The military health system has three missions: (1) maintaining the health of active-duty service members; (2) maintaining readinessthe capability to treat wartime casualties; and (3) providing care to the dependents of active-duty personnel, retirees and their families, and survivors of military personnel. In fiscal year 1999, DOD’s annual appropriations included about $16 billion for health care, of which over $1 billion funded the care of seniors. In the mid-1990s, DOD implemented the TRICARE framework for military health care in response to rapidly rising costs and beneficiary concerns about access to military care. Its goals were to improve beneficiary access and quality while containing costs. TRICARE provides care through over 600 MTFs and a network of civilian providers managed by outside contractors. TRICARE offers three options: TRICARE Prime, a managed care option; TRICARE Extra, a preferred provider option; and TRICARE Standard, a fee-for-service option. TRICARE covers inpatient services, outpatient services such as physician visits and lab tests, and skilled nursing facility and other post-acute care. TRICARE also covers prescription drugs, which are available at MTFs, through DOD’s national mail order pharmacy (NMOP), and at civilian pharmacies. Medicare is a federally financed health insurance program that covers health care expenses of the elderly, some people with disabilities, and people with end-stage kidney disease. Military retirees aged 65 or older are eligible for Medicare on the same basis as civilian retirees. Medicare enrollees receive part A benefits and are eligible for optional part B benefits if they pay a monthly premium. Under traditional Medicare, beneficiaries choose their own providers, and Medicare reimburses those providers on a fee-for-service basis. Beneficiaries who receive care through traditional Medicare are responsible for paying a share of the costs for services. Most beneficiaries have supplemental coverage that pays for many of the costs not covered by Medicare. Major sources of this coverage include employer-sponsored health insurance, “Medigap” policies sold by private insurers to individuals, and state Medicaid programs. Beneficiaries have an alternative to traditional Medicare, the Medicare+Choice option. Medicare+Choice allows beneficiaries to enroll in private managed care plans and other types of health plans. Managed care plans provide all traditional Medicare benefits and typically offer additional benefits, such as prescription drug coverage. Plan members generally pay less out-of-pocket than under traditional Medicare. When choosing a plan, beneficiaries must weigh these benefits against other features of managed care. For example, beneficiaries enrolled in Medicare managed care plans generally must use the physicians in a plan’s network and often must obtain plan approval before they can see a specialist. Older military retirees who enroll in Medicare+Choice plans may choose to supplement the care they receive through the plan with space-available care provided by MTFs in their areas. The space-available care they receive saves the plan money if it otherwise would have provided the care. Similarly, MTF care provided to older retirees who are in traditional Medicare reduces Medicare spending. Today, there are about 1.5 million retired military personnel, dependents, and survivors aged 65 or older residing in the United States who are eligible for certain military health care services. About 600,000 of these seniors live within about 40 miles of an MTF. Retirees have access to all MTF and network services through TRICARE until they turn age 65 and become eligible for Medicare. Subsequently, they can only use military health care on a space-available basis, that is, when MTFs have unused capacity after caring for younger beneficiaries. In the 1990s, downsizing and changes in access policies led to reduced space-available care throughout the military health system. Some retirees aged 65 or older rely heavily on military facilities for their health care, but most do not, and over 60 percent do not use military health care facilities at all. Sweeping changes in retiree benefits and military health care are occurring in 2001 as a result of the Floyd D. Spence National Defense Authorization Act for Fiscal Year 2001. This legislation gave older retirees two major benefits: Pharmacy benefit. Beginning April 1, 2001, military retirees from the uniformed services aged 65 or older have access to prescription drugs through TRICARE’s NMOP and at civilian pharmacies, as well as through pharmacies at MTFs. TRICARE eligibility. On October 1, 2001, older retirees enrolled in Medicare part B became eligible for TRICARE coveragecommonly termed TRICARE For Life. As a result, TRICARE is now a secondary payer for these retirees’ Medicare-covered servicespaying most of the required cost-sharing. In addition, older retirees can