Health insurers brace for continued high Medicare Advantage medical costs

During the fourth-quarter earnings season, medical costs for Medicare Advantage (MA) became a central topic of discussion between health insurers and investors, as medical utilization in some parts of their businesses rose unexpectedly, spreading like weeds.

However, insurers' forecasts for how rising medical utilization would affect 2024 results varied widely.

Some insurers were more effective than analysts expected in controlling medical costs, saying the cost increases would not affect this year's outlook, and some even raised their 2024 expectations. These companies includeUnitedHealth、Centene、ElevanceandCigna。

However,HumanaandCVSlowered their 2024 earnings expectations after last year's results and said they expect medical costs to remain high this year.

Humana's outlook is particularly grim: the Kentucky-based insurer's earnings expectation for 2024 is only about half of what analysts expected.

Even insurers whose 2023 financial outlook was unaffected said they plan to cut benefits or raise premiums this year. These plan adjustments are designed to protect profit margins in the MA business—a business that has historically contributed significant profits but now faces challenges that could threaten the survival of this "golden goose."

Why did insurers fail to anticipate rising medical costs?

MA plans have surged in popularity in recent years.More than half of Medicare seniorsare currently enrolled in such plans, which are attractive due to lower monthly premiums and benefits such as dental and vision coverage. Intense competition among insurers for members, coupled withpervasive marketing, has also fueled popularity. Competition is fierce because MA'sprofit margin per enrollee can be up to twice as high as other types of plans。

However, increased membership has also brought more problems for some insurers due to rising medical utilization. Since the second quarter of last year,seniors began seeking medical services that had been delayed during the COVID-19 pandemic, driving up insurers' spending.

For example, CVS added 800,000 new MA enrollees in 2024, most of whom were taken from other insurers after CVS aggressively expanded benefits. But this is backfiring on the Rhode Island-based insurer, which, due to high medical costs,lowered its earnings per share expectations for this year。

According to JPMorgan analyst Lisa Gill, there may be several explanations for what is driving higher medical utilization and why insurers failed to accurately predict this trend.

MA enrollees are typically healthier than traditional Medicare enrollees. But as more seniors join MA, the plan's risk pool may be shifting toward sicker individuals, Gill wrote in a research note in early February. With seniors avoiding medical care during the pandemic, insurers may have missed early warning signs of high disease severity.

Gill said higher demand may have existed earlier, but healthcare providers were unable to meet it due to labor shortages, which have now eased. Similarly, insurers' new MA enrollees may lack diagnostic history relative to their overall population, resulting in lower visibility into their health status.

The medical loss ratio (MLR) is a useful metric for understanding how unexpectedly high utilization affects insurers.

The medical loss ratio is the proportion of premiums that insurers spend on clinical services and quality improvement. The higher the MLR, the less premium insurers have for administration or marketing, or to retain as profit. Therefore, insurers typically strive to keep MLR low (but within regulatory limits to avoid sanctions).

In the fourth quarter, MLRs for insurers' Medicare businesses soared, as utilization trends that emerged earlier in 2023 combined with the typical seasonal rise in winter medical spending.

Utilization inflation

Insurers attributed rising medical costs to different factors.

Seniors covered by UnitedHealth and Humana (which together holdnearly half of the MA market share) continued to seek outpatient care heavily in the fourth quarter, including procedures such as orthopedic surgeries.

UnitedHealth's members spent more on seasonal illnesses such as flu, COVID, or the respiratory virus RSV. Elevance, Centene, and CVS also reported an overall rise in outpatient care, such as elective surgeries, as well as increased spending on seasonal demand.

But that was not the case for Cigna—whose spending on seasonal illnesses was lower than expected—and similarly for Humana. Humana's care growth was "not driven by respiratory issues," Chief Financial Officer Susan Diamond said on the fourth-quarter earnings call in January.

"We don't have clear indications that this is something that can reasonably be assumed to be seasonal," Diamond said.

As for inpatient care, Centene and CVS did not report hospital service utilization higher than expected. Elevance also did not indicate that inpatient trends drove cost increases.

However, UnitedHealth and Humana warned investors about rising inpatient costs, which is concerning for insurers given the higher cost of hospital care coverage. UnitedHealth attributed it to expensive COVID hospitalizations, while Humana said it observed increases in short-term hospital stays across facilities.

Humana's Diamond said,recent government regulationsrequiring MA insurers to comply with traditional Medicare coverage decisions may be a potential driver of rising inpatient spending. The rule requires insurers to cover inpatient stays when patients are expected to need hospitalization for at least two midnights.

Other insurers said they were prepared for the so-called "two-midnight rule."

On February 6,Centene CFO Drew Asher told investorsthat the company had incorporated this rule into its 2024 planning. Meanwhile, CVS CFO Tom Cowhey said the next day thatthe company had internally adjustedto address the rule.

Looking ahead

Rising utilization—combined with weaker payment rates, changes in MA quality ratings, and risk adjustment model changes—has created upward pressure on MLRs, especially for insurers with high MA exposure like Humana and UnitedHealth.

The key question is how much of this utilization increase will carry over into this year, and whether insurers have adequately accounted for utilization changes in their plan designs.

Except for Elevance, all major insurers expect 2024 MLRs to be higher than in 2023. However, the increases range from 0.8 percentage points for UnitedHealth to 2.7 percentage points for Humana.

The exceptionElevance expects its MLRto remain flat.

Facing a challenging financial environment, insurers—even those that performed well last year in controlling medical costs—said they have cut benefits, raised premiums, or exited underperforming markets to improve profitability.

This applies to insurers expecting MA membership growth this year (UnitedHealth, CVS) as well as those expecting declines (Cigna) or flat numbers (Elevance).

Therefore, further growth may be suppressed as insurers prioritize profit margins.

"We are first focused on restoring margins, with market share growth as a secondary consideration," Brian Kane, who heads CVS's health benefits division, told investors on a February earnings call.

"I think next year is a year where the industry may reprice. I don't know how the industry absorbs this utilization increase and the regulatory changes that will persist in 2025 and 2026," Humana CEO Bruce Broussard said on the company's earnings call.

Insurers said they may further adjust plans given the2025 MA ratesproposed by the government in the middle of earnings season. These rates represent new efforts by regulators to curb Medicare spending growth.

Executives at Humana, Centene, and CVS all said the payment changes were insufficient to cover cost trends.Humanaand Centene said the rule would result in rate decreases of 1.6% and 1.3%, respectively. (This is before risk scores, which should increase overall reimbursement in 2025.)

Insurers warned regulators that if the rates are finalized as proposed, seniors could see reduced benefits.

"We will adjust our bids accordingly," Asher said on Centene's call. "If we don't make progress on the final rates, from an industry perspective, the product may become less attractive to seniors."