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Advance Possibility

The Evolution of Risk Adjustment and Medicare Advantage

March 16, 2023

The law of the jungle known as “survival of the fittest” was a prevalent theme in the health insurance market in the twentieth century. Prior to 1997, some health plans would hand-pick the population’s healthiest members so that they wouldn’t have to assume significant risk. As a result, people with poor health who were likely to incur substantial medical costs had a difficult time getting insurance coverage. Hence, risk adjustment arose as a solution to improve the overall health of the U.S. population.

Risk adjustment gives health plans the necessary incentives to enroll beneficiaries with a variety of health problems — from those who are generally healthy to those who have several chronic disorders.

From TEFRA to Medicare

Risk adjustment wasn’t implemented overnight. In 1985, the federal government began experimenting with various types of risk contracts, gradually making improvements until it created what we know as Medicare today. Outlined below are the six key acts that implemented and transformed risk adjustment:

1. 1985 – 1997: Tax Equity and Fiscal Responsibility Act (TEFRA)

TEFRA was responsible for launching the Medicare Risk Program in 1985, where health plans were reimbursed for taking on the cost risk of providing care to members. TEFRA introduced a prepayment system whereby Health Maintenance Organizations (HMOs) would receive monthly payments from the federal government fixed by the Health Care Financing Administration (HCFA), now known as the Centers for Medicare & Medicaid Services (CMS).(1) HCFA reimbursed plans for 95% of the market-average fee-for-service (FFS) for member’s healthcare costs. Age, gender, and the member’s Original Reason for Entitlement (OREC) were taken into account for calculating plan payments, and payment rates were county-specific. (2)

Plans assumed that because providers were now more effective, they could deliver care at a reduced cost. Nonetheless, a lot of Medicare Risk plans had participants with heavy utilization levels. TEFRA left Medicare, especially dual-eligible beneficiaries (Medicare and Medicaid), responsible for covering all of the high-risk population’s medical expenses. Furthermore, under TEFRA, beneficiaries had only two options: to stay within the FFS environment or to enroll in an HMO program. (2)

2. 1997 – 2004: Balanced Budget Act (BBA)

The heavy costs incurred by high-utilization members from TEFRA compelled the federal government to cut spending in 1997 with the BBA. This was the act responsible for Medicare Advantage (MA), formerly known as Medicare + Choice (M+C). So, members could now choose between traditional Medicare or one of the three M + C plans. The BBA required that the Primary Inpatient Diagnostic Cost Group (PIPDCG) technique, the system utilized for risk adjustment, be incorporated into the payment structure. (2)

Since the goal was cost cutting, BBA enforced a ceiling of 2% on all yearly payment increases to plans, with the main portion of savings expected to come from a reduction in private plan payments over a ten-year period. This resulted in huge decreases in participation in the M + C program. (1)

3. 2000 – 2010: Benefits Improvement and Protection (BIPA)

CMS had to do something to increase participation and stop this bleeding. So, they created BIPA. BIPA included provisions that would increase the monthly payment rates to plans. Some of these included bonuses if plans entered areas where there was no other plan, higher payment rates if members belonged to more urban counties, and increases in the minimum floor payment rates. (1)

This act was also responsible for creating the CMS-HCC model in 2004, which takes data from diagnoses found in inpatient, outpatient, and professional claims for risk adjustment. (2)

4. 2003 – 2010: Medicare Modernization Act (MMA)

The objective of the MMA was to further enhance population health. This was the time that Medicare Part D was introduced and M + C was renamed MA. (2)

MMA helped move away from taking 95% of Medicare FFS with an adjustment for risk to a modified bidding process. Plan payments increased from 95% of FFS to 114%. (2)

A modified risk model was created for the new Part D pharmacy program. Medicare Part D was a new prescription drug benefit program implemented in 2006 which completely outsourced paying for drugs to the private industry. This was a huge success. Obtaining drugs for treatment became easier and more efficient as these private plans had agreements set in place with drug manufacturers. (3) Health plans put in a bid to CMS for the price of delivering these drugs to their respective member population. Within a few years, most Medicare beneficiaries enrolled in one type of Part D plan, providing a whole new source of diagnostic material. (2)

