958 F.2d 537 (3rd Cir. 1992), 91-1795, Sacred Heart Medical Center v. Sullivan

Docket Nº:91-1795.
Citation:958 F.2d 537
Party Name:SACRED HEART MEDICAL CENTER, v. Louis W. SULLIVAN, M.D., in his official capacity as Secretary of Health and Human Services. Louis W. Sullivan, M.D., Secretary of Health & Human Services, Appellant.
Case Date:March 09, 1992
Court:United States Courts of Appeals, Court of Appeals for the Third Circuit

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958 F.2d 537 (3rd Cir. 1992)



Louis W. SULLIVAN, M.D., in his official capacity as Secretary of Health and Human Services. Louis W. Sullivan, M.D., Secretary of Health & Human Services, Appellant.

No. 91-1795.

United States Court of Appeals, Third Circuit

March 9, 1992

Argued Feb. 14, 1992.

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Stuart M. Gerson, Asst. Atty. Gen., Michael M. Baylson, U.S. Atty., Anthony J. Steinmeyer, Scott R. McIntosh (argued), Attys., Appellate Staff, Civil Div., Dept. of Justice, Washington, D.C., for appellants.

Dennis M. Barry (argued), David J. Tuckfield, Vinson & Elkins, Washington, D.C., Lewis J. Hoch, Fox, Rothschild, O'Brien & Frankel, Philadelphia, Pa., for appellee.

Before GREENBERG, COWEN, and SEITZ, Circuit Judges.


GREENBERG, Circuit Judge.


The defendant, Louis W. Sullivan, Secretary of Health and Human Services, appeals from an order of the district court entered on July 12, 1991, compelling him "to make an appropriate retroactive adjustment to the calculation of [appellee Sacred Heart Medical Center's] hospital-specific costs and the Medicare reimbursements based thereon" in this Medicare reimbursement

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case. This case originated when Sacred Heart commenced an administrative proceeding against the Secretary of Health and Human Services ("HHS") before the Provider Reimbursement Review Board (the "Board") under 42 U.S.C. § 1395oo(a) to recover reimbursement from HHS under the Prospective Payment System ("PPS") for certain inpatient operating costs the Hospital had incurred. The Board determined that Sacred Heart was not entitled to reimbursement, a decision the Administrator of the Health Care Financing Administration ("HCFA") declined to review.

Sacred Heart then sought judicial review of the Board's decision in the United States District Court for the Eastern District of Pennsylvania, which exercised jurisdiction pursuant to 42 U.S.C. § 1395oo(f). The parties filed cross-motions for summary judgment, and on July 11, 1991, the district court issued a memorandum opinion determining that Sacred Heart was entitled to the reimbursement it requested. The Secretary filed a timely notice of appeal and we have jurisdiction to review the district court's final order under 28 U.S.C. § 1291.


The facts of this case are not in dispute. Sacred Heart is a 236-bed, non-profit hospital located in Chester, Pennsylvania, said to be an "economically distressed area with the highest percentage of people in public housing in the [United States.]" Sacred Heart opened its facilities to the public in 1959, but undertook no new construction until the 1980's. As a result, the Pennsylvania Department of Health cited the Hospital for code violations and licensure deficiencies and, in addition, the Health Systems Agency of Southeastern Pennsylvania ("HSA"), the local health planning agency, and the Joint Commission on Accreditation of Hospitals, noted numerous "deficiencies" related to the Hospital's physical plant. 1

To remedy this problem, the Hospital submitted a letter of intent to the HSA proposing an expansion of its facilities. The HSA accepted this proposal, and recommended to the Pennsylvania Department of Health that Sacred Heart be expanded. That department, in turn, approved the expansion and recommended to HHS that Sacred Heart's construction-related expenditures be reimbursed. HHS accepted this recommendation, and approved the project. Although the construction was scheduled to be completed in August 1982, it was not actually completed until June 1983 due to construction problems, delays in financing, problems with a concrete sub-contractor, delays in the delivery of cabinetry, and a carpenter's strike.

In the expansion a free-standing building was constructed and connected to the existing facility. This new building houses the Hospital's intensive care unit, one floor of patient rooms, an area for maintenance equipment, the lobby, the admissions area, the emergency room, the laboratory, the radiology department, the physical therapy department and a nuclear medicine unit. Sacred Heart hired 19 nurses to cover the new facilities. This expansion is the focus of the appeal, for Sacred Heart claims that it is entitled to be compensated for its increased operating costs resulting from the expansion, while the Secretary claims that the relevant federal statute and implementing regulations do not require the government to reimburse the Hospital for these costs.

