How the Government Updates Payment Rates for Medicare Advantage Plans

Medicare Advantage offers Medicare benefits through private insurance plans, as an alternative to traditional Medicare. The federal Centers for Medicare and Medicaid Services (CMS), the agency that runs Medicare, pays these private plans on a capitated basis — a per person, per month rate to cover health care services for each enrollee.

Every year, CMS is statutorily required to update how much Medicare Advantage plans are paid to cover their enrollees. The rates are revised upward or downward, largely driven by how CMS updates two things: 1) the benchmark, or the maximum amount the federal government will pay plans for an average person in each county, and 2) the risk adjustment model, which CMS uses to modify payments based on enrollees’ expected health care costs.

In addition to being complex, the payment update process can be controversial. CMS’s methodological changes affect plan revenue, and plans sometimes argue that certain updates will jeopardize their ability to deliver stable, affordable benefits. Some changes can invite substantial pushback; for example, in response to objections raised by insurers and providers, last year’s proposed revisions to Medicare Advantage’s risk adjustment model will be phased in over three years.

Accurate payments to Medicare Advantage plans help ensure these plans can meet patients’ health needs while making efficient use of taxpayer dollars. About half of all Medicare beneficiaries are now enrolled in Medicare Advantage. As enrollment in these plans continues to grow, how they are paid — and how much —will be central to the debate over the efficiency and sustainability of Medicare spending.

This explainer lays out the steps CMS follows when updating annual payment rates for Medicare’s private plans. To learn the fundamentals of Medicare Advantage, how it compares to traditional Medicare, and how plans are paid, see our primer.

What does the annual update process involve?

The process begins with CMS releasing its advance notice, a document that outlines the agency’s planned changes to how it will calculate Medicare Advantage payment rates for the following calendar year. CMS must release the advance notice at least 60 days prior to release of the final rate announcement (published on or before the first Monday in April every year). The public is given 30 days to submit comments on the advance notice.

Released alongside the rate announcement is a rate book that details the maximum amount Medicare will pay plans in a given area — what’s known as the benchmark. Insurers use these rates to develop and submit their “bids” to offer Medicare plans. These bids represent their estimated costs of providing Medicare Parts A and B services to the average enrollee.

The benchmarks and the risk adjustment model — used to modify payments to account for enrollees’ health status — are the major items that CMS updates when calculating payment rates for the next year.

How does CMS set the new benchmarks for Medicare Advantage plans?

Each county-level benchmark is based on the average spending on health care for traditional Medicare beneficiaries in the county.

To determine benchmarks, CMS first uses its most recent data to project national per capita fee-for-service (FFS) spending for the coming year — what’s known as the FFS United States Per Capita Cost (USPCC). To calculate FFS per capita spending in each county, CMS multiplies the projected FFS USPCC for the coming year ($1,105.10 for 2024) by a county-level geographic index called the average geographic adjustment (AGA).

To arrive at the benchmarks, each county-level FFS per capita spending number is first multiplied by a percentage, between 95 and 115 percent, to account for FFS spending levels in that area. Plans in counties with relatively low FFS spending have benchmarks set at higher percentages of FFS per capita spending in the county. That number is in turn adjusted for plan quality, as determined by a plan’s quality rating on a five-star scale derived from about 40 measures of health outcomes, patient experience, access, and process.

Each year, CMS refines how it calculates national FFS per capita spending and the AGA to reflect the most recent enrollment numbers, benefit expenditure data, and FFS payment rules. To update FFS costs, CMS makes adjustments based on data from other programs that affect calculations of FFS costs, including the Medicare Shared Savings Program, Advanced Alternative Payment Models, and CMS Innovation Center models that test new ways of incentivizing more effective and efficient care delivery. CMS accounts for the savings and losses that providers accrued under these programs as a result of achieving or falling short of different performance metrics.

To update the AGAs, CMS “reprices” the historical claims data used to determine AGAs to reflect changes in FFS payment rules, as well as the most current wage indices and costs of delivering care in different geographic areas. Each county’s AGA is based on a five-year average of FFS Medicare spending in that county and weighted by enrollment and local risk scores, which are the numbers that reflect the diagnoses and clinical profiles of people served in that area. At least every three years, CMS updates the five years of FFS claims data used to calculate the AGA, a process known as “rebasing.”

In addition to the FFS USPCC described above, CMS calculates two other USPCCs that play a role in determining payments. The first is the total USPCC, which covers most FFS and Medicare Advantage beneficiaries. This amount is used to calculate the benchmark cap in each county. The total USPCC’s growth rate is known as the Medicare Advantage growth percentage, or the National Per Capita Medicare Advantage Growth Percentage. This rate conveys how payments to plans are changing over time. The second is the end-stage renal disease (ESRD) USPCC, which covers beneficiaries in traditional Medicare who are undergoing kidney dialysis. CMS determines Medicare Advantage ESRD payment rates by applying an AGA to the projected ESRD USPCC rates.

