Medicare Advantage – Payments

Since the 1980s, Medicare has included a private insurance option. The goal of this private plan was to reduce Medicare costs while improving health care quality and promoting innovation. Despite the original objective of achieving savings, the Medicare Payment Advisory Commission (MedPAC) estimated that, in 2024, Medicare spent 22 percent more for Medicare Advantage (MA) enrollees than it would have spent if those individuals had been covered under Traditional Medicare. The cumulative financial impact of these higher payments translated into an estimated $83 billion in additional Medicare spending in 2024 alone. Other experts have also found evidence of higher payments in MA of similar magnitude.

Given the prominence of Medicare’s private plans, MA payment efficiency is of growing concern. Today, MA enrolls over half of the Medicare population. Individuals from racial and ethnic minority groups and those with low-income, including dual-eligibles, increasingly enrolling in Medicare’s private plans. Higher federal payments to MA plans worsen Medicare’s financial outlook, hasten the Medicare Trust Fund’s insolvency date, increase the nation’s health expenditures, and increase costs for everyone with Medicare.

In part, these higher payments allow MA insurers to offer enrollees plans with improved financial protections such as lower cost-sharing, lower out-of-pocket spending caps, no (“zero dollar”) or low additional premiums, and in some cases, reduced Part B premiums. They also help MA plans finance supplemental benefits that are not available under Traditional Medicare, such as some coverage for vision, dental, and hearing services.

MA plans have long been permitted to offer supplemental benefits such as vision, dental, and hearing care. Since 2019, they can offer a much wider array of supplemental benefits, including services such as help for family caregivers, adult day care, housekeeping, and non-medical transportation. MA insurers now also have greater flexibility to design and tailor those benefits and associated cost-sharing to enrollees’ health conditions. However, information on the extent to which MA enrollees use supplemental benefits and whether they improve health outcomes is lacking (see also Data Collection and Reporting).

Notably, higher payments to MA plans increase out-of-pocket costs for everyone with Medicare, including people with Traditional Medicare who cannot access MA’s supplemental benefits and financial protections. This is because Part B premiums and deductibles are calculated to increase as a function of total Part B spending.

While policymakers have previously taken steps to address aspects of MA’s payment methodology, the last major reform occurred in 2010 as part of the Affordable Care Act. That law sought to address higher payments for MA enrollees that existed at the time by bringing MA payments closer to those for people with Traditional Medicare. But MA payments have increased significantly over the past decade and a half. As Medicare continues to make higher payments that finance additional benefits available only to MA enrollees, the program forgoes the opportunity to make other coverage improvements that could benefit everyone with Medicare more broadly and equitably.

Current Medicare Advantage payment methodology: Medicare pays MA plans a fixed monthly per-enrollee amount to provide health care benefits. Payments to MA plans are calculated based on plan bids, county-level benchmarks, and plan quality ratings. The bid is an estimate of how much it will cost the plan to cover Medicare Parts A and B benefits for an average enrollee. Benchmarks are administratively set amounts based on Traditional Medicare spending that represent the maximum Medicare would pay in the area. Benchmarks serve as targets against which insurers make plan bids. Plans with higher quality rankings (4 or more stars) on MA’s quality bonus program (known as the Medicare Star Rating System) have bonus amounts added to their benchmarks (increasing benchmarks by 5 or 10 additional percentage points).

Benchmarks are determined as a percentage of spending for people with Traditional Medicare. Counties in the highest-spending quartile have benchmarks of 95 percent of Traditional Medicare spending in the county. Intermediate spending quartile counties receive 100 percent and 107.5 percent, respectively. And counties in the lowest-spending quartile have benchmarks of 115 percent of county spending in Traditional Medicare.

When plan bids are lower than the benchmark—as they almost always are in today’s high MA payment environment—Medicare pays plans a base rate, consisting of their bid plus a rebate. The rebate is at least half of the difference between the bid and the benchmark. Plans with higher star ratings get bigger rebates.

Plans with 3.5 or 4 stars receive 65 percent of the difference between their bid and the benchmark, and those with more than 4 stars receive 70 percent of the difference.

MA plans must use their rebate dollars (minus any associated administrative expenses and profits) to offer supplemental benefits, lower premiums, or reduce enrollee cost-sharing. Over the last decade, annual per-enrollee rebates have grown dramatically, from $900 in 2014 to $2,329 in 2024.

In addition, MA’s base rates are “risk-adjusted” for each enrollee’s health and demographic characteristics (e.g., age, sex, Medicaid enrollment, and disability status) based primarily on diagnostic information provided by the plans themselves. Each enrollee’s health conditions and demographic characteristics are summarized in a risk score that reflects an MA plan’s expected spending for that enrollee based on Traditional Medicare’s national spending average. Plans receive higher payments for enrollees with higher risk scores. These individuals are expected to incur more costs, for example, because they are in poorer health and require more complex care than other enrollees. Conversely, plans receive lower payments for healthier enrollees. This approach was intended to reduce financial incentives for MA plans to avoid enrolling costlier individuals with higher medical needs and only enroll healthier, lower-cost beneficiaries.

MA’s current payment rules result in a paradox. The vast majority of MA plans say they can provide Medicare benefits at a notably lower cost than Traditional Medicare—as evidenced by the fact that nearly all MA plan bids are lower than Traditional Medicare costs (18% lower on average in 2024). Yet, the Medicare program pays more for MA enrollees than it would if those individuals were covered under Traditional Medicare.

There are several drivers of Medicare’s higher payments to MA plans:

Coding intensity (upcoding): MA insurers have a strong financial incentive to ensure providers in their networks thoroughly record and submit all their enrollees’ possible diagnoses. This is because adding new medical conditions eligible for risk adjustment raises an enrollee’s risk score and results in higher payments to the plan. Payments to providers in Traditional Medicare do not vary by the beneficiary’s condition.

