Curbing Upcoding and Risk Selection in Capitation Health Care Programs: A Principal-Agent Framework

Curbing Upcoding and Risk Selection in Capitation Health Care Programs: A Principal-Agent Framework This study examines a capitation-based healthcare model in which a government entity contracts with private insurers or providers to deliver a defined set of benefits to enrolled individuals. The U.S. Medicare Advantage (MA) program serves as the primary example, offering a rich context for analyzing the design and performance of public-private partnerships in healthcare. Under MA, the Centers for Medicare & Medicaid Services (CMS) pays private health plans a fixed, risk-adjusted amount per enrollee, transferring financial risk from the government to the insurer. This payment structure incentivizes cost containment but introduces challenges related to incentive alignment and information asymmetry. Three core components define the MA model: (1) Capitation payments, adjusted via the Hierarchical Condition Category (HCC) model based on demographic and diagnostic data; (2) Enrollment mechanisms allowing Medicare beneficiaries to opt into MA plans, which often include additional benefits beyond traditional Medicare; and (3) Care management strategies employed by insurers, including network design, utilization controls such as prior authorizations, and cost-sharing arrangements. These features collectively shape access, quality, and financial outcomes for enrollees. The capitation arrangement creates a classic principal-agent problem. The government, as principal, delegates service delivery to private insurers, who act as agents with superior information about enrollee health and care utilization. This asymmetry gives rise to moral hazard (e.g., upcoding diagnoses to inflate risk levels), and undertreatment risks (e.g., restricting access to costly services). These behaviors can undermine the goals of equitable access and efficient care delivery. To address these challenges, we propose a principal-agent framework that models insurer incentives and identifies mechanisms to realign them with public objectives. By analyzing how payment structures, monitoring tools, and contract design influence agent behavior, the framework offers insights into mitigating inefficiencies and promoting value-based care. The relevance of this framework extends beyond the U.S. context. Hong Kong’s evolving healthcare reforms, particularly its “strategic purchasing” initiatives, reflect similar dynamics. The SAR government is increasingly subsidizing and procuring services from private providers to alleviate pressure on the public system and improve access. These reforms mirror the MA model’s public-private partnership approach and underscore the broader applicability of our analysis. By drawing lessons from MA, this research informs policy design in Hong Kong and other systems seeking to balance cost, quality, and access through innovative contracting with private healthcare entities.