Medicare helps the elderly and certain disabled people meet the costs of health care services. Medicare is primarily a federally financed and administered health insurance program, which reimburses fee-for-service providers for each covered service rendered. However, Medicare also offers beneficiaries the option of enrolling in managed care plans—mostly risk contract HMOs. While nearly two-thirds of beneficiaries have access to at least one Medicare HMO that provides service in their zip code areas, only about 10 percent of beneficiaries belong to a Medicare HMO. Most beneficiaries are still enrolled in the traditional fee-for-service program. Under Medicare’s initial authority for paying HMOs that provided care to beneficiaries, few HMOs contracted with Medicare. As enacted in 1972, the legislation limited a participating HMO’s profit potential while losses had to be fully absorbed. Consequently, most Medicare HMOs chose to be paid on a cost basis. Facing neither profit nor loss from serving Medicare beneficiaries, cost contract HMOs lacked a strong incentive to reduce unnecessary care and deliver care efficiently. Legislation changed Medicare’s payment mechanism in 1982. Since then, HMOs have been able to enter into more attractive risk contracts with HCFA. The HMO receives a fixed monthly capitation payment—the AAPCC rate—for each beneficiary enrolled in exchange for providing all Medicare part A and part B services. The risk to the HMO is that for any particular beneficiary, the cost of care may exceed the prepaid amount. Each year, a risk HMO must estimate what it would charge Medicare beneficiaries for Medicare-covered services if they were commercial enrollees. The estimate of the premiums it would charge to provide such services to non-Medicare enrollees is adjusted to reflect the differences in (1) the benefits provided to Medicare enrollees and (2) the use of services by Medicare beneficiaries. This estimate (which includes the normal profit of a for-profit HMO) is used to identify any excess profits the HMO will derive from the Medicare business. The HMO is permitted to retain all profits up to the level earned on its non-Medicare business. If the expected Medicare profit exceeds the estimated profit on its non-Medicare business, the HMO must either return the excess to Medicare or provide additional supplemental benefits or reduced copayments or deductibles to beneficiaries. Virtually all HMOs faced with this choice have opted to provide increased benefits, which Medicare beneficiaries can find very attractive. Before an HMO can enter into a risk contract, the law requires it to have at least 5,000 commercial enrollees. An HMO serving primarily rural areas must have at least 1,500 members. In addition, the Medicare law’s “50-50 rule” states that no more than 50 percent of an HMO’s enrollment may be Medicare beneficiaries and Medicaid recipients. Medicare beneficiaries enrolled in a risk HMO face a “lock-in” requirement. Once they enroll, they must receive virtually all their health care services through the HMO. If a beneficiary goes outside the HMO for any health care services, neither the HMO nor Medicare is required to pay the cost. Exceptions are made for emergency and similar type care, which can be obtained anywhere in the country, and for which the HMO should pay. A few risk HMOs now offer a “point of service” option through which beneficiaries can receive certain services outside the plan’s network of providers but must pay more than for “within-plan” services. Beneficiaries consider a number of factors when deciding whether to enroll in a Medicare risk HMO, including (1) their familiarity with managed care, (2) their attachment to current health care providers, (3) whether they travel out of the area or live part of the year in another state, and (4) likely out-of-pocket costs in a risk HMO versus the fee-for-service program (plus the cost of a Medigap policy). In a risk HMO, the beneficiary may be charged a fixed monthly premium and a copayment each time a service is used. Depending on the additional benefits a Medicare HMO provides, enrolling may be an alternative to buying Medigap insurance, often at a lower cost to the beneficiary. Many employers provide health benefits to retired employees who receive Medicare. Some employers, faced with rising retiree health care costs and new accounting rules, believe they can reduce costs when their Medicare-eligible retirees enroll in risk HMOs. As a result, some employers are providing retirees with incentives to join risk HMOs. They may limit their contribution to just cover the cost of a Medicare risk HMO, thereby causing retirees who do not join an HMO to face increased health care costs. To remain in Medicare’s fee-for-service plan these beneficiaries may have to buy a Medigap policy and pay