Reinsurance, Repayments, and Risk Adjustment in Individual Health Insurance:

Abstract: Reinsurance -- extra payments a health plan receives once spending for an individual exceeds a pre-defined threshold -- can complement risk adjustment of health plan payments to improve fit of payments to plan spending at the individual and group level. Reinsurance can reduce selection incentives not corrected by risk adjustment and mitigate a plan’s business risk. This paper proposes three improvements in health plan payment systems using reinsurance. First, we base reinsurance payments on spending not accounted for by the risk adjustment system, which we refer to as residual spending, rather than just high spending. Second, we propose pairing reinsurance for positive residual spending (i.e. individual-level losses) with repayments for negative residual spending (i.e. individual-level profits). Third, we optimize the weights on the risk adjustors taking account of the presence of reinsurance/repayment. We implement our methodology in data from Germany, The Netherlands and the U.S. Marketplaces, comparing our modified approach to plan payment with risk adjustment as currently practiced in the three settings. The combination of the three improvements yields very substantial improvements in the fit of payments to plan spending in all three countries.