DOD’s primary medical mission is to maintain the health of 1.6 million active duty service personnel and to provide health care during military operations. Also, DOD offers health care to 6.6 million non-active duty beneficiaries, including dependents of active duty personnel, military retirees, and dependents of retirees. Most care is provided in about 115 hospitals and 470 clinics worldwide—collectively referred to as military treatment facilities (MTF)—operated by the Army, Navy, and Air Force. The DOD direct care system is supplemented by care that is mostly paid for by DOD but is provided by civilian physicians under the CHAMPUS program. DOD is currently transitioning to a nationwide managed care program called TRICARE, under which the CHAMPUS program is now offered as one of three health care options called TRICARE Standard. In response to the rapid escalation of CHAMPUS costs in the 1980s, the Congress urged DOD, beginning with the Appropriations Act for Fiscal Year 1991 (P.L. 101-511), that physician payments under CHAMPUS be gradually brought in line with payments under Medicare, with reductions not to exceed 15 percent in a given year. Starting with the DOD Appropriations Act for Fiscal Year 1993 (P.L. 102-396), the Congress also enacted provisions (1) directing DOD, through regulations, to limit beneficiaries’ out-of-pocket costs through balance billing limits and (2) authorizing waivers to “freeze” CMAC rates at current levels if DOD determines that further rate reductions would impair beneficiaries’ adequate access to health care. DOD set balance billing limits for nonparticipating physicians at 115 percent of CMAC, which is the same limitation used for the Medicare program. By basing physician reimbursement on the Medicare fee schedule, DOD estimates that beneficiaries will save about $155 million in out-of-pocket costs in fiscal year 1998. To further contain rising health care costs, the Congress directed DOD in the National Defense Authorization Act for Fiscal Year 1994 (P.L. 103-160) to prescribe and implement a nationwide managed health care benefit program modeled on HMOs. Drawing from its experience with demonstrations of alternative health care delivery approaches, DOD designed TRICARE. As a triple-option benefit program, TRICARE is designed to give beneficiaries a choice among an HMO, a preferred provider organization (PPO), and a fee-for-service benefit. The HMO option, called TRICARE Prime, is the only option for which beneficiaries must enroll. TRICARE Extra is the PPO option, and TRICARE Standard is the fee-for-service option, which remains identical in structure to the previous CHAMPUS program. Regional MCSCs help administer the TRICARE program. The MCSCs’ many responsibilities include claims processing, customer service, and developing and maintaining an adequate network of civilian physicians. CMAC rates serve as the maximum level of reimbursement under each of TRICARE’s three options. To treat military beneficiaries under the Prime and Extra options, civilian physicians must join a network through the MCSC. The MCSC individually contracts with physicians or physician groups at a negotiated reimbursement rate, which is usually discounted from the CMAC rate. Network physicians are reimbursed at their negotiated rate regardless of whether they are providing care to enrollees under Prime or nonenrollees under the Extra option. Network physicians must accept their negotiated rate as payment in full. Physicians who do not join the network may still provide care to military beneficiaries under TRICARE Standard, for which they are reimbursed up to the full CMAC rate. Under this option, physicians may choose, on a case-by-case basis, whether to participate on a claim, that is, accept the CMAC rate as payment in full, less any applicable copayment. By law, physicians who decide not to participate on a particular claim under TRICARE Standard will receive the full CMAC rate and can balance bill the beneficiary for up to an additional 15 percent above that rate. The methodology DOD uses to set and transition CMAC rates to the Medicare level of payment complies with statutory requirements established under section 1079(h) of title 10 U.S.C. and generally conforms with accepted actuarial practice. Since 1991, DOD has annually adjusted and set CMAC rates on the basis of the Medicare fee schedule, which will result in a savings of about $770 million in fiscal year 1998. The methodology used to adjust CMAC rates is described in appendix II. As of March 1997, the most recent available CMAC rate update, approximately 80 percent of the national CMAC rates were at the same level as Medicare and about 20 percent were higher than Medicare because the transition for these rates is not yet complete. Only the rates for 61 of about 7,000 procedures—less than 1 percent—were below the Medicare level of payment. DOD has proposed a new rule (62 Fed. Reg. 61058 (1997)) to increase the payment amounts for the 61 procedures to the Medicare