We analyze the optimal design of a risk adjustment scheme in competitive health insurance markets when insurers have better information on their customers’ risk profiles than the sponsor of the health insurance. The sponsor offers a menu of risk adjustment schemes to elicit this information from the insurers. The optimal scheme includes a voluntary reinsurance option. When the sponsor has a sufficiently large bias towards high-cost consumers, the optimal risk adjustment scheme should be complemented by a community rating requirement on the insurers. This induces inefficient coverage of low cost types, but the cost savings that result from their reduced coverage are shared with high-cost types. These gains for high cost types then outweigh the efficiency-loss of incomplete coverage for low-cost types.