Medicare has a long-standing history of offering its beneficiaries managed care coveragethrough private plans as an alternative to the traditional fee-for-service (FFS) program, in which apayment is made for each Medicare-covered service provided to a beneficiary. Beginning in the1970s, private health plans were allowed to contract with Medicare on a cost-reimbursement basis. In 1982, Medicare's risk contract program was created, allowing private entities, mostly healthmaintenance organizations (HMOs), to contract with Medicare. Then, in 1997, Congress passed the Balanced Budget Act of 1997 (BBA, P.L. 105-33 ),replacing the risk contract program with the Medicare+Choice (M+C) program. The M+C programestablished a new payment structure, designed to achieve two major goals: (1) reduce spending, and(2) reduce the variation in payments across the country. In general, the program made monthlypayments in advance to participating private health plans for each enrolled beneficiary in a paymentarea (typically a county). In exchange, the plans agreed to furnish all required Medicare-covereditems and services, except hospice services, to each enrollee. Several legislative changes have beenenacted since 1999, to address some of the issues arising from the passage of the BBA. (1) Most recently, Congress made substantial changes to the M+C program with the passage ofthe Medicare Prescription Drug, Improvement and Modernization Act of 2003 (MMA, P.L.108-173 ). The act creates the Medicare Advantage (MA) program to replace the M+C program and introducesseveral enhancements intended to increase the availability of private plans to Medicare beneficiaries. In addition to the immediate payment increases to plans, beginning in 2006, the MA program willchange the payment structure for local plans and introduce regional plans that operate like PreferredProvider Organizations -- a popular option in the private health insurance market. The MA programprovides financial incentives for plans to participate in this new regional option. Additionally, in2006 beneficiaries will have access to a Medicare Part D prescription drug plan whether they are inFFS Medicare or enrolled in Medicare managed care. (2) Finally, beginning in 2010 a limited number of geographic areaswill be selected to examine enhanced competition among local MA plans and competition betweenthose private plans and FFS Medicare. The MMA made many changes to the payments for Medicare managed care plans, includingimmediate changes, effective March 2004, and then other changes that do not take effect until 2006and 2010. This set of changes creates a multi-tiered payment system, one for local plans, anotherfor regional plans and then beginning in 2010 another one for local plans in areas designated as costcontainment areas. The immediate changes became effective on March 1, 2004. First, a fourth paymentmechanism was added to the calculation of MA payments, so that in 2004, plans are paid the highestof the floor, minimum percent increase, the blend, or a new amount. (See below for a description ofthe three previous payment amounts.) The new payment amount is 100% of fee-for-service (FFS)payments made for persons enrolled in traditional Medicare. The FFS payment is calculated basedon the adjusted average per capita costs for the year for an MA payment area (a county), for servicescovered under Medicare Parts A and B for beneficiaries entitled to benefits under Part A, enrolledin Part B and not enrolled in an MA plan. Other immediate changes were also made to modify thestatutory formulas used to calculate MA payments. All of these immediate changes, discussed inmore detail below, had the effect of increasing payments to MA plans. Additional changes to payments for local MA plans will be made, beginning in 2006. TheSecretary will determine MA payment rates by comparing plan bids (the plan's estimated averagerevenue requirement, (i.e., their estimate of the cost of providing required Medicare Parts A and Bservices) to a benchmark (the maximum amount the federal government is willing to pay a plan forproviding these required benefits). After plans submit their bids, the Secretary will have theauthority to negotiate the bid amount, similar to the authority of the Director of the Office ofPersonnel Management (OPM) with respect to the Federal Employees Health Benefits program. TheSecretary will calculate the benchmark by updating the previous year's payment in a local area bythe statutorily required increase. If a plan's bid is less than the benchmark, its payment will equalits bid plus a rebate of 75% of the difference (between the benchmark and the bid). The rebate maybe used to provide additional benefits, reduce cost sharing, or may be applied towards the monthlyPart B premium, prescription drug premium, or supplemental premium (for services beyond requiredMedicare benefits). The remaining 25% of the difference will be retained by the federal government. If a plan's bid is equal to or above the benchmark, its