fee schedule amounts. The proposed rule is expected to be finalized in March 1998 after comments are received and analyzed. See appendix III for a list of these procedures. While CMAC rates are initially set at the national level, adjustments are made for each procedure code for 225 different localities within the United States. The locality-adjusted CMAC rates are the rates actually used to reimburse physicians. We found that the selected high-volume CMAC rates at each of the four locations were generally consistent with Medicare rates. DOD began using CMAC rates to reimburse civilian physicians on May 1, 1992. During the initial CMAC transition process to the Medicare level of payment, some physicians expressed concern about the low level of payment for certain obstetric and pediatric procedures, but payment levels for these procedures have since been addressed by DOD and HHS’ Health Care Financing Administration (HCFA). Current physician complaints about the CMAC level of reimbursement are primarily directed at the discounted CMAC rates paid to TRICARE network physicians under the Prime and Extra options rather than the full CMAC rate used to reimburse nonnetwork physicians under the Standard option. DOD reports that the vast majority of physicians who accept military beneficiaries as patients under the Standard option agree to accept the CMAC rate as payment in full for their services and do not balance bill for additional payment. During the transition of CMAC rates, physicians initially complained about the CMAC reimbursement levels for obstetric and pediatric procedures. In response to complaints about obstetric rates, HCFA reexamined and adjusted the Medicare fee schedule’s obstetric cost components and increased the reimbursement rates for some obstetrical delivery procedures. DOD, in turn, made corresponding adjustments to obstetric fees during its yearly CMAC revision. DOD did not, however, adjust pediatric rates. Physicians argued that CMAC rates for pediatric procedures should not be set at the same levels as services provided to adults because physician costs for caring for children are higher. To determine the validity of this concern, DOD commissioned a study, which concluded that only 12.3 percent of all payments would be for services for which there is a higher cost for children, and 56.2 percent of all payments would be for services for which there is a lower cost for children. The study found that 31.5 percent of payments were the same for children and adults. Consequently, DOD concluded that no payment differential was needed. According to the actuaries, DOD’s decision conforms with common insurance industry practice. Because most CMAC rates are equivalent to Medicare rates, the discounted CMAC rates that TRICARE network physicians agree to accept are typically below the Medicare level of payment. The American Medical Association and some medical society members we interviewed told us that they considered the discounted CMAC rates network physicians were being asked to accept by the MCSCs to be too low, but that the full CMAC rate paid under Standard, though not desirable, is acceptable. Because of this, some physicians told us that they would not join the TRICARE network but would continue to see military beneficiaries under the Standard option. In the four locations, we found that the differences in the discounted CMAC rates physicians are willing to accept depend largely upon local health care market conditions such as the degree of HMO penetration as well as the dependence of the local physicians on the military beneficiary population. Physicians whose practices include a large percentage of military beneficiaries are more likely to join the network and accept the discounted rates offered by the MCSCs to maintain their patient base. For example, in Ozark, Alabama, one of the two rural, low-HMO-penetration locations we selected, the median discount rate physicians were willing to accept to maintain their patient base was 10 percent. In Abilene, Texas, the other rural, low-HMO-penetration location we visited, most physicians said that they did not need to join the network to maintain their patient base, and consequently, many of those who did agree to join did so only on the condition that their fee would not be discounted. In each of these locations, DOD and MCSC officials told us that the local physicians also tended to be unfamiliar with and averse to managed care. In contrast, however, network physicians in the two urban, high-HMO-penetration locations—San Diego, California, and Jacksonville, Florida—accepted higher median discounts of 15 and 20 percent, respectively. According to the actuaries, in areas with significant competition among managed care plans such as the states of Florida, California, Minnesota, and Massachusetts, physician reimbursement is approaching the Medicare level of payment, and in some of these areas, typical reimbursement is based on 80 percent of the Medicare level of payment.