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To evaluate the effectiveness and possible cost savings of influenza vaccination.Members age 65 and older in a Medicare managed care plan during the 1994–1995, 1995–1996, and 1996–1997 influenza seasons.The study examined administrative data on influenza vaccination and subsequent hospitalizations. Outcomes included hospitalization with pneumonia or influenza, with any respiratory condition, and with congestive heart failure (CHF).Vaccinated subjects experienced fewer hospitalizations with respiratory conditions or CHF than had unvaccinated subjects (OR=0.8 (95% CI, 0.7, 0.9) in analyses adjusted for age, sex, pneumococcal vaccination, health utilization, and morbidity). Analyses adjusted in addition for ethnicity obtained similar results among the subgroup of members whose ethnicity was known. Subjects without major disease in the previous 12 months had lower odds ratios for vaccination than subjects with major disease (OR values of 0.5 [95% CI, 0.4, 0.7] and 0.9 [95% CI, 0.8, 1.1], respectively). Subjects ages 65 to 79 had lower odds ratios for vaccination than subjects ages 80 and older (OR values of 0.7 [95% CI, 0.6, 0.9] and 0.9 [95% CI, 0.8, 1.1], respectively). Estimated cost savings averaged about $80 per vaccinated subject.Subjects ages 65 to 79 who had received influenza vaccination experienced fewer hospitalizations and had lower costs than had unvaccinated subjects. Associations were weaker for subjects age 80 and older. The results, consistent with recommendations for the use of influenza vaccine, suggest that people ages 65 to 79 should be heavily targeted for vaccination.