Executive Summary

• Medicare Advantage (MA) is the private sector-based counterpart to fee-for-service (FFS) Medicare and operates on a capitated payment model, where Medicare gives plans an agreed-upon amount per plan enrollee in exchange for assuming financial risk and complying with program rules.
• Premiums follow a benchmark-bid-rebate formula that includes government-set benchmarks, plan bids, risk adjustment, and quality bonuses to determine both Medicare’s payments to plans and the amounts that beneficiaries pay in premiums and cost-sharing.
• This primer explains how the Centers for Medicare and Medicaid Services sets county-level benchmarks based on local fee-for-service spending, how plans submit standardized bids for Part A and B benefits, and how the relationship between bids and benchmarks determines plan payments, rebates, and the room available to lower premiums or enhance benefits.

This primer is part of a three-part series on Medicare Advantage. The first paper focused on the annual rulemaking cycle, and the next will focus on risk adjustment and coding.

Introduction

Medicare Advantage (MA) is the private sector-based counterpart to fee-for-service (FFS) Medicare and operates on a capitated payment model. Under the capitated model, Medicare gives plans an agreed-upon amount per plan enrollee in exchange for assuming financial risk and complying with program rules. This combines aspects of the employer-based insurance market and government-supported health programs.

As discussed in a previous primer, MA is governed by an annual, highly structured policy and rate-setting cycle. The Centers for Medicare and Medicaid Services (CMS) updates payment benchmarks, risk-adjustment parameters, and operational rules each year through the Advance Notice, Rate Announcement, and MA–Part D rulemaking, supplemented by Health Plan Management System guidance. These processes define the environment in which plans design benefits, build bids, and market products to beneficiaries.

Premiums follow a benchmark-bid-rebate formula that determines both Medicare’s payments to plans and the amounts that beneficiaries pay in premiums and cost-sharing. County-level benchmarks derived from fee-for-service spending, plan bids for Part A and B benefits, and quality bonus payments together determine plan payments, rebates, and beneficiary premiums. This primer walks through the key factors that underpin MA program design as well as the process for determining MA premiums and consumer cost-sharing.

The Basic Financing Model: Benchmarks, Bids, and Base Payments

MA plans are paid on a capitated basis. For each enrollee, Medicare pays a plan a fixed, monthly amount that is intended to cover the cost of providing Medicare Part A and Part B benefits, adjusted for the enrollee’s health status (risk score). The starting point for this payment is the county-level benchmark.

Benchmarks are set by CMS using formulas that rely primarily on traditional Medicare (fee-for-service) spending in each county, subject to caps and adjustments established in statute. The intent is to reflect local cost levels and create a ceiling on how much Medicare will pay a plan for a typical beneficiary in that area. To set these county-level benchmarks, CMS first ranks counties nationally by their per capita FFS spending and assigns each county to one of four quartiles. Each quartile is then mapped to a statutory percentage of local FFS spending. For example, lower-spending counties receive a benchmark equal to 115 percent of FFS, while the highest-spending counties receive a benchmark equal to 95 percent of FFS, with intermediate quartiles at 107.5 and 100 percent.

Each year, MA organizations respond to those benchmarks by submitting a bid for each plan. The bid represents the plan’s standardized estimate of the per-member, per-month cost of furnishing Medicare Part A and Part B benefits (the “basic” benefit package) to an average-risk beneficiary in each service area, including administrative costs and margins.

The relationship between the plan’s bid and the benchmark – along with the plan’s quality rating – determines:

• how much Medicare pays the plan for Part A and B services (the base payment);
• whether the plan receives a rebate and how large it is; and
• whether the enrollee owes an additional MA premium on top of the standard Part B premium.

In simplified terms:

• If the bid is at or below the benchmark, Medicare pays the bid amount (risk-adjusted) and may also pay a rebate.
• If the bid is above the benchmark, Medicare pays up to the benchmark, and the enrollee pays the difference through a premium.

Because almost all individual Medicare Advantage Prescription Drug (MA–PD) plans now bid below their benchmarks, many beneficiaries see low or $0 supplemental premiums for MA coverage, even though the underlying payments from Medicare to plans can be relatively generous.

