Risk-Type Concentration and Efficiency Incentives: A Challenge for the Risk Adjustment Formula*

An important goal of risk-adjusted capitation payments (RACPs) to competitive community-rated health plans—that may differ in coverage and/or the organisation of delivering care—is to reduce incentives for risk selection while maintaining incentives for efficiency. In most schemes, RACPs are simply based on the average observed costs in risk groups (in a prior year). We show that under this procedure, incentives for efficiency will not always be maintained: when identical risk types are concentrated in the same health plans—due to selection, specialisation or just coincidence—cost savings can be captured by the RACPs and leak away from these plans.