enroll in TRICARE Plusa program that provides MTF primary care. The Medicare subvention demonstration permitted DOD to create managed care organizations that participate in the Medicare+Choice program and enroll older retirees. Medicare may pay DOD for enrollees’ care, but only after DOD has spent an amount equal to what it has spent historically on care for all older retirees. Under the demonstration, enrolled retirees receive their Medicare-covered benefits and additional TRICARE benefits (notably prescription drugs) through TRICARE Senior Prime, the DOD-run managed care organizations set up by the demonstration. To be eligible for Senior Prime, retirees must reside in one of the six geographic areas covered by the demonstration, be enrolled in both Medicare part A and part B, and be eligible for military health care benefits. They also must have either (1) used a military treatment facility before July 1, 1997, or (2) turned age 65 on or after July 1, 1997. Senior Prime is based on TRICARE Prime, DOD’s managed care program for active-duty personnel, family members, and retirees under age 65. Although DOD could charge enrollees a premium for Senior Prime, as any Medicare+Choice organization can, it has chosen not to do so. Services can be provided, at Senior Prime’s option, at an MTF or by a civilian network provider. Copayments differ by where the service was provided. For example, inpatient care is free at the MTF, but a copayment is charged for care at a civilian hospital. Senior Prime gives its members priority for treatment at MTFs over other older military retirees (that is, nonenrollees). Like enrollees in private Medicare managed care plans, Senior Prime enrollees agree that the plan will be the sole source of their Medicare benefits. Enrollees who use civilian providers without authorization are responsible for the full charge. Senior Prime began delivering care at its first site in September 1998 and was delivering care at all sites by January 1999. Sites differ in the numbers of older retirees in their area and enrollment (see table 1), as well as by geographic region, size of military health facility, and managed care penetration in the local Medicare market. The demonstration sites were not representative of all military health care service areas. This was because sites’ ability to support the demonstration was a factor in site selection. Military health care resources were greater in demonstration areas than in other military health care service areas. At the start of the demonstration, about 80 percent of older retirees in the demonstration areas lived near a military medical center—a teaching hospital with multiple specialty clinics—whereas in service areas that were not in the demonstration, only 30 percent of older retirees were served by a nearby medical center. The BBA authorized the demonstration for a 3-year period beginning on January 1, 1998, and ending on December 31, 2000. The Floyd D. Spence National Defense Authorization Act for Fiscal Year 2001 extended the demonstration for another year—through 2001. DOD has announced that Senior Prime will end on December 31, 2001, because the new TRICARE For Life program will provide expanded health care coverage to older military retirees. In establishing the demonstration, the BBA also established rules for Medicare to follow in paying DOD. The monthly Senior Prime capitation rate was set at 95 percent of the Medicare+Choice capitation rate, consistent with a belief that DOD could provide care at lower cost than the private sector. The rate was further adjusted by excluding the part of the Medicare+Choice rate that reflects graduate medical education (GME) and disproportionate share hospital (DSH) payments, as well as a percentage of payments made for hospitals’ capital costs. The GME and capital costs exclusions took into account the fact that GME and capital costs in the military health system are funded by DOD appropriations, and the DSH exclusion recognizes that DOD medical facilities do not treat the low- income patients for whom DSH payments compensate hospitals. The law directed the Health Care Financing Administration (HCFA) and DOD to determine the amount of the capital adjustment, and the two agencies agreed to exclude two-thirds of the capital costs reflected in the Medicare+Choice rate. The total amount that Medicare could pay DOD for the demonstration was capped at $50 million in 1998, $60 million in 1999, and $65 million in 2000. The BBA also required that participating MTFs maintain their “level of effort” (LOE). That is, they had to spend as much on care for older retirees as they did prior to the demonstration before Medicare could make any payment. This provision ensured that the government would not pay for the same care twice—through both the DOD appropriations and Medicare. (Appendix III explains how LOE works in practice and how Medicare’s final payment to DOD is determined.)