Diplomat Lakewood Inc. v. Harris, 78-1852

CourtUnited States Courts of Appeals. United States Court of Appeals (District of Columbia)
Citation613 F.2d 1009
Docket NumberNo. 78-1852,78-1852
PartiesThe DIPLOMAT LAKEWOOD INCORPORATED, an Ohio Corporation, Appellant, v. Patricia Roberts HARRIS, Secretary, U. S. Department of Health, Education and Welfare, Appellee.
Decision Date16 November 1979

George R. Clark with whom Thomas C. Fox, Washington, D. C., was on the brief, for appellant.

Michele A. Goldfarb, Asst. U. S. Atty., Washington, D. C., with whom Earl J. Silbert *, U. S. Atty., John A. Terry and William H. Briggs, Jr., Asst. U. S. Attys., Washington, D. C., were on the brief, for appellee.

Before McGOWAN and WALD, Circuit Judges, and PENN, ** District Judge, United States District Court for the District of Columbia.

Opinion for the Court filed by Circuit Judge WALD.

WALD, Circuit Judge:

This is an action by an independent nursing home (I. e., one not affiliated with a hospital) with more than 100 beds for reimbursement of certain costs under the Medicare program. At issue are regulations the Secretary of Health, Education and Welfare (HEW) issued in 1972 requiring a more accurate method of cost computation for hospitals or hospital-nursing home complexes having 100 beds or more, and another less accurate one for all independent nursing homes, including those with 100 or more beds. The appellant here lost substantial sums of money in Medicare reimbursement by being forced to use the less accurate method.

An HEW administrative review board for Medicare providers to which the appellant applied for relief concluded that, whatever equities weighed in the appellant's favor, the regulations were binding, and the 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 accurate cost-computation method than that demanded of large hospitals and large hospital-nursing home complexes to be arbitrary, capricious and not in accordance with law. We reverse.


The Diplomat Lakewood Incorporated (Diplomat) owns and operates a 129-bed nursing home in northeastern Ohio which provides care to elderly, infirm patients under the Medicare program, 42 U.S.C. § 1395 Et seq. (1976). 1 Diplomat's nursing home contains a distinct part certified as a "skilled nursing facility" under § 1861(j) of the statute, Id. § 1395x(j); that facility provides "extended care services" 2 to patients. Therefore, Diplomat qualifies as a "provider of services" under the statute for the services rendered in its skilled nursing facility. Id. § 1395x(u). Diplomat also provides "intermediate" and "custodial" types of care which are less intensive than skilled nursing care and for which Diplomat does not receive Medicare reimbursement.

The relevant statute requires that providers be reimbursed for the services they furnish Medicare patients on the basis of their customary charge for, or the "reasonable cost" of, those services, whichever is less. Id. § 1395f(b). Reasonable costs must be determined pursuant to methods set forth by regulation. Id. § 1395x(v)(1)(A). Those computation methods must be fashioned to insure that Medicare costs are not borne by non-Medicare patients. Id.

Reimbursement to providers for services rendered to Medicare beneficiaries is made either by the Secretary or, more commonly, by private insurance companies which serve as fiscal intermediaries pursuant to contracts with the Secretary. Id. § 1395h. 3 The intermediaries make interim estimated payments to providers. Id. § 1395g; 42 C.F.R. § 405.454 (1978). At the close of the providers' fiscal year, the intermediaries make final determinations regarding properly reimbursable costs based upon "cost reports" which the providers are required to file. Id. § 405.406(b).

Providers must distinguish between "routine" and "ancillary" services in their accounting. "Routine" services include bed, board, nursing care, minor medical and surgical supplies, and the use of equipment for which a separate charge is not made. Id. § 405.452(d)(2). All other services I. e., those "for which charges are customarily made in addition to routine charges" are "ancillary" services. Id. § 405.452(d)(3).

A skilled nursing facility administers the next most intensive level of care below a hospital. Medicare beneficiaries in skilled nursing homes must be certified by a physician as requiring daily supervised professional health care. Id. § 405.1632. Approximately one-fourth of Diplomat's patients require this high degree of care and otherwise qualify for Medicare benefits. It is acknowledged generally that patients in skilled nursing facilities require more of some routine services E. g., more nursing care, more minor medical and surgical supplies and greater use of equipment than patients receiving lower levels of care.

