to
allow consumers to purchase health care coverage with
Risk Mitigation
premiums that reflect differences in plan design and
Individuals differ in their risk in the health insurance
available benefits rather than the risk of enrollees who
market based on their health status, with sicker individuals
choose a particular plan.
considered high-risk individuals and expected to have
greater health costs than healthier individuals (i.e., low-risk
Risk Adjustment Program Operations
individuals). One phenomenon facing health insurance
The Centers for Medicare & Medicaid Services (CMS)
markets is that high-risk individuals who expect or plan for
administers the risk adjustment program, which began in
high use of health services (e.g., older or sicker individuals)
2014 and is currently in its fifth year of operations (for the
tend to seek out coverage and enroll in plans with more
2018 benefit year). Figure 1 summarizes the risk
benefits than low-risk individuals who do not expect to use
adjustment process.
many or any of the health services (e.g., younger or
healthier individuals).
Figure 1. Risk Adjustment Process Flow
Prior to the ACA, state laws (and federal law under limited
circumstances) determined whether insurers could
minimize their exposure to this phenomenon by charging
higher or lower premiums to consumers based on factors
such as age, gender, and health status. However, under
current federal law, insurers are unable to set premiums
based on gender or health status, and insurers are limited in
how much they can vary premiums by age. Without these
tools to account for the risk of individuals who expect or
plan for high use of health care services, insurers still may
attempt to avoid the enrollment of these individuals by
designing plans or using marketing techniques that are not
likely to appeal to them. Financial assistance, such as
premium tax credits and cost-sharing subsidies for on-
exchange plans, and the individual mandate (though the
penalty has been effectively eliminated as of January 1,
2019) are intended to encourage enrollment for all
Source: CRS-developed flow chart of the permanent risk adjustment
individuals, including low-risk individuals. Encouraging
program based on information from CMS.
enrollment for both high-risk and low-risk individuals is
Notes: CMS = Centers for Medicare & Medicaid Services.
intended to reduce the chances that only high-risk
individuals—who expect or plan to have high use of health
https://crsreports.congress.gov
link to page 2 link to page 2
Risk Adjustment in the Private Health Insurance Market
Each benefit year, CMS determines required payments and
state and market with three insurers. Insurer A’s premium is
charges between eligible health plans in each state. It first
10% below the market average ($270 compared to $300)
measures a plan’s risk using a risk score for each enrollee in
and it attracted a healthier-than-average population (relative
the plan, and it then calculates the payment or charge based
risk is negative 10%). Therefore, Insurer A had a risk
on a transfer formula. CMS calculates a risk score for each
adjustment charge of $30 (10% of $300, the state average
actual enrollee in a plan using the enrollee’s demographic
premium for the market). While the $30 charge is 10% of
information, diagnoses, and several other factors. The risk
the state average premium, it amounts to about 11% of
score is a relative measure of how costly that enrollee is
Insurer A’s actual premium ($270). Given its relative risk,
anticipated to be for the plan.
Insurer A would have expected the net premium after the
10% risk adjustment charge to be $243 ($270 in premium,
CMS administers the risk adjustment program on a budget-
minus a $27 risk adjustment charge). However, since the
neutral basis, so the sum of all charges for plans with lower-
risk adjustment charge is calculated using the market
than-average risk equals the sum of payments made to plans
average premium ($300), the net premium is actually $240
with higher-than-average risk within a state and market
($270 - $30) after the risk adjustment charge, so Insurer A
(individual or small group). A plan’s risk adjustment
is left with a shortfall of 1% of premium. Insurer C attracted
payment or charge (i.e., transfer) is determined by
a sicker-than-average population (relative risk of positive
calculating a plan’s predicted costs relative to the statewide
10%), and it also has a shortfall of about 1% of premium.
average (considering the health status of enrollees by using
the risk scores aggregated into the plan liability risk score)
Table 1. Hypothetical Risk Adjustment Transfers
and subtracting the expected premium revenue the plan can
collect based on allowable rating factors (i.e., individual or
A
B
C
Market
family enrollment, geographic rating area, tobacco use, and
age), relative to the statewide average, with both terms
Market Share
15%
70%
15%
100%
adjusted for additional factors. The value that results from
Actual Premium PMPM
$270
$300
$330
$300
the difference between predicted costs and expected
premiums is then multiplied by the state average premium
Relative Risk
-10%
0%
10%
0%
for the state and the market to determine the charge (if
Expected Net Premium
$243
$300
$363
$301
predicted costs are less than expected premiums) or the
PMPM
payment (if predicted costs are greater than expected
premiums). Figure 2 lists the factors used to calculate
Transfer Amount PMPM
-$30
$0
$30
$0
transfers.
