And in an important development for disease-management companies like XLHealth, Medicare since 2004 permits insurers to target coverage and marketing materials to people with chronic illnesses, through products known as "special-needs plans."

Previously, to prevent discrimination against sicker people, private insurers operating in Medicare couldn't pick and choose which types of beneficiaries they would target. But after the change, insurers can create programs geared to people who need more-intensive services, such as home visits from nurses. If the insurers are successful in reducing the patients' health costs with more preventive care, they get to keep the savings, or use it to lower patients' spending and provide additional services.

Reversing Course

Before the switch, private insurers operating in Medicare were said to be taking steps to avoid sick people, such as putting youthful-looking seniors in their marketing materials or offering perks like gym memberships that would be more likely to attract low-cost customers. Now, some Medicare experts say, if the new plans are successful, the opposite will be true, and the plans will follow the money to dialysis clinics and nursing homes. Many of XLHealth's informational meetings were held at all-you-can-eat buffet restaurants.

"The people these plans were running from five years ago now become the desirables. It's totally standing the economics of this industry on their head," says John Gorman, president and CEO of Gorman Health Group LLC, a Washington consulting firm that advises health insurers offering private coverage to Medicare patients.

It's easy to see why insurers would be attracted to the new payment model. On top of the set amount a plan receives per patient in the managed-care arm of Medicare, known as Medicare Advantage, under the new model, additional payments are tacked on for each health problem the patient has -- a technique known as "risk adjustment."

Bigger Payments

Before risk adjustment, Medicare would have paid a health plan about $8,145 per year to take care of a 70-year-old woman with high blood pressure and osteoporosis, under an example formulated by XLHealth. The amount would have been the same regardless of the severity of her health conditions; only the age and sex of patients was taken into account. Under the new model, Medicare would pay widely varying amounts of money for the same patient, depending on how sick she was.

If her health problems were not severe, the insurer would receive about $4,075 for the year -- much less than under the old model. But if the woman had diabetes, the amount would jump to $6,197. If the diabetes had led to circulatory problems, the insurer would receive $12,182 -- much more than under the old model. If the patient also had emphysema, congestive heart failure and depression, the insurer would receive $30,126 for the year.

XLHealth officials emphasize preventive care for patients enrolled in their "Care Improvement Plus" plan. They don't limit the number of doctor visits a patient can have, a traditional tool of managed-care plans, and they encourage the use of medications that will help manage chronic problems. "These patients aren't going to bankrupt our health plan by going to an internist more," says Paul Serini, executive vice president of XLHealth. "In this population, more care is better care" because it prevents more costly hospitalizations.

At the informational meeting at the apartment complex in Baltimore, 66-year-old Rosalee Jones liked what she heard. "I think the plan they have might be a very good one," said Ms. Jones, who has heart problems, high blood pressure and diabetes that caused her to lose her right leg and start using a wheelchair a couple of years ago. With her current coverage, under traditional Medicare, "I'm not too sure who's doing what," Ms. Jones said. "I get piles of bills from everyone. I'm wondering how they expect me to pay for all of them." After Ms. Hudgins's talk, Ms. Jones signed up for XLHealth's program.

Roberta and Jimmy McKay, who live in Baltimore and both have diabetes, have been enrolled in XLHealth since the spring. Ms. McKay, who is 65, says she likes to go to the doctor and be visited by the XLHealth nurse, who checks whether the diabetes is causing additional problems. "I think it's great because she might come and pick up on something that you didn't really realize was going on," Ms. McKay says.

Enrollment Growing

At the moment, Medicare coverage based on specific illnesses is a small sliver of the overall program. The plans are part of a broader effort by the government to give more flexibility, and higher payments, for experimenting with new models of taking care of various types of Medicare beneficiaries. The umbrella term "special-needs plans" applies to both the chronic-care plans XLHealth is offering and the more numerous plans targeted at patients in both Medicare and the Medicaid program for the poor. All told, 550,000 people were enrolled in special-needs plans as of Aug. 1. But the numbers "are growing at a very fast rate," says David Lewis, an official at the government's Medicare agency who oversees Medicare Advantage. The number of special-needs plans has jumped to 276 this year from 11 in 2005. And the "good-sized growth," Mr. Lewis says, will carry into next year.

Much of the future growth will be in special-needs plans that focus on people with chronic illnesses, Mr. Gorman predicts. In part, that's because the higher payments for people with health problems have been phased in over time and will kick in fully next year. Some disease-management companies, such as XLHealth, see the extra payments as a way to expand their services as a full-fledged insurer. A privately held company backed in part by Goldman Sachs Equity Fund, XLHealth plans to introduce its program in more states next year. It currently serves the eight counties surrounding Baltimore, where it is based.

Big health-insurance companies like UnitedHealth Group Inc. view the sector as an opportunity. UnitedHealth has long offered special-needs plans geared toward patients in nursing homes through an experimental Medicare program. Next year, the company plans to begin offering chronic-disease plans too.

In part, the government and the insurers are responding to a well-known challenge facing Medicare: 83% of its beneficiaries have at least one chronic condition. Most significantly, 23% of beneficiaries have five or more chronic conditions, and they account for 68% of Medicare spending, according to an article published last year in the New England Journal of Medicine by Gerard F. Anderson, a professor in the department of health policy and management at the Johns Hopkins Bloomberg School of Public Health.

Managing Care

With growing concerns about the future financing of Medicare, the government is looking at special-needs plans as a path toward improved patient care, as plans are encouraged to take extra steps to keep the sickest patients out of the hospital. The plans also may shed light on how to keep costs down for people with chronic illnesses. And compared with traditional Medicare, government officials say, special-needs plans will do a better job of making sure patients get the care they need and don't get repetitive tests or medications that interact badly.

"This is an efficient way of managing their care. We hope to have better outcomes all around," says Medicare's Mr. Lewis. As to whether the plans might save the government money, Mr. Lewis says they "hold a lot of promise for the future."

At the moment, the government probably isn't saving any money and actually appears to be paying private health-insurance plans more for taking care of patients than it would if the same people were in the government program. Some critics say this gives an unfair advantage to the private sector over traditional Medicare. To be sure, it remains to be seen whether the government will save money in the long run if private insurers have a larger role.

Health insurers, for their part, say they are confident that they will do a better job of keeping down costs and organizing care, especially when it comes to people with chronic illnesses.

Write to Sarah Lueck at sarah.lueck@wsj.com⁵ and Jane Zhang at Jane.Zhang@wsj.com⁶