Two large health programs—TRICARE and Medicare—influenced the design and operation of the Medicare subvention demonstration. The military health system has three missions: (1) maintaining the health of active-duty service personnel, (2) medically supporting military operations, and (3) providing care to the dependents of active-duty personnel, retirees and their families, and survivors. 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 offers health care coverage to approximately 6.6 million active-duty military personnel, retirees, dependents, and survivors under age 65. These beneficiaries have three main options: TRICARE Prime, a managed care option; TRICARE Extra, a preferred provider option; and TRICARE Standard, a fee-for-service option. A new option, TRICARE Plus, allows beneficiaries to enroll with a primary care provider at participating MTFs. TRICARE covers inpatient services, outpatient services such as physician visits and lab tests, and skilled nursing facility and other post-acute care. It also covers prescription drugs, which are available at MTFs, through DOD’s National Mail Order Pharmacy, and at civilian pharmacies. TRICARE delivers care through over 600 MTFs—such as medical centers, community hospitals, or major clinics that serve military installations—and a network of civilian providers managed by DOD’s managed care support contractors. Managed care support contractors also assist beneficiaries and support regional DOD management by providing services such as enrollment and utilization management. There are about 1.5 million retired military personnel, dependents, and survivors age 65 or older residing in the United States. About 600,000 of these seniors live within 40 miles of an MTF. In the past, retirees had access to all MTF and network services through TRICARE until they turned age 65 and became eligible for Medicare, at which point they could only use military health care on a space-available basis—that is, when MTFs had unused capacity after caring for higher priority beneficiaries. In the 1990s, downsizing and changes in access policies led to reduced space- available care throughout the military health system. Moves to contain costs by relying more on military care and less on civilian providers under contract to DOD also contributed to the decrease in space-available care. As is the case today, MTF capacity varied from a full range of services at major medical centers to limited outpatient care at small clinics. Some retirees aged 65 or older relied heavily on military facilities for their health care, but most did not, and about 60 percent did not use military health care facilities at all. Retirees could obtain prescriptions from MTFs, but not from TRICARE’s National Mail Order Pharmacy or network of civilian pharmacies. In addition to using these DOD resources, retirees could receive care paid for by Medicare and other public or private insurance for which they were eligible. Significant changes in retiree benefits and military health care occurred in 2001 as a result of the NDAA. This legislation gave older retirees two major benefits: Pharmacy benefit. Effective April 1, 2001, retirees age 65 and older were given access to prescription drugs through TRICARE’s National Mail Order Pharmacy and at civilian pharmacies. TRICARE eligibility. Effective October 1, 2001, retirees age 65 and older 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 their required cost-sharing. This includes copayments required of retirees enrolled in civilian Medicare managed care plans. Retirees are eligible to enroll in TRICARE Plus but are not allowed to enroll in TRICARE Prime. Medicare is a federally financed health insurance program for persons age 65 and older, some people with disabilities, and people with end-stage kidney disease. Eligible beneficiaries are automatically covered by part A, which covers inpatient hospital, skilled nursing facility and hospice care, as well as some home health care. They also can pay a monthly premium to join part B, which covers physician and outpatient services as well as those home health services not covered under part A. Traditional Medicare allows beneficiaries to choose any provider that accepts Medicare payment and requires beneficiaries to pay for part of their care. Most beneficiaries have supplemental coverage that reimburses them for many of the costs that Medicare requires them to pay. Major sources of this coverage include employer-sponsored health insurance; “Medigap” policies, sold by private insurers to individuals; and Medicaid, a joint federal-state program that finances health care for low-income people. The alternative to traditional Medicare, Medicare+Choice, offers beneficiaries the option of enrolling in managed care or other private health plans. All Medicare+Choice plans cover basic Medicare benefits, and many also cover additional benefits such as prescription drugs. Typically, Medicare+Choice managed care plans have limited cost-sharing but restrict members’ choice of providers and may require an additional monthly premium. Under the Medicare subvention demonstration, DOD established and operated six Medicare+Choice managed care plans, called TRICARE Senior Prime, at sites selected jointly by DOD and HCFA. Enrollment in Senior Prime was open to military retirees enrolled in Medicare part A and part B who resided within roughly 40 miles of a participating MTF. About 125,000 retirees were eligible for the demonstration. DOD capped enrollment at about 28,000 for the demonstration as a whole; each MTF had its own enrollment cap. In addition, retirees enrolled in TRICARE Prime who had a primary care provider at a demonstration MTF could “age in” to Senior Prime upon reaching age 65, even if MTFs’ enrollment caps had been reached. Senior Prime offered enrollees the full range of Medicare-covered services as well as additional TRICARE services, notably prescription drugs. It also gave them higher priority for care at MTFs than retirees who did not join the program. Enrollees paid the Medicare part B premium, but no additional premium to DOD. Care at MTFs was free of charge, but enrollees had to pay any applicable cost-sharing amounts when MTFs referred them to the civilian network for care (for example, $12 for an office visit). All primary care was provided at MTFs, but DOD purchased some hospital and specialty care from the civilian network. Purchased care was used for services not available at MTFs as well as when MTFs did not have sufficient capacity in particular specialties. Although the demonstration was authorized to begin in January 1998, implementation was delayed, and the first site began delivering care in September 1998. All sites were operational by January 1999. The six demonstration sites are in different regions of the country and include 10 MTFs that vary in size and types of services offered (see table 1), as well as by managed care penetration in the local Medicare market. The five medical centers offer a wide range of inpatient services and specialty care as well as primary care. They accounted for over 75 percent of all enrollees in the demonstration. The two San Antonio medical centers had 38 percent of all enrollees. The four community hospitals have more limited capabilities, and the civilian network provided much of the specialty care. At Dover, the MTF is a clinic that offers only outpatient services, thus requiring all inpatient and specialty care to be obtained at another MTF or purchased from the civilian network. The BBA established rules for Medicare to follow in paying DOD for Senior Prime care. It authorized Medicare to pay DOD in a way that was similar to the way it pays civilian Medicare+Choice plans, with several major exceptions: Senior Prime’s capitation rate—a fixed monthly payment for each enrollee—differed from the Medicare+Choice rate in several ways. The Senior Prime rate was set at 95 percent of the rate that Medicare would pay civilian Medicare+Choice plans in the demonstration areas, 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 exclusion took into account the fact that GME in the military health system is funded by DOD appropriations, and the DSH exclusion recognized that DOD medical facilities do not treat the low-income patients for whom DSH payments compensate hospitals. The law directed 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 Senior Prime capitation rate was to be adjusted if there was “compelling” evidence that enrollees were healthier or sicker than their Medicare fee-for-service counterparts. The adjustment was intended to reflect whether Senior Prime enrollees would be expected to be significantly more or less costly than the average Medicare beneficiary. HCFA and DOD agreed that if the difference between the adjusted and unadjusted payments equaled or exceeded 2.5 percent, then that would be compelling evidence that enrollees’ health status differed from that of their Medicare counterparts. In that case, the Medicare payment would reflect the adjustment. The BBA required that, before DOD could receive Medicare payment, participating MTFs must spend as much on care for retirees age 65 and older as they did prior to the demonstration.