Actual Net Premium
$240
$300
$360
$300
Figure 2. Factors Used in Calculating Transfers
PMPM
Excess/(Shortfall) PMPM
($3)
$0
($3)
($1)
Source: Barb Klever, MAAA, FSA, Scott Allen, MAAA, FSA, and
Bethany Axtman, MAAA, EA, FSA, et al., Insights on the ACA Risk
Adjustment Program, American Academy of Actuaries, April 2016.
Notes: PMPM = Per member per month.
As demonstrated in this example, if insurers’ premiums do
not correctly account for how their enrollees’ risk differs
from the market, then premiums may be incorrect (i.e., too
Source: CRS-developed list of factors in the transfer formula based
high or too low), which may result in unanticipated losses
on CMS information about the risk adjustment program.
or gains.
The risk adjustment program compensates insurers for a
Program Outcomes
portion of financial losses related to having an enrollee
There is not a lot of research on the risk adjustment
population with higher-than-average risk (i.e., sicker)
program. However, the American Academy of Actuaries
relative to other insurers. However, it is not intended to
published a report analyzing 2014 benefit year data that
ensure that premiums can cover the costs of average claims
suggests some evidence that the risk adjustment program
within a state. Premiums are determined before the plans
was functioning as intended in that year. It reported that
are sold to consumers and thus are based on estimates of
risk adjustment transfers reduced the medical loss ratios for
expected cost, whereas claims represent the actual costs
insurers with high loss ratios and increased the loss ratios
incurred by an insurer. If the costs of enrollees in a state
among insurers with low loss ratios, generally bringing the
and market are greater than expected, the statewide average
loss ratios closer together for insurers that received
premium likely will be too low. Though the risk adjustment
payments and those that experienced charges. The medical
program still would transfer funds between insurers, the
loss ratio for an insurer is the percentage of premiums spent
premiums may not cover the cost of enrollees in the entire
on health care claims and other expenses related to
state or market. Also, the risk adjustment program does not
improving health care quality. By bringing the loss ratios
ensure more stable premiums from one year to the next.
for insurers closer together, the risk adjustment program
worked to even out insurers’ experiences in a particular
Table 1 shows an example of how risk adjustment
market.
payments and charges may be distributed in a hypothetical
https://crsreports.congress.gov
Risk Adjustment in the Private Health Insurance Market
IF10994
Bernadette Fernandez, Specialist in Health Care
Financing
Disclaimer
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan shared staff to
congressional committees and Members of Congress. It operates solely at the behest of and under the direction of Congress.
Information in a CRS Report should not be relied upon for purposes other than public understanding of information that has
been provided by CRS to Members of Congress in connection with CRS’s institutional role. CRS Reports, as a work of the
United States Government, are not subject to copyright protection in the United States. Any CRS Report may be
reproduced and distributed in its entirety without permission from CRS. However, as a CRS Report may include
copyrighted images or material from a third party, you may need to obtain the permission of the copyright holder if you
wish to copy or otherwise use copyrighted material.
https://crsreports.congress.gov | IF10994 · VERSION 4 · NEW
Updated October 3, 2018
Risk Adjustment in the Private Health Insurance Market
Section 1343 of the Patient Protection and Affordable Care
services—purchase health insurance. However, that
Act (ACA; P.L. 111-148, as amended) established a
remains a possibility, and an insurer may experience losses
permanent risk adjustment program that is designed to
if it enrolls a disproportionate share of high-risk enrollees
assess charges to private health plans in a state that have
with high health care costs.
relatively healthier enrollees and to use collected charges to
make payments to private health plans in the same state that
Under current law, absent a risk adjustment mechanism, a
have relatively sicker enrollees. The risk adjustment
plan that enrolls a larger proportion of sicker (i.e., high-
program aims to reduce the incentives insurers may have to
risk) enrollees than other plans in the market would need to
avoid enrolling individuals who are at risk of high health
charge a more costly average premium (across all enrollees)
care costs. All non-grandfathered, individual (non-group)
to be financially viable. Under the risk adjustment program,
market and small-group market health plans, both inside
an insurer can set premiums for plans with sicker-than-
and outside of the exchanges, participate in this program.