How is the risk adjustment process updated?

The risk adjustment model that CMS uses, called the CMS Hierarchical Condition Categories (HCC) model, estimates enrollees’ costs and risk scores that influence plan payments. Categories of conditions — like diabetes, major depressive and bipolar disorders — are based on clinical diagnosis codes logged by patients’ providers. A hierarchy is imposed so that each beneficiary’s risk score, and payments to plans, are driven only by their most serious conditions.

Each risk score is the sum of a beneficiary’s demographic characteristics and health conditions that are expected to drive their health care costs. The risk score is made up of “relative factors,” numbers that represent the costs of each characteristic or condition. A risk score of 1.0 represents the expected costs for the average Medicare beneficiary. Healthier enrollees would have risk scores below 1.0, while sicker enrollees would have risk scores above 1.0.

CMS regularly updates these HCC model inputs to account for the latest health care utilization and cost data. The updates generally fall into these categories:

• Recalibration. CMS periodically updates the HCC model with more recent years of data, reflecting the latest beneficiary diagnoses and expenditures. It also periodically updates the “denominator year” — the year of data used to calculate the relative factors described above. For 2024, CMS updated the year from 2015 to 2020.
• Reclassification. CMS makes clinical revisions — updates to the condition categories or diagnosis codes used in the model — based on changes in the Medicare population, disease patterns, treatment methods, and coding practices. For instance, sometimes CMS removes codes that have proven to be unreliable predictors of costs, or codes that plans or providers have been using inappropriately. In the 2024 advance notice, CMS removed HCCs for protein-calorie malnutrition and angina pectoris (a type of chest pain).
• Adjustments to coding pattern differences. Risk adjustment incentivizes plans to thoroughly document their enrollees’ diagnoses. While this may result in more complete coding, it can also drive increased coding for conditions that have no bearing on patients’ health expenditures — a practice known as upcoding — and portray enrollees as less healthy than they are.
  
  To mitigate these incentives, Congress required CMS to reduce Medicare Advantage enrollees’ risk scores to address coding differences between Medicare Advantage and traditional Medicare. Since 2018, a 5.9 percent downward adjustment to Medicare Advantage risk scores has been required. While CMS administrators have the authority to increase the percentage, none have chosen to do so. In addition, as of 2022, all diagnosis codes used for risk adjustment must come from encounter data, or the items and services provided to enrollees.
• Normalization factor updates. CMS applies to risk scores a number called a normalization factor to account for changes in the health status and demographics of traditional Medicare beneficiaries in the denominator year relative to the payment year. CMS calculates the normalization factor by using historical data on risk scores and the payment year risk adjustment model. For 2024, the denominator year will be 2020, and thus the normalization factor will adjust for differences between traditional Medicare beneficiaries in 2020 versus those in 2024.

How do Medicare Advantage plans submit bids?

Alongside the rate announcement, CMS publishes a bid pricing tool that plans must fill out to submit their bids (their cost estimates for providing Parts A and B services). Plans enter their per member, per month cost and utilization data, best projection of costs, and more. The standardized tool calculates the plan’s bid, benchmark, and rebate, if the bid is lower than the benchmark. Otherwise, if the bid exceeds the benchmark, the tool calculates the beneficiary premium. To submit a bid, plans need to provide a completed bid pricing tool, accompanying documentation, and actuarial certification by early June.

How does CMS use plan bids to make final decisions?

Every year from mid-June to late July, CMS’s Office of the Actuary determines whether each bid is reasonable. Bid reviewers may correspond with plans throughout this process to resolve any issues that arise. The actuary’s office can authorize plans to resubmit bids if they properly address concerns flagged by reviewers. Once CMS wraps up bid pricing review in mid-August, plans can move into the contracting phase. An organization must meet certain criteria, such as administrative capabilities, before successfully entering the contract. That organization can offer more than one plan under a contract.

The Centers for Medicare and Medicaid Services annually updates how, and how much, it pays Medicare Advantage plans to accurately reflect the anticipated costs of enrollees’ care. The county-level benchmarks and the HCC risk adjustment model are the two key annually updated inputs. Accurate estimates of patients’ costs and health conditions ensure that payments are sufficient in meeting patients’ needs. As Medicare Advantage enrollment continues to grow, the way that plans are paid will likely be a key element of debates over the Medicare program’s efficiency and sustainability.