When Bids Are Below the Benchmark: Rebates and Premium Reductions

If a plan bids below the benchmark, Medicare pays the plan its risk-adjusted bid for Part A and B benefits and also provides a rebate equal to a share of the difference between the bid and the benchmark. Statute sets the rebate percentage based on the plan Star Rating:

• Plans with lower quality scores generally receive a 50 percent rebate share.
• Mid-range plans receive 65 percent.
• Plans with higher Star Ratings receive 70 percent of the difference as a rebate.

The rebate is not paid directly to the enrollee. Instead, law and regulation restrict how plans may use those dollars. CMS requires that rebate amounts be applied to one or more of the following:

• Reducing Part A/B cost sharing (for example, lowering copayments for hospital stays or primary care visits);
• Financing supplemental benefits that are not covered under traditional Medicare (such as vision, dental, hearing, transportation, or certain care-management services);
• Reducing the Part D basic premium for enrollees in MA–PD plans; and
• “Buying down” the beneficiary’s Part B premium, within defined limits.

Plans allocate rebates across these uses by applying standardized bid-pricing tools provided by CMS. In practice, a significant share of rebates support supplemental benefits and lower cost sharing, with smaller portions used for Part D premium reductions and Part B premium buy-downs. Recent Medicare Payment Advisory Committee (MedPAC) analysis indicates that, on average, MA plans devote more than two-fifths of rebates to reduced cost sharing and more than a quarter to non-Medicare supplemental services.

From the beneficiary’s perspective, the key consequence of bidding below the benchmark is that a plan can offer a $0 MA premium for Part A and B benefits while still receiving full payment from Medicare and obtaining additional rebate dollars to enhance the benefit package.

When Bids Are Above the Benchmark: Premiums for the Basic Benefit

If a plan bids above the benchmark, Medicare’s payment is capped at the benchmark amount. The difference between the standardized bid and the benchmark must be financed by an enrollee premium. In this case:

• The base Medicare payment to the plan equals the risk-adjusted benchmark.
• There is no rebate, because the plan’s bid does not generate “savings” relative to the benchmark.
• Enrollees in the plan pay an additional premium that covers the difference between the bid and benchmark for Part A and B benefits.

Plans in this situation are competing on the basis of benefit design, network configuration, and brand, but they are at a disadvantage relative to plans able to offer $0 premiums and richer benefits funded through rebates. As a result, relatively few plans now bid above the benchmark in the individual MA-PD market.

The Role of Star Ratings and Quality Bonus Payments

Star Ratings introduce another important dimension into the premium determination process. MA plans are rated on a 5-star scale based on measures of quality and performance. Plans with higher ratings are eligible for Quality Bonus Payments that directly increase their benchmarks.

Higher benchmarks for high-rated plans have two major effects:

• They increase the spread between the benchmark and the plan bid (if the bid remains below the benchmark), which raises the dollar amount of the rebate.
• They improve the plan’s ability to fund supplemental benefits, reduce cost sharing, and buy down premiums relative to lower-rated competitors.

Because rebate percentages are also higher for plans with better Star Ratings, high-quality plans can leverage both higher benchmarks and higher rebate shares. This compounding effect helps explain why higher-rated plans tend to offer more generous benefit packages and more $0-premium options.

Conversely, plans with lower Star Ratings face lower benchmarks and lower rebate percentages. They may need to charge higher premiums or offer leaner benefits to remain financially viable, which can further affect their competitiveness and enrollment. Recent litigation over Star Ratings underscores their importance: Changes in ratings can materially alter bonus payments and thus affect the resources available for rebates, premiums, and supplemental benefits.

Geographic and Plan-type Variation

The mechanics described above operate nationally, but the outcomes vary substantially across markets and plan types.

