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Medicare accounts for expected differences in resource needs of patients or health plan enrollees by risk-adjusting the payments it makes to health care facilities, such as hospitals, skilled nursing facilities, and home health agencies, and the premiums it pays to health plans. Risk adjustment is intended to ensure that payments or premiums are adequate for patients or plan enrollees who require more resources than average in order to protect beneficiary access as well as the financial condition of the provider or plan. At the same time, risk adjustment lowers payments or premiums for beneficiaries who are expected to use fewer resources to reduce incentives for providers or plans to favor these beneficiaries. This paper describes the origins and importance of risk adjustment, summarizes current risk adjustment by Medicare, and discusses issues and problems with risk adjustment methods.

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