(A) The Medicare Program:

1. "Reasonable Cost" Reimbursement:

Part A of the Medicare Program, codified at 42 U.S.C. § 1395c et seq. of the Social Security Act ("SSA"), provides the elderly and the disabled with "basic protection against the costs of hospital, related post-hospital, home health services, and hospice care...." 42 U.S.C. § 1395c. Hospitals and other health care providers participating in the Medicare Program generally cannot collect payment for these health services from the Medicare beneficiaries themselves, but must instead obtain reimbursement

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from HHS in the manner set forth in the Medicare Program.

From 1966 to 1982, the Medicare Program reimbursed hospitals and other health care providers for the "reasonable cost" of covered services, which was defined as the "cost actually incurred" exclusive of costs "found to be unnecessary in the efficient delivery of needed health services." Section 1395x(v). Necessary costs included operating costs, which often increased from year to year. Under this regime, hospitals and other health care providers had little incentive to curb operating costs and render services more economically, for the federal government bore the financial burden of the increases. 2

In 1982, Congress determined that the Medicare Program should be modified to provide hospitals with better incentives to render services more economically. Accordingly, in the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA") Congress amended the SSA by imposing a ceiling on the rate of increase of inpatient operating costs recoverable by a hospital. 3

Under TEFRA, the rate-of-increase limit was computed according to a hospital's "target amount" which, in turn, was calculated according to a hospital's cost reporting or "base" period. The statute provided: " 'target amount' means with respect to a hospital for a particular 12-month cost reporting period--(i) in the case of the first reporting period for which this subsection is in effect, the allowable operating costs of inpatient hospital services ... recognized ... for such hospital for the preceding 12-month cost reporting period." Section 1395ww(b)(3)(A). For each reporting period subsequent to the initial period, the target amount was increased by a specified percentage. Section 1395ww(b)(3)(A). Under this system, hospitals were obligated to absorb operating costs in excess of their target amounts, but they received bonuses if their operating costs were less than their targeted amounts. Section 1395ww(b)(1)(A).

TEFRA additionally set forth specific exceptions and adjustments applicable to the rate-of-increase limits. For example, and of great significance here, section 1395ww(b)(4)(A) directed the Secretary to "provide for an exemption from, or an exception and adjustment to, the [rate-of-increase] method ... where events beyond the hospital's control or extraordinary circumstances ... create a distortion in the increase in costs for a cost reporting period...." (emphasis supplied). Accordingly, the HCFA 4 promulgated regulations permitting hospitals to modify their target amounts where they have incurred costs "due to extraordinary circumstances" or where "factors ... could result in a significant distortion in the operating costs of inpatient hospital services." 42 C.F.R. § 405.463(g)(2) and (h), redesignated 42 C.F.R. §§ 413.40(g)(2) and (h). In addition, section 1395ww(b)(4)(A) authorized the Secretary to "provide for such ... other exemptions from, and exceptions and adjustments to, [the rate-of-increase] method as the Secretary deems appropriate...."

2. Prospective Payment System:

In 1983 Congress again amended the SSA, replacing the newly-instituted TEFRA system with the PPS. The purpose of the new prospective system, which constituted a far more radical reform of inpatient operating cost reimbursement than did TEFRA, was "to reform the financial incentives hospitals face, promoting efficiency ... by rewarding cost/effective hospital practices." H.R.Rep. No. 25, 98th Cong., 1st Sess. 132

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(1983), reprinted in 1983 U.S.C.C.A.N. 143, 219, 351. Under this system, which remains in effect, hospitals and other health care providers are reimbursed on the basis of prospectively determined national and regional rates rather than reasonable operating costs. This system classifies all Medicare patients into one of approximately 470 "diagnosis-related-groups" ("DRGs") and establishes fixed rates for each DRG. 5 When a hospital's actual operating costs exceed its federally prescribed limit for the given DRG, the hospital must absorb the difference. Conversely, if a hospital's costs are lower than the federal rates, the hospital retains the difference.

While Congress was anxious to restrain costs, it recognized that a sudden break from the "reasonable cost" method of reimbursement could pose financial hardship for many health care providers. Thus, "to minimize disruption that might otherwise occur because of sudden changes in reimbursement levels," Congress established a three-year transition period between the TEFRA system and the PPS system, and later extended this transition period for an additional year. S.Rep. No. 23, 98th Cong., 1st Sess. 53 (1983)...

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