Strategic Cross-Subsidization in Healthcare Capitation Programs: Evidence from Medicare Advantage

Problem definition: This study identifies a resource misallocation problem in Medicare Advantage (MA), the United States’ largest healthcare capitation program, which may result in discrepancies between patients’ health status and the healthcare resources allocated to them. Methodology/results: Utilizing a large commercial insurance database with claims from more than 2 million MA enrollees, this research investigates the allocation of MA capitation payments. By exploiting an exogenous policy shock on MA capitation payments through a difference-in-difference design, we find empirical evidence of an illegal practice known as “cross-subsidization.” This practice involves MA health plans strategically reallocating portions of the capitation payments intended for one group of patients to spend on another group of patients. Additionally, we show that this cross-subsidization practice is associated with the risk selection problem in MA, where low-risk patients are more likely to enroll in MA compared with high-risk patients. Managerial implications: This research unveils a previously undocumented healthcare resource misallocation problem, that is, strategic cross-subsidization. This practice is explicitly prohibited by law in the United States due to its heightened effect on the undesired risk selection within capitation programs, where health plans cherry-pick profitable enrollees through strategic benefit designs. Our study has direct practical implications as it underscores the need for greater transparency in MA claims data to enable the Centers for Medicare & Medicaid Services to more effectively administer the MA program. Supplemental Material: The online appendices are available at https://doi.org/10.1287/msom.2023.0637 .