MA plans have several tools, not available in Traditional Medicare, to code more enrollee diagnoses—most notably health risk assessments (HRAs) and chart reviews. An HRA is a tool used to identify enrollees’ health risks and evaluate their medical conditions during an annual wellness visit or a plan-initiated home visit. MA plans use chart reviews to identify diagnoses not captured through provider claims or in the MA plan encounter data. Many diagnoses are only reported through HRAs and chart reviews with no supporting or corresponding documentation of a medical encounter either to record the diagnoses or more notably to treat the diagnoses. In some cases, MA plan providers have been found to fraudulently assess enrollees as having more health conditions than they did.

Analyses and court documents have shown that many MA plans engage in practices to increase health risk coding intensity or upcoding. These efforts result in MA enrollees’ average risk score being significantly higher than that of similar people with Traditional Medicare. MedPAC estimated that in 2024, MA enrollee risk scores were about 20 percent higher on average than scores for similar people with Traditional Medicare. This resulted in substantially higher per capita payments to MA plans.

By law, the Centers for Medicare & Medicaid Services (CMS) reduces all MA risk scores by the same amount to make them more consistent with Traditional Medicare scores. In 2024, this coding intensity adjustment reduced MA risk scores by 5.9 percent, the minimum required by the law. Several studies have concluded that the current level of risk score reduction is insufficient to account for the payment effects of upcoding. Although CMS can impose a larger coding intensity adjustment, it has never done so. In recent years, CMS made some administrative changes to the risk-adjustment model to discourage intensive coding practices, coupled with plans to recoup some overpayments to MA insurers related to inaccurate diagnoses for plan years 2018 and beyond.

Favorable selection: Despite its goal of ensuring MA plans do not avoid individuals with higher medical needs and thus costlier care, recent MedPAC evidence indicates that the current risk-adjustment methodology does not appropriately account for favorable selection of MA enrollees. The tendency is for MA plans to enroll individuals who incur lower costs than individuals with similar health risk profiles who enroll in Traditional Medicare.

A growing number of studies show that people with Traditional Medicare who have below average expenditures within a given risk score are disproportionately more likely to switch from Traditional Medicare to MA. As a result, over time, MA increasingly enrolls individuals who are less costly than those who remain in Traditional Medicare, and for whom the risk-adjustment methodology predicts inflated payment estimates compared to what MA plans spend.

Since favorable selection is the gap between spending predicted by the current risk-adjustment formula and a plan’s actual spending for an MA enrollee—and not simply a measure of predicted spending—it has persisted despite more high-spending beneficiaries (including dual-eligibles) enrolling in MA plans.

There are several possible underlying factors that lead to this favorable selection. For example, by maintaining relatively narrow networks, MA plans may be less likely to attract individuals seeking care from certain providers, such as cancer centers, and who tend to have higher medical spending. Individuals requiring more complex care may be more likely to disenroll from MA plans with utilization management requirements such as prior authorization, or referrals for specialists.

Another body of evidence indicates that people with greater medical needs and costs due to a disability, with a greater number of chronic conditions, or those nearing end of life are more likely to switch from MA to Traditional Medicare.

Generous Quality Bonus Payments: The MA quality bonus program is intended to incentivize plans to deliver high-quality care and to encourage enrollment in higher-quality MA plans. Unlike other Traditional Medicare quality incentive programs in which bonuses paid to high performers are offset by penalties to low performers, MA’s quality bonus program is not budget neutral, and substantially increases Medicare’s overall spending.

Today, the majority of MA plans receive high star ratings, leading observers to question whether MA’s generous quality bonus program is a reliable tool to distinguish quality differences between plans. According to MedPAC, in 2024, nearly three-quarters of MA enrollees were in a plan with four or more stars that received a quality-related benchmark increase. Notably, experts have shown that, as implemented, MA’s quality bonus program does not effectively promote high-quality care, and that star ratings are not an effective tool to help consumers distinguish between plans when making coverage choices.

Other flaws of the current MA Star Rating System raised by experts include quality ratings at the MA contract level as opposed to the plan level, inclusion of quality metrics that are difficult for consumers to interpret or reflect providers’ performance as opposed to the MA plan’s performance, and a lack of quality measures that capture important outcomes or experiences for MA enrollees.

High Payment Benchmarks: Today, MA benchmarks are significantly higher than Traditional Medicare spending (8 percentage points higher on average in 2024) and that gap has grown over time. In 2017, the average benchmark was 6 percentage points higher than Traditional Medicare spending in the same year.

Some experts argue that, in many areas, MA’s benchmark levels are set too high, resulting in a system where MA plans’ efficiencies do not translate into savings for the Medicare program and all Medicare beneficiaries. In addition, as MA overtakes enrollment in Traditional Medicare, observers question the accuracy of calculating MA benchmarks based on Traditional Medicare spending. This system was established when MA was a significantly smaller part of the Medicare program. Compounding the flaws in the benchmark-setting system, many plans also qualify for quality bonus payments discussed above that further increase their benchmarks. Notably, evidence suggests that reductions in MA benchmarks would have a limited impact on consumers’ access to MA plans, result in small increases in MA out-of-pocket costs, and lead to modest declines in availability of supplemental benefits.

Under today’s rules, areas with low Traditional Medicare spending are assigned higher benchmarks, and areas with high Traditional Medicare spending have lower benchmarks. When mandated by the Affordable Care Act, these geographic differences in benchmark levels were intended, in part, to ensure that certain areas would not face problems attracting plans or have insufficient funding to offer extra benefits. However, studies show that, nationwide, payments are adequate to incentivize large numbers of plans and robust supplemental benefits offerings.