A. The 1966 Regulations

In 1966 the Secretary promulgated regulations giving all skilled nursing homes two options in computing their costs: the Departmental Method or the Combination Method. 20 C.F.R. § 405.452(a); 31 Fed.Reg. 14808, 14817 (1966). For Diplomat, the computation of reimbursable costs for ancillary services is essentially the same under either method. The two methods differed, however, in how reimbursable costs for routine services were to be computed.

Under the Departmental Method, providers computed "(t)he ratio of (Medicare) beneficiary charges to total patient charges for the services of each Department (as) . . . applied to the cost of the department." Id. 405.452(a) (1) (emphasis supplied). 4 The figure resulting from that process included the providers' reimbursable Medicare costs for both routine and ancillary services.

The Combination Method provided that The cost of "routine services" for program beneficiaries is determined on the basis of Average cost per diem of these services . . . (plus) the cost of ancillary services used by beneficiaries, determined by apportioning the total cost of ancillary services on the ratio of beneficiary charges for ancillary services to total patient charges for such services.

Id. § 405.452(a)(2) (emphasis supplied). 5

In simplified terms, therefore, the Combination Method requires providers operating nursing homes to average the costs of their routine services for all patients, regardless of the level of care I. e., skilled, intermediate or custodial. In contrast, under the Departmental Method a nursing home provider is paid on the basis of the costs attributable to the routine services its Medicare patients receive at the skilled nursing level of care. As explained below, that distinction becomes crucial in determining whether the Secretary abused his 6 discretion in 1972 by requiring that large independent nursing homes use the Combination Method, because that method of cost computation has no adequate mechanism for reflecting the fact that patients in skilled nursing facilities generally require and receive more routine services than patients receiving lower levels of care, 7 and it therefore is less accurate than the Departmental Method.

Until 1972 Diplomat utilized the Departmental Method in order to reflect the fact that all of its Medicare patients received the more intensive routine services provided in its skilled nursing unit.

B. The 1972 Regulations

In December 1970 the Committee on Finance of the United States (Senate Finance Committee) reported on several amendments to the Medicare reimbursement standards not relevant here. In its report, however, the Senate Finance Committee described two "additional matters of concern," one of which involved the option in the 1966 regulations for Medicare providers allowing them to use either the Departmental or Combination Method. S.Rep.No. 1431, 91st Cong., 2d Sess. 178-80 (1970) (hereinafter 1970 Senate Report ).

According to the 1970 Senate Report, both the Comptroller General and HEW's Audit Agency had recommended a total scrapping of the less accurate Combination Method because it resulted in the inclusion of some nonreimbursable ancillary costs (E. g., for pediatric and obstetrical care) under the Medicare statute. The Committee was concerned, however, about imposing the more precise but admittedly more burdensome Departmental Method on smaller institutions. A compromise was struck. The Committee and the Secretary "concur(red)" that facilities with fewer than 100 beds should be required to use the Combination Method; "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." Id. at 179.

On November 17, 1971, the Secretary proposed several changes in the Medicare regulations, one of which was to eliminate the option between the Departmental and Combination Method for all providers. Despite the Senate Finance Committee's 1970 Report, however, emphasizing facility size as the distinguishing factor between nursing homes for accounting purposes, All independent nursing homes of whatever size were required to use the less accurate Combination Method for cost reporting periods beginning after December 31, 1971. 36 Fed.Reg. 22987, 22989 (1971). On the other hand, large (over-100-bed) hospitals or hospital-nursing home complexes had to use the Departmental Method. In spite of the drastic effect of that proposal on large independent nursing homes, the preamble to the proposed regulations gave no explanation for the differentiation.

On April 21, 1972, the Secretary adopted the November 1971 proposed regulations with no change. 37 Fed.Reg. 10353, 10355 (1972). Again no justification was offered for the requirement that large independent nursing homes use the Combination Method. The Secretary said only:

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