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Risk adjustment is an actuarial tool used to predict healthcare costs and adjust payments to healthcare plans to cover expected relative costs for providing coverage to enrollees. Risk adjustment ensures that health insurance plans have adequate funding to provide care to people who are likely to have high healthcare costs while at the same time preventing overcompensation for healthy patients. Insurance plans compete on the basis of quality and service, which are the foundation of value-based purchasing (VBP) and healthcare reform.

Why is Risk Adjustment so Important?

Risk adjustment promotes fair payments to health insurance plans by rewarding efficiency and encouraging the provision of high-quality care for the chronically ill. For example, risk scores can be used to identify those patients who may benefit from disease management intervention to prevent costly emergency department visits or inpatient admissions. In addition, it has been determined that risk scores help predict post-discharge costs more effectively than inpatient costs. This is because patients with higher risk scores have a greater number of medical complications and therefore have significantly higher post-discharge costs. Risk scores then may be used to design post-discharge care plans to flag these patients for more intense follow-up.

How is Risk Adjustment Used in Healthcare?

Healthcare risk adjustment methodologies are used to account for changes in severity and case mixes for enrollees over time. It allows payers to accurately set performance targets for quality improvement and cost control, which are both key to success under VBP initiatives. Risk adjustment has been fundamental in reducing “cherry picking” among health plans by providing incentives to enroll high-cost individuals while at the same time ensuring that the necessary resources are available to provide efficient and effective treatment. The methodology used to risk-adjust premiums varies, depending on the patient population, source of payment, and healthcare market regula­tions. Today, healthcare risk adjustment is used across all major public programs offering health coverage in the U.S., including Medicare (Part C & D), state Medicaid-managed care programs, and commercial insurance for all plans in the individual and small group markets, operating both inside and outside health insurance exchanges.

A Break From Tradition: The Medicare HMO

While risk adjustment methodologies have been around for years, they have taken on a whole new significance as a result of the Patient Protection and Affordable Care Act (PPACA)of 2010. However, it didn’t start there. A glimpse of just how important risk adjustment would become to the future of American healthcare was revealed with the enactment of the Balanced Budget Act of 1997. This Act created Medicare+Choice, a Medicare Health Maintenance Organization (HMO) that is often referred to as “Medicare Part C.” Medicare+Choice was administered by private health insurance plans and offered as an alternative to the original Medicare fee-for-service (FFS) program. Medicare+Choice encompassed both Medicare Part A and B coverage and generally offered additional benefits, such as vision, dental, and hearing, and many included prescription drug coverage. This was followed by the Medicare Modernization Act of 2003, which changed Medicare+Choice to the “Medicare Advantage” risk model. The new Medicare risk adjustment model, referred to as CMS-HCCs (Hierarchical Condition Categories), was gradually phased in starting in 2004, with full implementation in January 2007. This risk adjustment model utilizes ambulatory and inpatient diagnoses to help predict individual expenditure variation among Medicare patients. 

Risk Adjustment is Not Exclusive to Medicare

With the enactment of the PPACA, the Medicare CMS-HCC risk adjustment program has been expanded to include the Medicare Shared Savings Programs (MSSP) and Accountable Care Organizations (ACOs). But do not think that risk adjustment is unique to Medicare payment reform. Medicaid plans have been using risk adjustment modeling since 1996. However, unlike Medicare, which uses the CMS-HCC model, there are many different risk adjustment models available for the Medicaid population, each with its own strengths and weaknesses. As a result, each state must determine if it will utilize a risk adjustment model, which one will best suit its needs, whether the model will be used to determine risk at the individual or aggregate level, and whether risk scores will be used on a prospective or concurrent basis. 

The commercial insurance market was brought into the fold in 2014, when the PPACA established 15 commercial risk adjustment models for all plans in the individual and small group markets. These models, developed by the U.S. Department of Health and Human Services (HHS) for the commercial market, are referred to as “HHS-HCC’s.” Their purpose is to prevent plans from denying coverage based on pre-existing conditions, to eliminate medical underwriting, and to limit premium variances based on age and other risk factors. While time will tell how successful any one risk adjustment methodology will be in predicting costs, in the end, risk adjustment is fundamental to healthcare reform and therefore is here to stay. 

Regardless of the patient population and the specific risk adjustment model being used, there is one commonality that holds true: complete, accurate, and specific clinical documentation of diagnoses is critical to success under any risk adjustment methodology.

About the Author 

Angela Carmichael is the director of HIM for J.A. Thomas & Associates, a Nuance Company. She is a registered health information administrator, a clinical documentation improvement practitioner and a certified coding specialist for both hospital and physician services. Angela has extensive experience in the health information management field, specializing in various payment methodologies, coding education, compliance, and management. Her experience includes services provided in the hospital, physician office, consulting, and insurance settings. She has expertise in technical writing, public speaking, testing, and training development.  In addition, Angela is an American Health Information Management Association (AHIMA)-approved ICD-10-CM/PCS instructor and ambassador. 

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