• Geographic variation: Since benchmarks are tied to local traditional Medicare spending and other statutory factors, some counties have relatively high benchmarks while others are lower. In high-benchmark areas, plans can often bid well below the benchmark and still cover costs, generating large rebates that support richer supplemental benefits and more $0-premium offerings. In lower-benchmark areas, there is less room between bids and benchmarks, limiting rebates and making it harder to finance additional benefits.
• Local coordinated-care plans versus other plan types: Local coordinated-care plans (health management organizations (HMOs) and local preferred provider organizations (PPOs)) account for nearly all MA enrollment and are available to almost all beneficiaries. Regional PPOs and private fee-for-service plans play a smaller role and may have different cost structures and network arrangements, which can influence the relationship between bids, rebates, and premiums.
• Special Needs Plans (SNPs): SNPs, including dual-eligible SNPs and institutional SNPs, operate under the same benchmark–bid–rebate framework but serve higher-need populations. Their bids and resulting premiums reflect more intensive care management and coordination, often financed with relatively high risk-adjusted payments and tailored supplemental benefits.
• Employer Group Waiver Plans (EGWPs): EGWPs follow a related but distinct bidding and payment process. Employers and unions sponsor these plans for retirees, and CMS applies different rules for how bids and benchmarks are constructed. Premiums and benefit structures in EGWPs are shaped both by CMS policy and by employer contribution strategies.

Despite these differences, the central logic is the same: Benchmarks set a ceiling, bids reflect plans’ estimated costs, and the gap between the two – modified by quality bonuses – determines whether plans can offer lower premiums and enhanced benefits through rebates.

Defining the Premium: What Beneficiaries Actually Pay

To beneficiaries, “the premium” for an MA plan is not a single number. It is the combination of several components, some of which are paid to Medicare and some to the plan:

• Part B premium
  • All MA enrollees must continue to pay the standard Part B premium, which is $202.90 per month in 2026, subject to income-related adjustments.
  • Some MA plans use rebate dollars to buy down part of this amount; in 2025, roughly one-third of individual MA enrollees were in plans that offer some Part B rebate, though in many cases the rebate is less than $10 per month.
• MA premium for Part A/B coverage
  • This is the plan-specific premium for the basic MA benefit package.
  • For plans that bid below the benchmark and use rebates to offset this premium, it may be $0.
  • For plans that bid above the benchmark, it is equal to the difference between the standardized bid and benchmark.
• Part D basic premium (for MA-PD plans)
  • For plans that include prescription drug coverage, the bid also incorporates Part D components, and the beneficiary may pay a Part D basic premium.
  • Plans can use rebates to reduce the Part D basic premium, often bringing the combined MA-PD premium to $0 even when the prescription drug component alone would have required a positive premium.
• Supplemental premium (if any)
  • Plans may charge an additional premium for supplemental benefits that go beyond traditional Medicare coverage and what can be financed entirely with rebates.
  • This supplemental premium supports benefits such as expanded dental packages, richer vision coverage, or broader non-medical services.

When MA plans advertise a “$0 premium,” they are usually referring to the MA plan premium (and sometimes the Part D basic premium), not the beneficiary’s Part B premium obligation, which continues unless explicitly offset by rebates. The structure of MA payment makes it possible for plans to charge $0 for the MA component while still receiving per-member, per-month payments from Medicare.

Implications for Beneficiaries and the Market

This premium-setting structure has several implications.

First, it explains the prevalence of $0-premium MA-PD plans. In 2025, KFF reported that 76 percent of MA-PD enrollees pay no premium beyond Part B, and 99 percent of beneficiaries have access to at least one $0-premium MA-PD in their county. These offerings are made possible when benchmarks exceed plan bids, generating rebates that must be returned to beneficiaries in the form of reduced premiums, lower cost sharing, or supplemental benefits.

Second, it highlights the degree to which beneficiary premiums depend on factors that are not directly visible to enrollees: local fee-for-service spending, CMS benchmark policy, the plan’s efficiency and cost management, and its Star Rating. Changes in any of these upstream parameters – such as a policy shift that lowers benchmarks or modifies the quality bonus program – can ripple through rebates, supplemental offerings, and premiums.

Third, the framework helps explain ongoing policy interest in MA payment accuracy. Analysts and oversight bodies have raised concerns that benchmarks and risk adjustment may lead to payments that exceed what traditional Medicare would have spent on similar beneficiaries, which in turn supports higher rebates and more generous benefits. At the same time, beneficiaries have responded to these enhanced offerings with strong enrollment growth, and sponsors emphasize the value of stable, predictable payment rules.

For purposes of this primer, the key takeaway is that MA premiums are not set in isolation. They are the product of a defined, formula-driven process in which government-set benchmarks, plan bids, risk adjustment, and quality bonuses interact to determine both Medicare’s payments to plans and the amounts that beneficiaries pay in premiums and cost sharing.