CMS set a limit on the amount of spending for prescription drugs per Part D enrollee. If any additional amount was spent, the beneficiary would enter a coverage gap also known as a “donut hole”. If the beneficiary was without a low income subsidy (LIS), they would have to cover 100% of those payments. (4)

5. 2011: Affordable Care Act (ACA)

Due to plan payments increasing to 114% of FFS, the government implemented a cost savings program for MA plans. The ACA was responsible for restructuring MA in order to correct the overpayment brought by the MMA. All plans were placed into “buckets”, or quartiles, based on how their payment rates compared with FFS payments. For example, counties with the lowest FFS payments were put into the highest quartile and vice versa. Ultimately, the ACA shaved down payment rates until the weighted average was down to 101% of FFS. The result was equal government spending for MA plans and Original Medicare FFS plans. (2)

The Medicare Quality and Performance Ratings, or the Star Program, analyze quality as part of the payment now. The Star Program is a fantastic tool for moving healthcare closer to value-based care. For instance, in addition to other incentives, the highest quality plans received an extra 5% of payments.(2)

In 2012, major changes were made to Medicare Part D models. The goal of the ACA was to phase down prescription costs incurred by Part D enrollees who were in the “donut hole” from 100% in 2011 to 25% in 2020. Additionally, plans required drug makers to offer a 50 percent discount on the cost of brand-name medications in the coverage gap starting in 2011. (4)

6. 2018: Bipartisan Budget Act of 2018 (BBA)

The drop in prescription drug payments for Part D enrollees to 25% was scheduled for 2020, however, this happened a year early in 2019. In 2018, the payment would have been capped at 30% (5) however, with modifications made by the BBA, Part D enrollees’ out-of-pocket expenses for brands in the gap would reduce from 35% of total expenses in 2018 to 25% for both generic and brand-name drugs in 2019. Furthermore, manufacturer discounts for brand-name drugs grew from 50% to 70%. (4)

Both locally and globally, risk adjustment is acknowledged as a crucial element of competitive health insurance markets. It enables a plan enrolling a higher percentage of high risk beneficiaries to, all things being equal, charge the same average premium as a plan enrolling a higher percentage of healthier, low risk beneficiaries. In other words, risk adjustment fulfilled the goal of bettering population health and eradicated the laws of the jungle.

If you have any other risk adjustment questions, feel free to reach us at https://www.episource.com/contact


1. Nelson, Frances R. “The Benefits Improvement and Protection Act (BIPA) and Its Impact on on the stability of provider networks in medicare + choice managed care organizations (MCOs)” Digital Scholarship @UNLV, University of Nevada, Las Vegas, Apr. 2005, https://digitalscholarship.unlv.edu/cgi/viewcontent.cgi?article=1444&context=thesesdissertations.

2. RISE. “Risk Adjustment Practitioner.” RISE, Wilmington PLC, https://www.risehealth.org/rise-institute/online-courses/risk-adjustment-practitioner/.

3. Megellas, Michelle M. “Medicare Modernization: The New Prescription Drug Benefit and Redesigned Part B and Part C.” Proceedings (Baylor University. Medical Center), U.S. National Library of Medicine, Jan. 2006, https://www.ncbi.nlm.nih.gov/pmc/articles/PMC1325278/.

4. Juliette Cubanski. “Closing the Medicare Part D Coverage Gap: Trends, Recent Changes, and What’s Ahead.” KFF, Kaiser Family Foundation , 21 Aug. 2018, https://www.kff.org/medicare/issue-brief/closing-the-medicare-part-d-coverage-gap-trends-recent-changes-and-whats-ahead/.

5. Norris, Louise. “Medicare and the Affordable Care Act.” Medicareresources.org, HealthInsurance.org LLC , 27 Sept. 2022, https://www.medicareresources.org/basic-medicare-information/health-reform-and-medicare/.