Reverse Cross Subsidization in Healthcare Capitation Programs: Evidence from Medicare Advantage

Capitation payment models have been increasingly adopted by the payers in the U.S. healthcare market during the past decade. However, healthcare services provided in Medicare Advantage (MA), the largest capitation program in the U.S., have been suggested to be more appealing to healthier patients and less appealing to sicker patients. The mismatch between a patient's health status and the benefits she gets from MA suggests that there may be a misallocation problem in MA. Despite extensive research on Medicare capitation program, little is known about how MA health plans actually allocate these capitation payments to different patients due to limited access to MA health plans' claims data. This paper utilizes a large commercial insurance database containing claims from more than 2 million MA enrollees to study the allocation problem of MA capitation payments. We empirically demonstrate that MA inadvertently incentivizes MA health plans to reallocate parts of the capitation payments from the sick to cross subsidize the healthy. By exploiting an exogenous policy shock on MA capitation payments through a Difference-in-Difference (DID) design, we identify, the first time in the literature, this reverse cross subsidization practice. Furthermore, we show that the reverse cross subsidization practice is associated with the risk selection problem in MA, where low-risk patients are more likely to enroll in MA compared to the high-risk patients.