When employers facilitate health plan choices, the method for setting employee premium contributions can create selection bias toward certain options. Selection bias happens when a sicker and more costly population tends to choose one option over another. A common example is when a more open network preferred provider organization (PPO) attracts those employees who want a broader range of providers and use their benefits more than those choosing a limited network health maintenance organization (HMO).
To reduce the selection bias, employers should adjust each option for morbidity. Because selection bias does not change the overall morbidity of the group, it is important to set the premium contributions without consideration for how healthy the subpopulation is within any one option. Otherwise, the option with the sicker subgroup will become more and more costly.
Risk adjustment is used to adjust the costs of two or more cohorts of people so all cohorts can be compared as if each had the same morbidity. A risk score is calculated for each person using age, gender, and medical conditions. Risk adjustment is a way to level the playing field so that the cost differences among options reflect benefit differences as well as network and operational performance differences, but not morbidity differences.