Risk adjustment is a method used to calculate payments to health plans and providers based on how sick or healthy their patients actually are. Instead of paying every plan or provider the same flat amount per person, risk adjustment increases payments for those caring for sicker, more expensive patients and decreases payments for those with healthier ones. It’s a foundational mechanism in both Medicare Advantage and the individual insurance markets created by the Affordable Care Act, and it exists to solve a specific problem: without it, insurers have a strong financial incentive to avoid enrolling people who are likely to need expensive care.
Why Risk Adjustment Exists
Health insurance markets have an inherent tension. Plans that attract sicker enrollees face higher costs, which forces them to raise premiums, which then pushes healthier people toward cheaper competitors. This cycle, called adverse selection, can destabilize entire markets. Risk adjustment counteracts this by aligning a plan’s expected revenue with its expected costs, making both high-cost and low-cost enrollees financially viable to cover.
The practical effect is that plans compete on the quality of their care and the efficiency of their networks rather than on how well they can cherry-pick healthy members. In the ACA marketplace, the goal is that plan premiums reflect differences in coverage and plan design, not differences in the health of the people who happen to sign up. Internationally, this concept is sometimes called “risk equalization,” and it’s considered a critical component of any competitive health insurance system.
How a Risk Score Is Calculated
Every person enrolled in a risk-adjusted program receives a risk score, a single number that represents their predicted healthcare costs relative to the average enrollee. The score starts with demographic factors like age and sex, then layers on diagnoses documented during medical visits. A healthy 30-year-old with no chronic conditions will have a low risk score. A 70-year-old with diabetes, heart failure, and kidney disease will have a much higher one.
The system used in Medicare Advantage and ACA markets is called the Hierarchical Condition Categories model, or HCC model. It works by mapping thousands of individual diagnosis codes into a smaller set of condition categories that are clinically meaningful and predict future costs. For example, diabetes isn’t treated as a single category. It’s broken into three tiers: diabetes without complications, diabetes with chronic complications, and diabetes with acute complications. Each tier carries a different weight in the risk score, with more severe forms contributing more.
How the Hierarchy Works
The “hierarchical” part of the model prevents double-counting related conditions. When a patient has multiple diagnoses within the same disease family, only the most severe one counts toward their risk score. If someone has both acute renal failure and chronic kidney disease (stage 5), the model drops the chronic kidney disease category and pays based on the acute condition alone. The logic is that the most severe diagnosis already captures the cost burden of the less severe ones beneath it.
This hierarchy applies across many disease families. A patient with metastatic cancer won’t also generate separate risk score credit for a less severe cancer diagnosis like breast or prostate cancer. Someone on dialysis won’t also trigger payments for the lower-severity kidney disease categories. The system is designed to reflect the true clinical picture without inflating costs through overlapping diagnoses.
Risk Adjustment in Medicare Advantage
Medicare Advantage plans receive a monthly per-person payment from the federal government for each enrollee. Risk adjustment determines how large that payment is. Plans submit diagnosis data through two systems: the Risk Adjustment Processing System (RAPS), which captures specific diagnoses relevant to risk scoring, and the Encounter Data System (EDS), which captures all services and items provided to enrollees. Together, these submissions build the clinical profile that generates each member’s risk score.
Between 2024 and 2026, CMS phased in a major update to the risk adjustment model. The new version, called V28, replaced the older V24 model using a one-third, two-thirds, full implementation schedule across those three years. V28 is built on more recent claims data and uses an updated mapping of diagnosis codes to condition categories. With full implementation in 2026, the Medicare Payment Advisory Commission projects that coding patterns in Medicare Advantage will increase payments to plans by about 4 percent even after applying a coding intensity adjustment.
Risk Adjustment in ACA Marketplaces
In the individual and small group insurance markets, risk adjustment works differently than in Medicare. Rather than the government adjusting what it pays each plan, the ACA program transfers money between plans. Plans with healthier-than-average enrollees make payments into a pool, and plans with sicker-than-average enrollees receive payments from it. No new government money enters the system. It’s a zero-sum redistribution designed to neutralize the financial advantage of attracting healthier members.
This transfer mechanism stabilizes premiums across the market. A newer insurer that happens to attract a disproportionate share of people with chronic conditions doesn’t have to set dramatically higher premiums to survive. The risk adjustment transfers compensate for that imbalance, reducing the potential for excessive premium growth or market instability both inside and outside of the ACA marketplaces.
Accuracy and Auditing
Because risk scores directly determine how much money flows to health plans, there’s a strong financial incentive to document every possible diagnosis. This creates a tension between thorough coding and inflated coding. CMS addresses this through the Risk Adjustment Data Validation program, or RADV, which is the primary tool for identifying overpayments to Medicare Advantage plans.
During a RADV audit, CMS pulls a sample of enrollees from a plan and checks whether the diagnoses submitted for risk adjustment are actually supported by the medical record. A diagnosis code submitted without proper clinical documentation is considered unsupported. If the audit reveals unsupported diagnoses, CMS can collect overpayments from the plan. This process is a significant compliance concern for insurers, as even well-intentioned documentation gaps can trigger financial recoveries.
What Risk Adjustment Means for Patients
For most people, risk adjustment operates entirely behind the scenes. You won’t see your risk score on any paperwork, and it doesn’t directly affect your out-of-pocket costs or the care you receive. But it shapes the insurance landscape in ways that matter. It’s the reason your insurer can’t profit simply by making it harder for sick people to enroll. It’s why plans that specialize in managing complex chronic conditions can remain financially viable alongside plans that attract mostly healthy young adults.
The system also explains why your doctor’s office puts so much emphasis on documenting every active condition at your annual visit. That documentation feeds into the coding that generates risk scores. When a provider accurately captures that a patient has both diabetes and early-stage kidney disease rather than just diabetes alone, that specificity translates into appropriate funding for the plan responsible for managing both conditions.