Medicare Advantage

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The US promoted Health Maintenance Organizations (HMOs), and people wanted HMOs to be a part of the Medicare program.

Through the HMO Act, employers with 50 or more employees were required to offer HMO plans. Then the Center for Medicare & Medicaid Services (CMS) decided to demonstrate HMO plans for Medicare patients. These private plans take a fixed amount (called a capitated payment) to take care of Medicare patients. Therefore, Part C was created to be the HMO option.

What is Medicare Advantage (MA)?

Medicare Advantage acts a substitute for the Original Medicare Part A and Part B benefits. Medicare Advantage originated with the passage of the Balanced Budget Act of 1997, which offered Medicare beneficiaries this option, instead of receiving these benefits through the original Medicare plan (Parts A and B). The original intention was to reduce the budget deficit by paying a fixed rate per member to private insurance companies. The CMS budget contributes 5.4% (or $854.3 billion) to the country’s GDP.

The program now enrolls 28% of all Medicare enrollees. In Traditional Medicare (TM), patients can see almost any doctor they want to, but in MA they pay much less to see in-network doctors. By restricting this option, insurance companies can control costs which reduce premiums and increases coverage.

Payers (insurance companies) may seek doctors who don’t charge a lot or who don’t refer a lot to expensive doctors, and they try to coordinate the care, to keep costs down.

The amount the doctor gets depends on the area and the plans they offer.

Medicare Advantage

Under the Affordable Care Act, Medicare Advantage plans get a percentage of what Traditional Medicare would spend on patients in a county. For example, MA plans would get 95% of what Traditional Medicare spends on its most expensive patients. The reason being is that payers would be gain economies of scale to reduce costs.

The Medicare Advantage Bidding Process

  1. Medicare Advantage Plans bid for each county, and if the bid is below the benchmark of what TM would spend (95% of them are) then the plan is paid the bid.
  2. 50 to 70% of the difference between the bid and benchmark is a rebate, which the plan uses to lower premium, copays or adds extra coverage.

– The rebate is higher for higher quality plans
– The government keeps the other 30-50%
– The government risk adjusts the payments based on the enrollees, i.e. sicker patients get more money.

How does Traditional Medicare compare to Medicare Advantage?

Medicare Advantage has come under criticism for spending too much on advertising and costing taxpayers more than Traditional Medicare but is increasing in popularity post the Affordable Care Act.

Medicare Advantage seems to be gaining momentum after the Affordable Care Act as the number of enrollees increase.

– Marilyn Tavenner, CMS Administrator

Medicare Advantage vs Traditional Medicare

  • Private plans can coordinate care within their networks.
  • Plans can negotiate rates with providers. While in Traditional Medicare, doctors can either take it or leave it.
  • Medicare Advantage plans are thought to be designed so that the sickest people choose Traditional Medicare by optimizing benefits in such a way.

In Traditional Medicare, there’s an incentive to over-serve as the more patients you see and bill for procedures, the more you get paid. While, in MA, the insurers have a fixed capitation per individual, so they have an incentive to underserve to keep costs under capitation.

Enrollees in MA may have to pay a monthly premium in addition to Original Medicare Part B (but this depends on the population demographics of that region).


  • People in Traditional Medicare can go to any doctor they like, while in Medicare Advantage, you can only go to doctors within your network.
  • Medicare Advantage plans are required to offer the same package that covers everything Original Medicare covers but not necessarily in the same way (i.e., they can offer lower copayment for doctor visits to balance out plans that require higher out-of-pocket costs.) They may use the capitation amount to offer supplemental benefits. However, the insurer pays for 100% of services once the individual reaches the maximum out-of-pocket costs.
  • Medicare Advantage must cover out-of-network costs if Traditional Medicare covers those procedures and tests.


In 2013, Medicare Advantage enrollees consisted of 14.4 million Americans (28% of all Medicare beneficiaries.) This is a 30% increase from 11.1 million in 2010.

Administrative Costs

Medicare Advantage Organizations are restricted to a 15% margin on administrative expenses and profit. There have been arguments made for and against the privatization of Medicare; specifically that the Center for Medicare & Medicaid Services (CMS) has a lower administrative cost than Medicare Advantage. However, the CMS cost does not include other government agencies helping out the CMS (like the IRS). Additionally, since Traditional Medicare tends to serve a “sicker” percentage of the population, its administrative cost to benefits paid would be lower than Medicare Advantage.

Results: Medicare Advantage vs Traditional Medicare

  • Data shows that there is a 20% fewer inpatient admissions utilization under Medicare Advantage
  • There is a 10% less utilization for outpatient services
  • People in their last few years of life used the Emergency Room 40-50% less in Medicare Advantage

Note: There are more preventive services in Medicare Advantage vs Traditional Medicare

The future for the Medicare Advantage program remains uncertain as proposed funding cuts are due to be voted on in the next few years. There were cuts proposed for 2015 but then they were reversed. Both programs provide plenty of benefits to enrollees, but with Medicare Advantage gaining momentum, will there be a reason to keep Traditional Medicare alive?

Policy Overview

The Affordable Care Act (ACA) planned $150 billion cuts into the Medicare Advantage program (MA) over the next 10 years to bring costs in line with Traditional Medicare costs. Currently, MA costs about 14% more than traditional Medicare per enrollee.

The ACA has established an annual fee on the health insurance sector that will impact MA revenues by 1.9% to 2.3%.

The ACA has also changed how CMS will pay Medicare Advantage Organizations (MAOs). This is done by phasing in benchmarks calculated as a percentage of per capital fee for service Medicare spending. This is likely to reduce MA plan payment benchmarks by 2.5%. There is a little confusion on how this benchmark will be set.

CMS began offsetting the effect of MAO’s more efficient coding in diagnosis reporting (since providers sent procedures not diagnosed so the patients seem riskier) by reducing MA plan payments (total of 4.91%)

Impact of ACA on Medicare Advantage

Projected Insurer Fees for 2014-1.9%-2.3%
ACA quartile impact for 2014-2.5%-2.5%
Star bonus increase for 20141.0%0.5%
Coding intensity change for 2014-1.5%-1.5%
Ratebook change for 2014-2.2%-2.2%
Total Reduction for 2014-6.9%-7.8%

Result – This will require an estimated $50-$90 increase in monthly premiums. However, the CMS has lowered the maximum premium increase/benefit reduction to $30.

How will Medicare Advantage Organizations make up this difference?

CMS recently announced that the average monthly premium for Medicare Advantage plans in 2015 would be $33.90—an increase of $2.94, or 9.5%, over the current year. But as a result of more individuals seeking out lower-cost plans, the CMS estimates that the average premium hike will be $1.30 per month. The agency anticipates that just more than 60% of beneficiaries who opt for private coverage will see no premium increase in 2015.

Prateek Agarwal
Prateek Agarwal
Member since June 20, 2011
Prateek Agarwal’s passion for economics began during his undergrad career at USC, where he studied economics and business. He started Intelligent Economist in 2011 as a way of teaching current and fellow students about the intricacies of the subject. Since then he has researched the field extensively and has published over 200 articles. If you have any questions, comments or suggestions, please email me or connect with me on LinkedIn -

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