Regulatory Risks and Margin Pressures in the Medicare Advantage Sector: A Post-Humana Analysis

The recent legal defeat of Humana Inc. (HUM) in its challenge to the Centers for Medicare & Medicaid Services (CMS) over 2026 Medicare Advantage star ratings underscores a growing regulatory risk for the sector. The Texas district court's dismissal of Humana's case—affirming CMS's decision to lower its quality ratings—has sent shockwaves through the industry. This ruling, coupled with broader CMS policy shifts since 2020, signals that margin pressures in Medicare Advantage (MA) are no longer cyclical but structural. For investors, the question is no longer if regulatory headwinds will persist, but how insurers will adapt to survive—and who will emerge stronger.

The Humana Setback: A Case Study in Regulatory Power

Humana's court loss is emblematic of the CMS's increasing authority to reshape the MA landscape. By maintaining its 2025 star ratings—despite the insurer's claims of methodological flaws—CMS effectively denied Humana access to billions in bonus payments tied to quality performance. The downgrade reduced the percentage of Humana's MA plans rated 4 stars or higher from 94% in 2024 to 25% in 2025, a catastrophic swing that slashed its 2026 revenue potential. This legal outcome reflects a pattern: CMS has become more aggressive in enforcing its rules, often to the detriment of insurers' profitability.

The broader implications are clear. Legal challenges to CMS decisions are increasingly unlikely to succeed, given the agency's procedural defenses (e.g., requiring insurers to exhaust administrative appeals first). For investors, this means regulatory risk is now a fixed cost of doing business in MA.

The CMS Playbook: Risk Adjustment, Star Ratings, and the IRA

Since 2020, CMS has systematically recalibrated the MA payment model to prioritize cost containment and health equity. Three pillars define this strategy:

1. Risk Adjustment Model Overhauls: The 2024 CMS-HCC model, now blended with the 2020 model at 67%/33%, has forced insurers to refine their coding practices. While this improves predictive accuracy, it also raises compliance costs and reduces the potential for gaming the system.
2. Star Ratings as a Revenue Lever: CMS has tightened the link between quality metrics and bonus payments. A one-star drop can cost insurers hundreds of millions annually, as seen in Humana's case.
3. IRA-Driven Part D Reforms: The Inflation Reduction Act (IRA) capped out-of-pocket drug costs at $2,000 and eliminated the coverage gap, directly increasing plan liabilities. This has forced MA-PD insurers to raise bids or absorb costs, squeezing margins.

Sector-Wide Margin Pressures and Strategic Shifts

The Humana case is part of a sector-wide recalibration. Other major insurers, including UnitedHealth Group (UNH) and Elevance Health (ELV), have also faced CMS over star ratings, with mixed legal outcomes. UnitedHealth's recent victory in a similar case highlights the unpredictability of regulatory battles. However, the broader trend is clear: insurers are reducing plan offerings, exiting unprofitable markets, and shifting focus to high-performing products.

For example, insurers have cut Medicare Advantage plans with prescription drug coverage by 6.6% in 2025, according to Leerink Partners. This “retreat” reflects a cost-cutting response to CMS's new guardrails on agent compensation, stricter network adequacy rules, and higher liability under the IRA. Investors should also note the rise in mid-year member outreach programs, as insurers scramble to ensure supplemental benefits (e.g., dental, fitness) are utilized to justify higher premiums.

Investment Implications: Who Survives the Regulatory Storm?

For long-term investors, the key differentiator among MA insurers will be their ability to adapt to CMS's evolving demands. Here are three strategic considerations:

1. Risk Adjustment Mastery: Insurers with robust data analytics and coding infrastructure (e.g., UnitedHealth) will outperform peers in navigating the 2024 CMS-HCC model.
2. Quality Performance Resilience: Companies that prioritize Star Ratings—through investments in care coordination and member satisfaction—will secure larger shares of quality bonus payments.
3. Cost Discipline: Insurers that exit unprofitable markets early (e.g., Humana's aggressive plan reductions) will preserve capital for high-margin segments.

Conclusion: Navigating the New Normal

The Medicare Advantage sector is entering a new era defined by regulatory rigor, margin compression, and strategic differentiation. While Humana's court loss is a cautionary tale, it also highlights the importance of resilience and agility. For investors, the path forward lies in identifying insurers that can balance regulatory compliance with operational efficiency. Those that fail to adapt—like Humana—risk becoming casualties in a sector increasingly shaped by CMS's regulatory agenda.

As the 2026 payment cycle approaches, the focus must shift from short-term legal battles to long-term strategic positioning. The winners will be those who embrace the new rules of the game—and turn them into competitive advantages.