Favorable Risk Selection in Medicare Advantage: The Effect of Allowing Non-Medical Services

Problem definition: Following recent legislation, private insurers participating in Medicare Advantage (MA) are allowed to expand their set of supplementary services to include benefits that are not primarily health related. This policy is meant to lead to lower costs and better care, but questions have been raised about how this affects the incentives of private insurers. We investigate the implications of the policy for MA offerings, beneficiary enrollment, and social welfare. Methodology/results: We develop a game-theoretical model of the interactions between a social planner, an MA insurer, and beneficiaries. We posit that, even after risk-adjustment based on clinical factors, the beneficiary population is heterogeneous in their vulnerability to severe health events due to social determinants of health (SDOH). Owing to this heterogeneity and the broadened remit of the new legislation, the insurer can therefore introduce (i) preventive supplementary services, reducing the risk of severe health events and therefore mostly benefiting vulnerable beneficiaries, or (ii) general well-being supplementary services that entail the same level of non-health-related utility for all beneficiaries. We demonstrate that the policy change incentivizes the insurer to provide preventive supplementary services—which have the largest health impact—if and only if it receives high capitation payments for enrolled beneficiaries. Otherwise, the insurer offers general well-being supplementary services at prices tailored to attract less vulnerable beneficiaries. Moreover, for intermediate values of the capitation payment, the insurer enrolls fewer beneficiaries than under status quo policies—highlighting how the policy change can backfire by exacerbating favorable beneficiary selection (cream skimming) issues inherent in capitation payment systems. Finally, we investigate whether the social planner can mitigate favorable selection by adjusting the capitation payment. We find that the planner may need to choose between inducing improved health outcomes at a high cost (via preventive services) and higher overall welfare (via general well-being services). Managerial implications: While allowing private insurers to offer a wider range of supplementary services has the potential to result in more preventive offerings (thereby lowering treatment costs), policymakers should be aware of the conditions under which the policy might, instead, increase cream skimming and reduce social welfare. Avoiding such outcomes may be costly.

Funding: W. Hwang acknowledges support from the National Research Foundation of Korea (NRF) grant funded by the Korean government (MSIT) [Grant RS-2024-00410082].

Supplemental Material: The online appendix is available at https://doi.org/10.1287/msom.2023.0474.