How Do Medicare Advantage Plans Make Money? The Formula Explained

Medicare Advantage plans make money by receiving a fixed monthly payment from the federal government for each member, adjusted for that member's documented health, and spending less than that payment on the member's care and the plan's administration. The payment is set by a formula: a county benchmark, the plan's own bid, a quality bonus tied to star ratings, and a risk score that rises with each diagnosis the plan documents. Plans must spend at least 85% of revenue on care, so the profit is a thin spread between a payment that CMS largely controls and a medical cost that the plan only partly controls.

Humana shows how much the formula matters. Roughly 80–85% of its revenue comes from the federal government. In the 2024 star ratings, about 94% of its members were in plans rated four stars or more. In the 2025 ratings, released in October 2024, the figure fell to about 25%, largely because one large contract was downgraded. Analysts put the lost bonus at about $1–3 billion of 2026 revenue (reported). No sales campaign or acquisition moved Humana's value as much as a quality formula run by CMS.

What is Medicare Advantage?

Medicare Advantage lets people eligible for Medicare choose a private plan instead of traditional, government-run Medicare. It grew from about 19% of eligible beneficiaries in 2007 to 54% (about 34.1 million people) in 2025 and 55% in 2026 (KFF). UnitedHealth (29% of enrollment in 2025) and Humana (17%) lead (KFF, reported).

Beneficiaries choose it because one plan replaces several (traditional Medicare plus a Medigap supplement plus a Part D drug plan), it has an out-of-pocket maximum that traditional Medicare lacks, it often costs no extra premium, and it adds dental, vision and other benefits. The trade-offs are provider networks and prior authorization.

How are Medicare Advantage plans paid?

The payment works in five steps. Chapter 8 of the book sets them out in full.

Part D drug coverage is paid separately. The plan then pays hospitals and doctors, usually at rates close to traditional Medicare's, or hands part of the payment and risk to a medical group through capitation.

What is a risk score?

A risk score measures how costly a member is expected to be relative to an average beneficiary, who scores 1.00. It is built from age, sex, Medicaid status, disability and diagnosed conditions under CMS's hierarchical condition category model. Each documented diagnosis can raise the score, and with it the payment. That creates the central tension of Medicare Advantage: a plan can increase revenue by keeping members healthier, or by documenting their conditions more completely, or both.

How does a Medicare Advantage plan earn a profit?

The book's Appendix A builds a stylized one-year profit and loss for a plan with 10,000 members. CMS pays $1,100 per member per month for a risk score of 1.00. Members' true morbidity is 1.05, care costs $900 a month per unit of true risk, administration costs $100 a month, and the 85% medical loss ratio floor applies.

Stylized; PMPM = per member per month. Not any real plan.

When coding matches members' health, the plan earns 3.9%. Each 0.01 of coded risk score is worth about $1.24 million a year to this plan, so coding the same people at 1.15 lifts revenue sharply with no change in care. The 85% floor claws some of that back, leaving 6.6% rather than the 12.2% the plan would otherwise keep. An 8% surge in medical use, with accurate coding, turns the plan to a loss. The example deliberately shows the incentive, not a permissible strategy: coding unsupported by the medical record is the subject of audits and False Claims Act cases.

The lesson is that coding moves the revenue line, care management moves the cost line, and the MLR floor limits how much of either gain a plan can keep.

Why are star ratings worth so much?

Star ratings run from one to five, in half stars, and combine about 40 measures: clinical quality, member experience surveys, health outcomes, drug-plan measures, and administrative measures such as appeals and complaints. Four stars brings both the 5-point benchmark bonus and a higher rebate share, so a rating can be worth hundreds of dollars per member per year.

Ratings are volatile. Humana fell to about 20% of members in four-star-plus plans in the 2026 ratings, sued CMS, lost twice in 2025 and appealed. The 2027 ratings, published in October 2026, showed a recovery to about 95%, while UnitedHealthcare fell to about 68% and Aetna to about 69% (reported). CMS reported about 71% of Medicare Advantage drug-plan enrollees in four-star-plus contracts for 2027 (CMS, reported).

Do Medicare Advantage plans get overpaid?

MedPAC, Congress's Medicare advisory commission, estimated in March 2025 that Medicare Advantage payments in 2025 were about 120% of what traditional Medicare would have spent on similar people, about $84 billion more. It attributed the gap mainly to two factors.

The industry disputes the method and argues that Medicare Advantage delivers richer benefits, lower out-of-pocket costs and better care management. The debate drives policy. CMS phased in the V28 risk model over 2024–2026, removing about 2,000 diagnosis codes it judged discretionary. Risk-adjustment data validation audits check medical records against submitted diagnoses, and in May 2025 CMS said it would audit all contracts each year (reported). A federal court in Texas vacated the 2023 audit rule in September 2025 in a case brought by Humana (reported). UnitedHealth said in 2025 that it was cooperating with federal civil and criminal investigations related to its Medicare business (reported).

What caused the 2024–2026 Medicare Advantage squeeze?

From late 2023, outpatient, surgical, behavioral and supplemental-benefit use rose faster than plans had bid. At the same time V28 cut risk scores, star ratings fell for several large carriers, and the Inflation Reduction Act's Part D redesign, which capped beneficiaries' drug spending at $2,000 a year from 2025, moved more catastrophic cost onto plans.

UnitedHealth Group shows the size of the swing. Its medical care ratio rose from a historical ~82–83% to about 85% in 2024 and about 89% in 2025, and each point on roughly $340 billion of premium is worth more than $3 billion of pre-tax profit. Insurers learn about rising costs late, because claims arrive weeks or months after care, so the surprises come as a soft warning followed by a larger cut. Our guide on how to analyze a health insurance company covers the early signals.

How does Medicare Advantage money reach doctors?

Many plans pass part of the payment, and the risk, to medical groups. A full-risk primary-care company such as Oak Street Health receives a share of premium, typically 80–90%, and pays for nearly all of its members' care. Oak Street's 2022 revenue was $2.16 billion, about 98% of it capitated. CVS bought it in 2023 for about $10.6 billion including debt.

The same formula that made these companies made them fragile. agilon health, which took full-risk contracts for independent physician groups it did not own, swung from a positive $205 million medical margin in 2024 to a negative $57 million in 2025, and its shares fell more than 95%. Optum Health's value-based margin fell to about 1% in the third quarter of 2025 from about 8% a year earlier (reported). The industry study on value-based care and risk contracting covers why so many failed, and our comparison of fee-for-service vs value-based care explains the trade-off.

Which factor of the Care Equation does Medicare Advantage turn on?

The Care Equation names four factors: care that works, a payer with a renewing budget, an affordable route to that payer, and proof that survives contracting and regulation. Medicare Advantage is the clearest case of the second factor: the federal government is always willing and usually able to pay. But it pays by formula, and the formula is political. Four of the program's economic levers are set by CMS (benchmark growth, the risk model, the coding adjustment and star methodology). Only two, the bid and medical management, are set by the plan.

That is why the book treats margins built on coding intensity as fragile. Savings that come from keeping members out of hospital survive a model change. Savings that exist only in documentation do not, and they also fail the fourth factor when an audit arrives.

The takeaway

Medicare Advantage plans earn the gap between a risk-adjusted federal payment and what their members' care costs, after an 85% floor on medical spending. The payment depends on county benchmarks, bids, star ratings and risk scores, most of which CMS controls and changes every year. From 2024 to 2026, rising utilization, the V28 model and tighter rates squeezed that gap across the industry. For the full mechanics of government payment, read Chapter 8, Government as Payer, and for the wider system, our guide to how the healthcare industry makes money.