average (i.e., high-risk) enrollees lower than the expected
cost of claims because it will receive a risk adjustment
This In Focus briefly describes risks the ACA’s risk
transfer payment to make up some or all of the difference.
adjustment program is expected to mitigate and provides an
Conversely, an insurer of a plan with healthier-than-average
overview of the program. More information about the risk
(i.e., low-risk) enrollees will set premiums higher than what
adjustment program is available in CRS Report R45334,
is needed to cover their anticipated claims cost because part
The Patient Protection and Affordable Care Act’s (ACA’s)
of that premium will be a risk adjustment charge owed to
Risk Adjustment Program: Frequently Asked Questions.
other insurers. The risk adjustment program is intended to
allow consumers to purchase health care coverage with
Risk Mitigation
premiums that reflect differences in plan design and
Individuals differ in their risk in the health insurance
available benefits rather than the risk of enrollees who
market based on their health status, with sicker individuals
choose a particular plan.
considered high-risk individuals and expected to have
greater health costs than healthier individuals (i.e., low-risk
Risk Adjustment Program Operations
individuals). One phenomenon facing health insurance
The Centers for Medicare & Medicaid Services (CMS)
markets is that high-risk individuals who expect or plan for
administers the risk adjustment program, which began in
high use of health services (e.g., older or sicker individuals)
2014 and is currently in its fifth year of operations (for the
tend to seek out coverage and enroll in plans with more
2018 benefit year). Figure 1 summarizes the risk
benefits than low-risk individuals who do not expect to use
adjustment process.
many or any of the health services (e.g., younger or
healthier individuals).
Figure 1. Risk Adjustment Process Flow
Prior to the ACA, state laws (and federal law under limited
circumstances) determined whether insurers could
minimize their exposure to this phenomenon by charging
higher or lower premiums to consumers based on factors
such as age, gender, and health status. However, under
current federal law, insurers are unable to set premiums
based on gender or health status, and insurers are limited in
how much they can vary premiums by age. Without these
tools to account for the risk of individuals who expect or
plan for high use of health care services, insurers still may
attempt to avoid the enrollment of these individuals by
designing plans or using marketing techniques that are not
likely to appeal to them. Financial assistance, such as
premium tax credits and cost-sharing subsidies for on-
exchange plans, and the individual mandate (though the
penalty has been effectively eliminated as of January 1,
2019) are intended to encourage enrollment for all
Source: CRS-developed flow chart of the permanent risk adjustment
individuals, including low-risk individuals. Encouraging
program based on information from CMS.
enrollment for both high-risk and low-risk individuals is
Notes: CMS = Centers for Medicare & Medicaid Services.
intended to reduce the chances that only high-risk
individuals—who expect or plan to have high use of health
https://crsreports.congress.gov
link to page 2 link to page 2
Risk Adjustment in the Private Health Insurance Market
Each benefit year, CMS determines required payments and
state and market with three insurers. Insurer A’s premium is
charges between eligible health plans in each state. It first
10% below the market average ($270 compared to $300)
measures a plan’s risk using a risk score for each enrollee in
and it attracted a healthier-than-average population (relative
the plan, and it then calculates the payment or charge based
risk is negative 10%). Therefore, Insurer A had a risk
on a transfer formula. CMS calculates a risk score for each
adjustment charge of $30 (10% of $300, the state average
actual enrollee in a plan using the enrollee’s demographic
premium for the market). While the $30 charge is 10% of
information, diagnoses, and several other factors. The risk
the state average premium, it amounts to about 11% of
score is a relative measure of how costly that enrollee is
Insurer A’s actual premium ($270). Given its relative risk,
anticipated to be for the plan.
