The M+C program, established by the Balanced Budget Act of 1997 (BBA), grew out of Medicare’s previous managed care option known as the risk- contract program. BBA included provisions designed to expand the number and type of health plan choices available to Medicare beneficiaries. BBA also modified the method used to set payment rates, both to encourage MCOs to serve new geographic areas and to pay them more appropriately for the beneficiaries they enrolled. Since the first of BBA’s payment reforms were implemented, MCOs have terminated some of their Medicare contracts and reduced the geographic areas served under other contracts. As a result, many beneficiaries previously enrolled in M+C plans have had to switch plans or return to the FFS program. In 1999, and again in 2000, Congress passed legislation that increased payment rates in an effort to make participation in the M+C program more attractive for MCOs. As of September 2001, about 5.6 million people—or approximately 14 percent of Medicare’s 40 million beneficiaries—were enrolled in M+C plans. Overall, approximately two-thirds of all beneficiaries lived in areas served by at least one MCO, but M+C plan availability varied among locations. Most beneficiaries living in urban areas, but less than one- quarter of beneficiaries living in rural areas, had access to one or more M+C plans. MCOs receive a fixed monthly payment for each beneficiary enrolled in their health plans, regardless of the actual cost of an individual enrollee’s care. Because Medicare establishes separate payment rates for each county, the amount that Medicare pays for a specific beneficiary depends, in part, on the beneficiary’s county of residence. The beneficiary’s demographic characteristics and an indicator of his or her health status also affect the monthly payment. These adjustments are made to the county rate so that the payment amount better reflects the expected health care costs of the specific beneficiary. Benefit packages—in terms of premiums, required cost sharing, and covered services—vary among M+C plans. All plans must cover the services available in the FFS program, with the exception of Medicare’s hospice benefit. MCOs may include additional benefits in their health plans, such as coverage for routine physical examinations and outpatient prescription drugs. Every July, as part of the annual contracting process, MCOs must estimate how much it will cost them to provide Medicare- covered benefits during the next calendar year. These estimated costs, which may include the organization’s normal profits, are supposed to reflect the premiums that the MCOs would charge to commercial and other customers, adjusted to reflect differences in Medicare’s covered benefits and beneficiaries’ expected use of services. For each M+C plan they intend to offer, MCOs submit a document, known as an adjusted community rate proposal (ACRP), that contains detailed estimates of the plan’s expected costs and revenues associated with providing covered benefits, and a description of the plan benefit package. CMS reviews each ACRP and compares the estimated costs to the plan’s projected Medicare revenues. If the estimated costs are less than the projected Medicare revenues, the MCO must either use the difference to cover additional benefits or contribute to a benefit stabilization fund that it can draw on to augment the plan’s revenues in future years. The cost of any additional benefits or stabilization fund contributions must also be detailed in the ACRP. Before 1998, Medicare’s managed care payment rate in each county was set equal to 95 percent of FFS per capita spending in that county, adjusted for certain demographic characteristics of the beneficiaries living in the county to account for differences in service use associated with those characteristics. These county payment rates—reflecting the underlying pattern of FFS spending—ranged from $221 to $767 PMPM in 1997. This variation in payment rates may have contributed, along with many other factors, to the uneven availability of Medicare managed care options across the country. Our work and research by others has found that the methodology used to adjust payments for the expected service use of enrolled beneficiaries did not adequately reflect the above average health status and below average expected health costs of typical M+C enrollees. Consequently, Medicare paid MCOs substantially more than it likely would have spent if beneficiaries enrolled in M+C plans had instead received services in the FFS program. Beginning in 1998, BBA substantially modified the method used to set county payment rates for M+C plans. Some of the modifications were designed to reduce excess payments, while others were designed for other purposes—such as increasing program participation of MCOs in geographic areas that historically had low payment rates. Specifically, the law required that each county’s payment rate equal the highest of three rates: a minimum amount, or “floor” (set at $367 in 1998 and increased