Who it covers
Medicare is the federal health insurance program for people 65 and older, people under 65 who have received Social Security Disability Insurance for 24 months, and people with end-stage renal disease or ALS (ALS coverage starts without the 24-month wait). It is run by the Centers for Medicare & Medicaid Services (CMS), part of HHS. People eligible for both Medicare and Medicaid are "dual eligibles"; Medicaid then helps with Medicare premiums and cost sharing and covers long-term services Medicare does not.
The four parts
- Part A — Hospital Insurance. Inpatient hospital stays, skilled nursing facility care after a qualifying hospital stay, hospice, and some home health. Funded mainly by the Medicare payroll tax into the Hospital Insurance (HI) Trust Fund. Most people pay no Part A premium because they or a spouse paid payroll taxes for about ten years (40 quarters). The HI trust fund's projected depletion date, reported each year by the Medicare Trustees, is the program's best-known solvency measure.
- Part B — Medical Insurance. Physician and other clinician services, hospital outpatient care, ambulatory surgery, durable medical equipment, many preventive services, and physician-administered ("Part B") drugs. Voluntary, with a monthly premium set so beneficiaries pay about a quarter of program cost; general federal revenue pays most of the rest. Higher-income beneficiaries pay income-related premiums (IRMAA). Part B has an annual deductible and generally 20% coinsurance with no out-of-pocket cap in Original Medicare, which is why many beneficiaries buy Medigap or have employer or Medicaid coverage.
- Part C — Medicare Advantage (MA). Private plans (HMOs, PPOs, special needs plans) that contract with CMS to provide all Part A and B benefits, usually with a cap on out-of-pocket costs and often Part D drugs and extra benefits (dental, vision, hearing). CMS pays plans a monthly capitated amount per enrollee. Since the mid-2020s more than half of eligible beneficiaries have chosen MA.
- Part D — Prescription drug coverage. Outpatient prescription drugs through private plans, offered either as standalone prescription drug plans (PDPs) alongside Original Medicare or inside MA plans (MA-PDs). Started in 2006. The Inflation Reduction Act of 2022 redesigned the benefit (including an annual out-of-pocket cap starting in 2025) and let Medicare negotiate prices for selected high-spend drugs.
"Original Medicare" (also "traditional" or "fee-for-service" Medicare) means Parts A and B paid directly by CMS, with the beneficiary free to see any provider that accepts Medicare.
How Original Medicare pays providers
CMS pays claims through regional contractors called Medicare Administrative Contractors (MACs), mostly under prospective payment systems — a rate set in advance per unit of service, updated each year by rulemaking:
- Inpatient hospitals — IPPS. One payment per stay based on the patient's Medicare Severity Diagnosis-Related Group (MS-DRG), adjusted for local wages and for things like teaching status, disproportionate share of low-income patients, and outlier cases.
- Hospital outpatient — OPPS, grouping services into Ambulatory Payment Classifications (APCs); ambulatory surgical centers are paid under a related ASC system.
- Physicians and clinicians — Physician Fee Schedule (PFS). Each service has relative value units (work, practice expense, malpractice) multiplied by a geographic adjustment and an annual conversion factor. Clinicians can also face payment adjustments under the Quality Payment Program (MIPS, or Advanced APMs for those in qualifying alternative payment models).
- Post-acute care has its own systems: skilled nursing (PDPM), home health (PDGM), inpatient rehabilitation and long-term care hospitals. Hospice, dialysis (ESRD PPS), clinical labs and durable equipment each have their own fee schedules.
- Critical access hospitals and some other rural facilities are paid on reasonable cost rather than prospective rates.
Each year CMS proposes and finalizes these rates in rules (the IPPS rule in spring/summer, the OPPS and PFS rules in summer/fall), with public comment in between.
How Medicare Advantage is paid
- CMS sets a benchmark for each county, tied to local fee-for-service spending.
- Each plan submits a bid — what it would cost to provide Parts A and B benefits. If the bid is below the benchmark, the plan gets part of the difference as a rebate that must fund extra benefits or lower costs for enrollees.
- Payments are risk-adjusted for each enrollee's health using the CMS-HCC model, based on diagnoses that providers document. This is why diagnosis coding is so financially important in MA, and why CMS audits it through Risk Adjustment Data Validation (RADV).
- Plans' Star Ratings (1 to 5 stars on quality and patient experience) drive Quality Bonus Payments and rebate shares, so Stars move real money.
- CMS publishes an Advance Notice early in the year and a final Rate Announcement in the spring that set the next year's payment rates, risk model and Star Ratings policy.
Value-based care inside Medicare
Medicare uses several ways to pay for outcomes and total cost rather than volume:
- Accountable care organizations (ACOs). Groups of providers that take responsibility for the total cost and quality of an assigned population. The permanent program is the Medicare Shared Savings Program (MSSP), created by the Affordable Care Act; ACOs share savings against a benchmark, and in higher tracks share losses too.
- CMS Innovation Center (CMMI) models, authorized by section 1115A of the Social Security Act, test new payment approaches — voluntary or mandatory — such as ACO models, bundled or episode payments, specialty models, and state total-cost-of-care models. A model that saves money without hurting quality (or improves quality without raising cost) can be expanded nationally.
- Hospital quality programs adjust payments for readmissions, hospital-acquired conditions and value-based purchasing scores.
Where to look for the numbers
Premiums, deductibles, the Part D out-of-pocket cap, payment rates and enrollment change every year. The authoritative sources are CMS's annual premium announcement, the annual payment rules, the MA Rate Announcement, and the Medicare Trustees Report.