Functional health measure for adjusting health maintenance organization capitation rates

Because of increasing interest in at-risk enrollment of Medicare beneficiaries by health maintenance organizations, a number of modifications to the adjusted average per capita cost (AAPCC) formula employed by the Health Care Financing Administration have been proposed recently. Researchers have found that new models, which include measures of prior years' utilization and costs, predict Medicare payments significantly better than does the purely demographic formula currently used. In this article, we show that inclusion of instrumental activities of daily living (IADL), a measure of beneficiaries' functional health status, can further improve AAPCC models that already incorporate measures of previous-period utilization and costs. Various models for predicting Medicare payments were examined and compared using survey data and Medicare claims for a random sample of 1,934 beneficiaries. For these models, explained variation in subsequent Medicare payments (as indicated by R(2) values) increased considerably when the IADL variable was included. Although actuarial concerns are associated with inclusion of the IADL score in the AAPCC, use of this measure is likely to offset other, possibly more serious, actuarial problems associated with including measures of previous utilization and costs.