each year); a minimum increase (2 percent) over the previous year’s payment rate; or a blend of historical FFS spending in a county and national average costs adjusted for local price levels. BBA required, for five years, that the annual payment rate updates to the floor and blend rates be lower than the increases in national FFS per capita spending. The law also mandated that by 2000, M+C payments be adjusted to reflect the health status of plans’ enrollees. In the years following the implementation of BBA’s payment and other reforms, MCOs terminated approximately 160 Medicare contracts and reduced the size of the geographic areas served under many of the contracts they renewed. Approximately 1.6 million beneficiaries had to switch to a different M+C plan or return to the FFS program because of these withdrawals. CMS expects that an additional 536,000 beneficiaries will be affected by withdrawals that will occur at the end of 2001. Most of the affected beneficiaries live in areas where other M+C plans are available, but approximately 38,000 beneficiaries will no longer have access to a M+C plan and will have to return to the FFS program. Managed care industry representatives have attributed the withdrawals to BBA’s payment reforms and new administrative requirements for MCOs. The representatives have stated that the payment reforms and the cost of meeting the new administrative requirements make it difficult for MCOs to offer benefit packages that are attractive to beneficiaries. To help maintain and expand beneficiary access to M+C plans, Congress twice revised the M+C program and modified BBA’s payment reforms. In 1999, Congress passed BBRA, which provided for new-entry bonus payments to MCOs that contracted with Medicare to serve areas where no M+C plans were being offered. The law also affected payment rates by modifying implementation of certain BBA payment reforms. In December 2000, Congress passed BIPA, which increased payment rates in all counties in March 2001. Before BIPA took effect, the floor rate was $415 PMPM in 2001. BIPA created a new rate category for counties located in metropolitan areas of at least 250,000 people and established $525 as the floor rate for those counties in 2001; for all other counties, the law increased the floor rate to $475. BIPA also mandated that 2001 county payment rates exceed 2000 rates by at least 3 percent, a 1 percentage point increase in the minimum annual update specified in BBA. The increases in county rates that resulted from these changes ranged from about $5 to $110 PMPM (or 1 to 27 percent). The legislation also extended BBRA’s new-entry bonus payments to counties where all existing Medicare MCOs had indicated they would withdraw at the end of 2001. Beginning in March 2001, as a result of BIPA, the average payment rate increase for M+C plans ranged from less than $1 to more than $100 PMPM. The amount of the increase depended on the specific counties each plan served and its expected enrollment in each county. Half of the M+C plans received overall payment rate increases of less than $10 PMPM, while the other half received $10 PMPM or more. BIPA provided that MCOs could use the additional money for each plan toward any combination of the following options: Improve the benefit package by Reducing beneficiary premiums, Reducing beneficiary cost sharing, Adding benefits, Enhancing benefits; Contribute to a benefit stabilization fund; or Stabilize or enhance beneficiary access to providers. BIPA required MCOs to submit revised contract proposals to cover that portion of the 2001 contract year—March through December—when the increased payment rates would be in effect and explain how they would use the additional money. The schedule for the submission and approval of the revised contracts, however, was compressed compared to the typical schedule. HCFA had originally announced the 2001 payment rates in March 2000. MCOs were not required to submit their 2001 contract proposals until July 2000—four months after the rates were announced. HCFA then spent two months reviewing and approving the contracts. Under BIPA’s time frames, the process—HCFA’ development and announcement of the new county rates, MCOs’ preparation and submission of contract proposals, and HCFA’s review and approval of those proposals—happened within six weeks. MCOs reported that some or all of the BIPA payment increase would be used to stabilize or enhance beneficiary access to providers for the majority of their M+C plans. Some of these MCOs stated that they would increase provider payments or contract with additional providers, but others—consistent with HCFA guidelines—may have revised their cost projections and reported that the additional money would be used to help offset projected cost increases. MCOs used additional money to improve their benefit packages for one-fourth of their plans—primarily by reducing the monthly premiums they charged to beneficiaries. MCOs put additional money into a benefit stabilization fund for a few of their plans.