Insurer A would have expected the net premium after the
10% risk adjustment charge to be $243 ($270 in premium,
CMS administers the risk adjustment program on a budget-
minus a $27 risk adjustment charge). However, since the
neutral basis, so the sum of all charges for plans with lower-
risk adjustment charge is calculated using the market
than-average risk equals the sum of payments made to plans
average premium ($300), the net premium is actually $240
with higher-than-average risk within a state and market
($270 - $30) after the risk adjustment charge, so Insurer A
(individual or small group). A plan’s risk adjustment
is left with a shortfall of 1% of premium. Insurer C attracted
payment or charge (i.e., transfer) is determined by
a sicker-than-average population (relative risk of positive
calculating a plan’s predicted costs relative to the statewide
10%), and it also has a shortfall of about 1% of premium.
average (considering the health status of enrollees by using
the risk scores aggregated into the plan liability risk score)
Table 1. Hypothetical Risk Adjustment Transfers
and subtracting the expected premium revenue the plan can
collect based on allowable rating factors (i.e., individual or
A
B
C
Market
family enrollment, geographic rating area, tobacco use, and
age), relative to the statewide average, with both terms
Market Share
15%
70%
15%
100%
adjusted for additional factors. The value that results from
Actual Premium PMPM
$270
$300
$330
$300
the difference between predicted costs and expected
premiums is then multiplied by the state average premium
Relative Risk
-10%
0%
10%
0%
for the state and the market to determine the charge (if
Expected Net Premium
$243
$300
$363
$301
predicted costs are less than expected premiums) or the
PMPM
payment (if predicted costs are greater than expected
premiums). Figure 2 lists the factors used to calculate
Transfer Amount PMPM
-$30
$0
$30
$0
transfers.
Actual Net Premium
$240
$300
$360
$300
Figure 2. Factors Used in Calculating Transfers
PMPM
Excess/(Shortfall) PMPM
($3)
$0
($3)
($1)
Source: Barb Klever, MAAA, FSA, Scott Allen, MAAA, FSA, and
Bethany Axtman, MAAA, EA, FSA, et al., Insights on the ACA Risk
Adjustment Program, American Academy of Actuaries, April 2016.
Notes: PMPM = Per member per month.
As demonstrated in this example, if insurers’ premiums do
not correctly account for how their enrollees’ risk differs
from the market, then premiums may be incorrect (i.e., too
Source: CRS-developed list of factors in the transfer formula based
high or too low), which may result in unanticipated losses
on CMS information about the risk adjustment program.
or gains.
The risk adjustment program compensates insurers for a
Program Outcomes
portion of financial losses related to having an enrollee
There is not a lot of research on the risk adjustment
population with higher-than-average risk (i.e., sicker)
program. However, the American Academy of Actuaries
relative to other insurers. However, it is not intended to
published a report analyzing 2014 benefit year data that
ensure that premiums can cover the costs of average claims
suggests some evidence that the risk adjustment program
within a state. Premiums are determined before the plans
was functioning as intended in that year. It reported that
are sold to consumers and thus are based on estimates of
risk adjustment transfers reduced the medical loss ratios for
expected cost, whereas claims represent the actual costs
insurers with high loss ratios and increased the loss ratios
incurred by an insurer. If the costs of enrollees in a state
among insurers with low loss ratios, generally bringing the
and market are greater than expected, the statewide average
loss ratios closer together for insurers that received
premium likely will be too low. Though the risk adjustment
payments and those that experienced charges. The medical
program still would transfer funds between insurers, the
loss ratio for an insurer is the percentage of premiums spent
premiums may not cover the cost of enrollees in the entire
on health care claims and other expenses related to
state or market. Also, the risk adjustment program does not
improving health care quality. By bringing the loss ratios
ensure more stable premiums from one year to the next.
for insurers closer together, the risk adjustment program
worked to even out insurers’ experiences in a particular
Table 1 shows an example of how risk adjustment
market.
payments and charges may be distributed in a hypothetical
https://crsreports.congress.gov
Risk Adjustment in the Private Health Insurance Market
IF10994
Bernadette Fernandez, Specialist in Health Care
Financing
Disclaimer
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan shared staff to
congressional committees and Members of Congress. It operates solely at the behest of and under the direction of Congress.
Information in a CRS Report should not be relied upon for purposes other than public understanding of information that has
been provided by CRS to Members of Congress in connection with CRS’s institutional role. CRS Reports, as a work of the
United States Government, are not subject to copyright protection in the United States. Any CRS Report may be
reproduced and distributed in its entirety without permission from CRS. However, as a CRS Report may include
copyrighted images or material from a third party, you may need to obtain the permission of the copyright holder if you
wish to copy or otherwise use copyrighted material.
https://crsreports.congress.gov | IF10994 · VERSION 4 · NEW