There has been speculation of a massive merger in the medical sector between two massive health insurers. Specifically, the rumor is The Cigna Group (NYSE: CI) is interested in acquiring Humana Inc. (NYSE: HUM). The conjecture caused both stocks to react, as Cigna stock fell 10% as the rumored surfaced on Oct. 18, 2024, and Humana stock remained relatively flat. Based on the reactions, the market doesn't see this as a favorable merger, and for good reason.

While there are many potential synergies in a merger, assuming it passes the regulatory antitrust sniff test (which is a big "if"), there is also a major sticking point that sinks any possibility of it coming to fruition called Medicare Advantage (MA).

Medicare: What It Is and How It Works

Medicare is a federal-sponsored health insurance plan available to Americans aged 65 or older. Its premiums are taken directly out of monthly Social Security benefits payments. Medicare is comprised of four parts:

• Part A covers inpatient hospital bills, home or skilled nursing, and hospice.
• Part B covers medical bills, including doctor visits, procedures and services, outpatient care and preventative care, as well as medical supplies and lab services.
• Part D covers prescription drugs.

Medicare follows a physician fee schedule that is released by the Centers for Medicare and Medicaid Services (CMS) every year, detailing how much the standard reimbursements are for every covered medical procedure under Medicare Part B. The fee schedule applies to fee-for-service, which reimburses on an itemized basis comprised of 80% from Medicare and 20% as a co-pay from the Medicare patient.

For example, a Medicare-participating doctor may bill $300 for a consult but only be eligible for a $100 reimbursement based on the Medicare fee schedule, while $80 is paid by Medicare and $20 is paid by the patient. If a patient has prescriptions to fill, then Medicare will pay 80%, and the patient is responsible for the 20%. The 20% patient responsibility can add up fast, which can be a major financial burden for seniors living on a fixed income. The health insurers, notably managed care organizations, applied their tactics to develop an all-inclusive type of health insurance funded mostly by Medicare payments.

Medicare Advantage Sounds Great on Paper  

The fourth part of Medicare is Part C, which is known as Medicare Advantage. This health insurance covers Parts A, B, and D in one plan. The premiums are taken directly from Social Security as traditional Medical would. A co-premium may apply for some options, which may include additional coverage. Medicare Advantage plans are known to offer additional benefits like health and wellness programs, gym memberships, transportation to and from the doctor's office, and preventative care. Initially, it seemed like an incredible bargain as seniors no longer had to pay additional monies out of pocket for expensive prescriptions or hospital bills.

Everyone was happy, as patients got full coverage with no more than 20% co-insurance payments. Medicare Advantage Plan providers like Humana and UnitedHealth Group Inc. (NYSE: UNH) made big profits. However, doctors, facilities, hospitals and medical providers were regularly getting stiffed, denied or underpaid from capitation.  

Medicare Advantage Plan Costs Surge

The unraveling occurred during the fall of 2023 when hospital/inpatient utilization rates surged seemingly out of the blue. This means that more seniors end up in hospitals using expensive resources. Humana shocked investors when they released their fourth quarter of 2023 earnings report, citing a surge in MA costs from inpatient utilization. Humana slashed their 2025 and 2024 full-year EPS guidance by 50% to 75%. For the full year 2025, adjusted EPS was cut to $16.00 versus $29.14 consensus estimates. Adjusted EPS for 2025 was slashed from $6.00 to $10.00 from the previous forecast of $37.00.

Like a contagion, other health insurers were also feeling the pain of rising MA plan member costs as medical benefit ratios (MBR) grew, squeezing margins. CVS Health Co. (NYSE: CVS) has been dealing with rising MA costs, pumping up its MBRs as it helped tank its adjusted operating income by 39.1% YoY. CVS Health recently replaced its CEO and is rumored to be contemplating splitting off with its Aetna health insurance subsidiary.

Cigna Saw the Writing on the Wall

Amidst the turmoil with health insurers, Cigna saw the writing on the wall and swiftly exited the MA business. They sold their Medicare business, which included Medicare Advantage, Medicare Part D, and the Cigna Supplemental Benefits businesses, to Healthcare Services Group Inc. (NASDAQ: HCSG) for $3.3 billion.

Cigna had the foresight and took prudent action. An acquisition of Humana would be the equivalent of playing hot potatoes with a ticking time bomb. A merger with Humana would make Cigna one of the largest health insurers in the country, but it would come with a lot of cost synergies.  

However, the reality is that MA makes up the majority of Humana's income, comprising over 85% of its premium income. Cigna can't overlook that fact, as it would be re-entering a business that it was prudent enough to divest before it became a major issue.