Does Health-Based Prospective Risk Adjustment Adequately Compensate for Individuals Diagnosed With a New Chronic Disease?

Many regulated health insurance markets use prospective risk adjustment (RA) to mitigate risk selection incentives for insurers. However, prospective RA might underpay insurers for people diagnosed with a new chronic disease. By tracking spending and RA payments over the period <i>t</i>-2 to <i>t</i>+2 for individuals diagnosed with a new chronic disease in year <i>t</i>, we find a substantial payment gap in year <i>t</i> and, to a lesser extent, in prior and/or subsequent years. The extent to which these gaps stimulate selection incentives for insurers depends on the possibilities for insurers to distort consumers' choice of insurance products. Possibilities which-in turn-depend on whether and when consumers respond to the onset of the chronic disease when choosing an insurance product. By analyzing "insurer switching" in the period <i>t</i>-2 to <i>t</i>+2 we find that-on average-people first diagnosed with a chronic disease are more likely to switch insurer than others.