Medicare Advantage plans make money by accepting a fixed monthly payment from the federal government for each enrollee, then spending less on that person’s care than the payment they received. The federal government is projected to pay between $500 and $600 billion to Medicare Advantage plans in 2025, and at the end of 2024, these plans averaged $1,655 in gross margin per enrollee, the highest of any insurance market segment.
The Capitation Payment Model
Unlike traditional Medicare, which pays doctors and hospitals each time a service is provided, Medicare Advantage works on a capitation model. The government pays each plan a fixed amount per member per month, regardless of how much care that person actually uses. If the plan spends less than it receives, it keeps a portion of the difference. If it spends more, it absorbs the loss.
The maximum the government will pay for an average enrollee in a given county is called the benchmark. This benchmark is tied to what traditional Medicare spends in that same county, but the exact percentage varies. Counties are divided into four groups based on spending levels. In the highest-spending counties (places like Miami-Dade County, Florida), the benchmark is set at 95% of traditional Medicare spending. In moderate-spending counties, it’s set at 100% or 107.5%. In the lowest-spending counties, it can go even higher. So in three-quarters of U.S. counties, the government is willing to pay private insurers as much as or more than it spends in traditional Medicare.
How Bids and Rebates Work
Each year, Medicare Advantage insurers submit a bid to the government estimating what it will cost them to cover standard Medicare benefits for an average enrollee. This bid gets compared to the county benchmark, and the math from that comparison determines how the plan gets paid.
If a plan bids below the benchmark, it doesn’t pocket the entire difference. Instead, it receives its bid amount plus a rebate worth 50% to 70% of the gap between its bid and the benchmark. The exact rebate percentage depends on the plan’s quality rating. A plan with a higher star rating gets to keep a larger share. The rest of the savings goes back to the federal government.
Plans must use their rebate dollars to benefit enrollees, typically by offering extras that traditional Medicare doesn’t cover: dental care, vision, hearing aids, gym memberships, or reduced premiums. These perks attract more enrollees, which means more monthly payments flowing in, which is how the rebate system ultimately feeds back into revenue growth.
Risk Adjustment and Diagnosis Coding
Not every enrollee is equally expensive to care for, so the government adjusts payments based on how sick each person is. This system, called risk adjustment, assigns every enrollee a score based on their diagnosed medical conditions. Certain diagnoses are mapped to condition categories that increase the payment a plan receives for that person.
This creates a powerful financial incentive. The more thoroughly a plan documents its enrollees’ health conditions, the higher its risk-adjusted payments. Plans invest heavily in annual wellness visits, in-home health assessments, and chart reviews specifically to capture every diagnosis that could raise an enrollee’s risk score. A person with diabetes, heart failure, and chronic kidney disease generates a significantly higher monthly payment than someone with no documented conditions. The system is designed to ensure plans aren’t penalized for enrolling sicker people, but it also means that aggressive coding practices can inflate revenue without any change in the care actually delivered. The HHS Office of Inspector General has repeatedly scrutinized these practices.
Quality Bonuses From Star Ratings
CMS rates every Medicare Advantage contract on a five-star scale based on measures like customer satisfaction, management of chronic conditions, and how quickly members can access care. Plans that earn four stars or higher receive a bonus: their benchmark increases by 5 percentage points, and in certain counties, by 10 percentage points. This higher benchmark means the plan can earn a larger rebate, which it can reinvest in benefits to attract even more members. Star ratings also determine whether a plan keeps 50%, 65%, or 70% of the gap between its bid and the benchmark. A five-star plan keeps 70%. A three-star plan keeps only 50%.
The financial stakes are enormous. A few tenths of a point in star ratings can mean millions of dollars in additional revenue across a large enrollment base, so insurers pour resources into the specific metrics CMS measures.
Controlling Costs Through Utilization Management
The other side of the profit equation is spending less on care. Because plans receive a fixed payment, every dollar they don’t spend on medical services flows toward administrative costs and profit. The primary tool for controlling spending is prior authorization, which requires doctors to get approval from the insurer before providing certain services.
Medicare Advantage insurers made nearly 53 million prior authorization decisions in 2024. Virtually all enrollees (99%) are in plans that require prior authorization for at least some services, most commonly expensive ones like inpatient hospital stays, skilled nursing facility stays, and chemotherapy. When an insurer denies or delays a service through this process, it directly reduces the plan’s medical spending.
Plans also steer members toward preferred provider networks where they’ve negotiated lower reimbursement rates with hospitals and doctors. Traditional Medicare lets beneficiaries see almost any provider in the country. Medicare Advantage plans typically restrict choices to a defined network, which gives them leverage to negotiate discounts. Lower provider rates mean the same care costs the plan less, widening the gap between revenue and expenses.
The Medical Loss Ratio Floor
There is a limit to how much plans can keep for themselves. The Affordable Care Act requires insurers to spend at least 85% of premium revenue on actual medical care and quality improvement. The remaining 15% covers administrative expenses, marketing, and profit. If a plan falls below this threshold, it must issue rebates to enrollees. This rule prevents plans from collecting government payments while providing minimal care, but 15% of a $500-plus billion market still leaves substantial room for profit.
Why Margins Are Higher Than Other Insurance
Medicare Advantage consistently produces the highest gross margins per enrollee of any insurance market. At the end of 2024, the $1,655 average gross margin per Medicare Advantage enrollee was nearly double the $846 seen in the employer group market and well above the $987 in the individual marketplace. Medicaid managed care plans averaged just $608.
The reason is straightforward: Medicare covers an older, sicker population, so both the costs and the government-funded premiums are much higher than in commercial insurance. Even when Medicare Advantage plans spend a similar percentage of their revenue on medical care as other insurers, the raw dollar amount left over is larger because the total dollars flowing through the system are larger. A plan spending 85% of a $12,000 annual premium keeps more than a plan spending 85% of a $6,000 premium.
Putting It All Together
The business model has several interlocking pieces, but the core logic is simple. The government pays a fixed amount per person. The plan tries to spend less than that amount on care. The difference, after regulatory minimums and rebate requirements, becomes the plan’s revenue for administration and profit. Plans amplify this model by documenting diagnoses thoroughly to maximize risk-adjusted payments, earning high star ratings to unlock bonus benchmarks, using prior authorization to limit unnecessary spending, and negotiating lower rates with providers. In 2025, government payments to Medicare Advantage plans are expected to increase by an average of 3.70%, adding over $16 billion to the market, which helps explain why major insurers continue to aggressively expand their Medicare Advantage enrollment.