Risk equalization, competition, and choice: A preliminary assessment of the 1993 German health reforms

Risk adjustment and/or equalization has become a central issue in the heath care reform initiatives of many countries, including Germany, Switzerland, the Netherlands, Israel, the U.K. and the U.S. Risk adjustment is widely seen as essential to prevent cream skimming and to promote fair competition. In this vein, the 1993 German health reforms require implementation of a riskbased contribution rate equalization scheme by 1996. This paper provides a preliminary assessment of the risk equalization methodology currently proposed for Germany. Recent research in the U.S. and the Netherlands is used to examine whether the sociodemographic factors being used in Germany are likely to be effective. Research findings from both countries indicate that risk formulas based only on socio-demographic factors predict only one-tenth to one-fourth of the maximum possible explainable variance. If the current formula is used, sickness funds with higher concentrations of high risk groups are likely to be substantially under compensated, and to face serious enrollment and financial problems. The authors conclude that improvements in the formula through measures based on diagnosis and prior hospitalization, disability status, and regional variations in utilization and cost are urgently needed before the system is implemented. The German experience is also relevant to other countries that have relied to date on socio-demographic measures for risk adjustment.