payment will be the benchmark amount andeach enrollee in that plan will pay an additional premium equal to the amount by which the bidexceeds the benchmark. Although the program is identified as competitive beginning in 2006, in fact the localbenchmark will not be determined in a competitive manner; that is, a payment to one plan in an areawill not be based on any other plan's bid to provide the standard package of Medicare services. Local plans will still continue to compete with one another in order to attract beneficiaries, butpayments to plans in local areas will continue to be based solely on statutorily defined increases. Beginning in 2006, MA plans that choose to offer prescription drug coverage, will also receive abenchmark payment for Part D prescription drug benefits. The benchmark will be competitivelydetermined, based on an adjusted average of all plan bids for the area. By basing the benchmark forPart D benefits on the bids submitted by other plans, the payment methodology applied to MA plansfor providing prescription drug coverage introduces a new form of competition into the program. Also beginning in 2006, the MA program will begin to offer MA regional plans in 26 regionsacross the country. MA regional plans cover both in- and out-of-network required services and haveboth a limit on out-of-pocket expenses and a unified Parts A and B deductible. Each year anorganization will submit a separate monthly bid amount for each plan it intends to offer in a region. The regional benchmark , will include two components; (1) a statutorily determined increase, and (2)a weighted average of plan bids. As with the Part D benchmark for MA plans that offer aprescription drug benefit, the addition of the second component introduces a new form ofcompetition among plans, by basing part of the benchmark on the bids submitted by the plans. Similar to local plans, plans with bids below the benchmark will be given a rebate while plans withbids above the benchmark will require an additional enrollee premium. Additional financial incentives will be provided to encourage regional plan participation. First, starting in 2007, the MMA establishes a stabilization fund to provide incentives for regionalplans to enter into and to remain in the MA program. There will be $10 billion initially provided tothe stabilization fund in 2007 and additional amounts will be added to the fund. Second, during2006 and 2007, Medicare will share risk with an MA regional plan if its costs fall above or belowa statutorily-specified risk corridor. Third, there will be $25 million available beginning in 2006(with an increased amount each year) for additional payments to certain hospitals in regional areasthat demonstrate they have high costs, that would otherwise prevent them from joining an MAnetwork. The MMA requires the Secretary to establish a program for the application of comparativecost adjustment (CCA) in CCA areas. The six-year CCA program is required to begin January 1,2010, and to end December 31, 2015, in a fixed number of geographic locations. The program isdesigned to examine the efficiency both among local private plans and between the MA program andtraditional Medicare. For that purpose (1) payments to local MA plans will, in part, be based oncompetitive bids (similar to payments for regional MA plans), and (2) Part B premiums forindividuals enrolled in traditional Medicare may be adjusted, either up of down, depending on therelative costs of Medicare FFS and managed care. This program will be phased-in so that paymentsand Part B premium adjustments will be fully phased in by the beginning of the fourth year. Thereis also a 5% annual limit on the Part B premium adjustment, so that the amount of the adjustmentfor a year can not exceed 5% of the amount of the monthly Part B premium, in non-CCA areas. In addition to these payment changes, all MA plans will be able to offer Part D Medicareprescription drug coverage beginning in 2006. As part of the annual bidding process, managed careorganizations offering MA plans with prescription drug coverage must include their estimate for thecost of the Part D prescription drug coverage for each MA plan they intend to offer. Plans may alsochoose to offer supplemental benefits, such as vision or dental coverage, which are not included inthe basic Medicare package. Plans will be required to submit a bid for any supplemental benefitsthey intend to offer. Each part of the MA local, regional, and CCA payment structure is discussed in more detailbelow, along with an analysis of the effect of the change in the MMA on Medicare managed care. The Medicare statute for the M+C program set the annual managed care per capita rate fora payment area (for a contract in a calendar year) at the highest of one of three amounts calculated for each county : a rate calculated as a blend of an area-specific (local) rate and a nationalrate, a minimum payment (or floor) rate, or a rate reflecting a minimum increase from the prior year's rate.