Medicare Advantage Reforms: A Crossroads for Health Insurers' Profitability and Strategy

The Medicare Advantage (MA) industry is at a pivotal moment. Regulatory reforms targeting billing practices like upcoding—where providers overstate diagnoses to inflate risk-adjustment scores—are reshaping the sector's dynamics. For insurers like Humana (HUM) and UnitedHealth Group (UNH), navigating these changes requires a blend of operational agility, policy engagement, and strategic portfolio shifts. The question for investors: Which companies are best positioned to thrive in this new era of compliance and accountability?

The Regulatory Hammer: CMS's Overhaul of Risk Adjustment

The Centers for Medicare & Medicaid Services (CMS) has escalated its fight against billing abuses. Starting in 2025, annual audits of all 550 MA plans—a 50-fold increase from prior years—aim to root out overpayments. CMS's blended risk adjustment model, now 67% reliant on new ICD-10-based calculations, reduces historical coding tactics that fueled profits. Meanwhile, DOJ lawsuits accuse insurers of kickback schemes to steer enrollees away from high-cost populations, signaling a zero-tolerance stance toward unethical practices.

The financial stakes are immense. CMS estimates overpayments of $17 billion annually, while MedPAC projects up to $43 billion in annual overcharges. If even 5% of projected 2025 MA payments ($25 billion) are clawed back, insurers could face a $1.25 billion hit. For MA-heavy players like Humana, which derives ~80% of earnings from Medicare, this threatens profitability unless strategies evolve.

Humana's Advocacy and Strategic Retreat: A Case Study in Adaptation

Humana has emerged as a paradoxical figure—both a target of regulators and a leader in advocating for reform. The company has publicly supported CMS's push to curb upcoding, framing it as a step toward fairer risk adjustment. Internally, it has taken preemptive action: cutting 10% of its 2025 MA plans and reducing Part D agent commissions to align with new marketing rules.

This move reflects a broader strategy to reduce regulatory exposure while focusing on sustainable growth. By shedding plans in markets with high compliance risks, Humana is prioritizing networks with healthier populations and stronger provider partnerships. Its recent partnerships with telehealth providers and primary care clinics also signal a shift toward value-based care, reducing reliance on risk-score arbitrage.

However, Humana's stock has underperformed peers this year, down 12% since January 2025 amid investor concerns about enrollment slowdowns. Yet its proactive stance on compliance could pay dividends long-term.

UnitedHealth's Crosswinds: Cyberattacks and Cost Pressures

UnitedHealth Group faces dual challenges: regulatory headwinds and operational disruptions. Its Q2 2025 results revealed a 5.5% year-over-year profit decline, driven by rising MA medical costs and the lingering fallout of the February 2025 Change Healthcare cyberattack. Direct costs from the breach, including a $9 billion provider loan program, added $1.30–$1.35 per share in expenses.

Regulatory changes further squeeze margins. CMS's 0.16% base payment cut for MA plans and stricter agent compensation rules have forced UnitedHealth to tighten enrollment practices. Unlike Humana's selective retreat, UnitedHealth's broader exposure to MA—40% of its membership—leaves it vulnerable to audit recoveries and enrollment declines.

AM Best's downgrade of UnitedHealth's credit outlook to “negative” underscores these risks. The rating agency cited concerns over MA's profitability and the company's rising financial leverage (43.7% debt-to-capitalization).

Investment Criteria: What to Watch for in 2025–2026

1. Operational Adaptability: Insurers with diversified revenue streams (e.g., Aetna's employer-group business or Cigna's global footprint) face less regulatory exposure.
2. Policy Engagement: Companies like Humana that align with CMS's reforms may secure favorable terms in future rulemakings.
3. Compliance Costs: The cost of audits, appeals, and retraining coders could eat into margins.
4. Network Adequacy: Insurers with robust primary care and behavioral health networks (e.g., Kaiser Permanente) are less reliant on risk-score inflation.

The Bottom Line: Favor the Diversified, Avoid the Overexposed

The MA sector's growth story remains intact, but profitability is narrowing. Investors should prioritize insurers with:
- Diversified revenue (e.g., Cigna's global health plans, Aetna's employer segment).
- Strong provider partnerships to reduce coding disputes.
- Transparent risk adjustment practices to avoid litigation.

Avoid MA-heavy stocks like HUM and UNH unless valuations reflect regulatory risks. Short-term volatility from audit recoveries and DOJ lawsuits will test investor nerves, but the winners will be those insurers that treat compliance as a competitive advantage, not a cost center.

In the coming quarters, look for CMS's audit outcomes and MA enrollment trends to crystallize the sector's trajectory. For now, the message is clear: adapt or be disrupted.