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Governments often contract with private firms to provide public services such as health care and education. To decrease firms' incentives to selectively enroll low-cost individuals, governments frequently "Risk-adjust" payments to firms based on enrollees' characteristics. The authors model how risk adjustment affects selection and differential payments - -the government's payments to a firm for covering an individual minus the counterfactual cost had the government directly covered her. They show that firms reduce selection along dimensions included in the risk-adjustment formula, while increasing selection along excluded dimensions.
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