Diplomat Lakewood Inc. v. Califano

Citation453 F. Supp. 442
Decision Date09 June 1978
Docket NumberCiv. A. No. 76-2052.
PartiesThe DIPLOMAT LAKEWOOD INCORPORATED, Plaintiff, v. Joseph A. CALIFANO, Jr., Defendant.
CourtU.S. District Court — District of Columbia

George R. Clark, Thomas C. Fox, Joel M. Hamme, Washington, D. C., for plaintiff.

William H. Briggs, Jr., Asst. U. S. Atty., Washington, D. C., for defendant.



This case arises under the Medicare provisions of the Social Security Act, which provide federally funded health insurance programs for the aged and the disabled.1 Under the Medicare program, the providers of services are reimbursed for the reasonable cost incurred. At issue in this proceeding is the validity of certain regulatory changes requiring the use of specific accounting methods for determining reimbursement to nursing homes. The matter comes before the Court on cross-motions for summary judgment. The Court concludes that the regulations are valid and the government is entitled to judgment as a matter of law.


The material facts are not in dispute. Plaintiff, Diplomat Lakewood Inc., owns and operates a 129 bed nursing home which provides services to Medicare beneficiaries and non-Medicare patients. The defendant, Secretary of Health, Education and Welfare (HEW), has certified Diplomat Lakewood as a "distinct part `skilled nursing facility'," demonstrating that it offers nursing services one level below intensive care to eligible Medicare beneficiaries in one section of the home. Approximately one-fourth of plaintiff's patients are Medicare beneficiaries who require this high degree of care.

As a provider Diplomat Lakewood is entitled to reimbursement by HEW for the "reasonable cost" of services rendered to Medicare patients.2 Reasonable cost is defined as "the cost actually incurred, excluding therefrom any part of incurred cost found to be unnecessary in the efficient delivery of needed health services." Congress invested the Secretary with broad discretion to prescribe regulations establishing methods of calculating reasonable cost. He is directed, however, to take into account both the direct and indirect costs of providers, in order to ensure that Medicare patients and patients not entitled to such benefits do not subsidize each other.3 This factor is especially crucial where a provider serves both groups of patients and an apportionment of costs between them becomes necessary.

At the initiation of the program in 1966, the Secretary promulgated regulations establishing two accounting methods for cost apportionment, the Departmental and the Combination Methods.4 In simplified terms, the key difference is that the Departmental Method requires a provider to make a relatively sophisticated allocation of beneficiary-nonbeneficiary costs within ancillary service departments such as X-ray and pharmacy, while the Combination Method utilizes a less complex system of ratios or percentages of aggregate routine and ancillary costs. Under the 1966 regulations a provider had the option of using either method, the Secretary having found that each fulfilled the statutory directive against cross-subsidization between Medicare and other patients.5 The parties agree that the Departmental Method is the more accurate of the two, if a provider has the requisite accounting ability to use it.

In May 1972, following notice and comment on the proposal, the Secretary eliminated the option allowing skilled nursing facilities to use either method. The new regulations, still in effect, require any hospital or hospital-affiliated skilled nursing facility having 100 or more beds to use the Departmental Method. All other skilled nursing facilities, regardless of bed number, must use the Combination Method.6

Prior to the regulatory change, Diplomat Lakewood utilized the Departmental Method. The change in regulations forced it, a nonaffiliated nursing home, to use the Combination Method. The required use of that method for fiscal years 1973 and 1974 resulted in a loss of $56,302 of Medicare reimbursement for actual costs to the plaintiff.

Diplomat Lakewood challenged the regulatory change before the Provider Reimbursement Review Board (Board).7 The Board found that plaintiff had indeed been denied Medicare reimbursement by using the Combination Method and that it had the accounting ability to utilize successfully the Departmental Method. Nonetheless, it upheld the regulations, finding itself bound by the action of the Secretary.

Diplomat Lakewood requests the Court to reverse the Board's decision, as not supported by substantial evidence, and to invalidate the regulatory change. Plaintiff's summary judgment motion claims that: 1) the new regulations make an arbitrary distinction between hospital-affiliated and other skilled nursing facilities of 100 or more beds; 2) the regulations exceed the Secretary's statutory authority because they force subsidization of Medicare costs by nonprogram sources; and 3) the Secretary violated § 4 of the Administrative Procedure Act (APA),8 by failing to publish a concise statement of basis and purpose of the new cost apportionment rules. The agency, in support of its cross-motion for summary judgment, argues that the regulations are valid and reasonable in all respects.

Legal Analysis

Under the judicial review provisions of the Administrative Procedure Act, the Court must set aside a hearing decision not supported by substantial evidence.9 Since the Board found itself bound to uphold the Secretary's regulations on cost apportionment, the Court must focus directly on Diplomat Lakewood's objections to the regulations.