the difference between the premium and the employer’s contribution. About 3.8 million Medicare beneficiaries were enrolled in risk HMOs in August 1996, but enrollment was concentrated primarily in urban areas in the West and in Florida. Only a handful of counties in the East, South, and Midwest had more than 5 percent of their Medicare population enrolled in risk HMOs. (See fig. 1.) In total, 242 of 3,141 counties had more than 5 percent enrollment in the Medicare risk HMO program—a level that for this study we classify as “higher enrollment.” In contrast, however, 2,663 of the counties—about 85 percent—had either no beneficiaries or fewer than 1 percent enrolled in risk HMOs. (We classify these areas as “lower enrollment.”) Our analysis of counties grouped by their AAPCC rates and risk HMO enrollment levels suggests that while AAPCC rates play a role, other factors also affect enrollment. (See table 1.) In addition to HMO presence in the health care market, such factors as population density, the number of Medicare beneficiaries, and employers’ policies on retiree health benefits can influence risk enrollment. The studies we reviewed all found that several factors—usually including AAPCC rates and HMO presence—help account for the differences in risk HMO enrollment from county to county.Moreover, a study using recent data found that the factor with the strongest influence was HMO presence. Greater HMO presence establishes more familiarity in an area for managed care in general and for a particular plan. HMOs can draw on that when trying to attract Medicare beneficiaries. Medicare risk HMO enrollment in 2,257 counties that had lower AAPCC rates was minimal or nonexistent, but the principal barrier to risk HMO enrollment was not the payment level. On average, the 2,257 counties with lower AAPCC rates and lower enrollment had fewer people per square mile, and only about 16 percent of these counties were urban in that they were included in an MSA. For the most part, the 2,257 counties were mainly rural or sparsely populated and consequently, most had few or no HMOs serving non-Medicare residents. Generally, HMOs thrive and exert a stronger presence in counties that are part of metropolitan areas. In the 10 states with the highest percentage of people enrolled in HMOs in 1994, about 92 percent of the population lived in an MSA. Markets need to be of sufficient size to generate an HMO presence in general and a risk HMO program in particular. According to one study, the most remote counties with the smallest populations are not likely to be included in HMO markets. Table 2 compares characteristics of the 10 states with the lowest level of total HMO market share (that is, commercial, Medicaid, and Medicare enrollment) and the 10 states with the highest total HMO market share. The 10 states with the lowest total HMO market shares averaged less than two HMOs each. Even if the counties that had lower payment rates and lower enrollments had an HMO present, most lacked a Medicare population of sufficient size to attract an HMO into the risk contract program. Table 3 shows these counties had an average of about 5,600 Medicare beneficiaries. According to officials at several multistate HMO chains we interviewed, one of the factors they consider most when selecting areas of the country in which to pursue the Medicare business is the size of the Medicare population. An official at one company estimated that no more than 20 to 30 percent of the beneficiaries in a new market will join a risk HMO, which suggests that only about 1,100 to 1,700 beneficiaries in each of these counties may join. In addition, officials at multistate HMOs said that they need to enroll at least 10,000 beneficiaries within a few years to spread the risk. In another study, HMO officials said that they do not enroll Medicare beneficiaries in rural areas because the Medicare population is not large enough to cover the fixed costs associated with this coverage. In a number of counties where AAPCC payments were relatively low, the rate of Medicare risk HMO enrollment was relatively high, our analysis showed. Risk HMO enrollment flourished because of other factors, including urban settings and stronger HMO presence. Most of these primarily urban counties were in the West, where HMOs have a longer history than in many other parts of the country. The counties in and around the Portland MSA and three other MSAs in Oregon illustrate how factors other than payment rates serve to raise risk HMO enrollment. A large number of Medicare beneficiaries were enrolled in risk HMOs that serve more urban, lower payment counties. About 400,000 beneficiaries—nearly 18 percent of those eligible—were enrolled in risk HMOs in 92 counties that had lower payment rates (less than $375) and higher enrollment (greater than 5 percent).