The plaintiff's principal arguments are that the 1972 regulations requiring it to use the Combination Method are arbitrary and capricious, and that the HEW decision was not based on "a consideration of all relevant factors." American Paper Institute v. Train, 177 U.S.App.D.C. 181, 191, 543 F.2d 328, 338 (1976). The Secretary did not review the potential impact of the mandated Combination Method on large nursing homes like Diplomat Lakewood, which had previously utilized the Departmental Method successfully.10 Instead, the agency acted in response to a report of the Senate Finance Committee, which stated in pertinent part:

The committee and the Department concur that the Department should simplify its cost finding and cost reporting requirements for smaller institutions (e. g. those having less than 100 beds) and require the use of the Combination Method by those institutions without an option to use the Departmental Method. At the same time larger institutions (e. g. those with 100 beds or more) should be required to carry out cost finding under more sophisticated methods and to apportion costs under the more accurate Departmental Method.

S.Rep.No.91-1431, 91st Cong., 2d Sess. 179 (1970). Even assuming that it was rational for HEW to consider only the factors enumerated in the Senate report, which focus on size, plaintiff argues that skilled nursing facilities of over 100 beds, like itself, should have been placed in the Departmental Method category, as indicated in the report. As further evidence of arbitrariness, plaintiff points out that the Secretary proposed rules in 1976, still pending, that would actually require all skilled nursing facilities to use the Departmental Method, in light of a survey conducted in 1974.11

In a related vein, Diplomat Lakewood argues that the Secretary exceeded his statutory authority in promulgating the 1972 regulations, since they allow subsidization of Medicare patients by nonbeneficiaries in facilities such as plaintiff. This result could have been avoided, the plaintiff urges, if large skilled nursing facilities not affiliated with hospitals were given the option of using the Departmental Method.

Plaintiff has the burden of establishing the invalidity of the regulations attacked here. American Nursing Home Association v. Cost of Living Council, 497 F.2d 909, 914-15 (Em.App.1974). After a consideration of the facts and the applicable law, the Court finds that plaintiff has failed to prove that the 1972 regulatory change was arbitrary, capricious and outside the Secretary's scope of authority. Realizing that calculation of actual Medicare costs incurred by each provider was an unrealistic goal, Congress vested the Secretary with broad discretion to develop accounting methods to determine reimbursement of the "reasonable cost" of Medicare, an imprecise concept. In reviewing his exercise of discretion in this complex statutory area, the Court owes the Secretary "great deference," Udall v. Tallman, 380 U.S. 1, 16, 85 S.Ct. 792, 13 L.Ed.2d 616 (1965). The Court is also mindful that the purpose of Medicare is to provide health services to the elderly at minimal cost to them, see National Welfare Rights Organization v. Mathews, 174 U.S.App.D.C. 410, 422, 533 F.2d 637, 649 (1976).

The Secretary promulgated the cost apportionment regulations only after extensive study had been undertaken. They were designed to correct two problems that had arisen in the initial years of the program. First, levels of reimbursement had been excessive, in large part because most hospitals were selecting the Combination Method to aggregate the costs of ancillary services and were therefore obtaining reimbursement for such inappropriate departments as pediatrics and obstetrics.12 Second, many smaller hospitals and nursing homes lacked the accounting capability to break down ancillary department costs under the Departmental Method; reimbursement requests filed under the...

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3 cases
  • Pacific Coast Medical Enterprises v. Harris
    • United States
    • U.S. Court of Appeals — Ninth Circuit
    • 28 Marzo 1980
    ...Secretary of HEW, 466 F.Supp. 605, 621-24 (D.D.C.), appeal docketed, No. 79-1460 (D.C. Cir., May 4, 1979).29 Diplomat Lakewood, Inc. v. Califano, 453 F.Supp. 442, 445 (D.D.C.1978).30 See, e. g., St. John's Hickey Memorial Hospital, Inc. v. Califano, 599 F.2d 803 (7th Cir. 1979); AMI-Chanco,......
  • Am. Med. Intern., Inc. v. Sec. of HEW
    • United States
    • U.S. District Court — District of Columbia
    • 2 Febrero 1979
    ...to carry out the Act. Springdale Convalescent Center v. Mathews, 545 F.2d 943, 951 (5th Cir. 1977). See Diplomat Lakewood, Inc. v. Califano, 453 F.Supp. 442 at 445 (D.D.C.1978). Plaintiffs, however, suggest that this Court deviate from the normal rule of deference in this case because the d......
  • Diplomat Lakewood Inc. v. Harris, 78-1852
    • United States
    • U.S. Court of Appeals — District of Columbia Circuit
    • 16 Noviembre 1979
    ...board denied relief. The district court found the regulations valid and granted the Secretary summary judgment. Diplomat Lakewood Inc. v. Califano, 453 F.Supp. 442 (D.D.C.1978). We find the requirement in the 1972 regulations that large independent nursing homes use a different and less acc......

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