Memorial Hospital/Adair County Health Center, Inc. v. Bowen, s. 86-5572

• Decision Date: 18 September 1987
• Docket Number: Nos. 86-5572,86-5573,s. 86-5572
• Citation: 829 F.2d 111
• Parties: , 19 Soc.Sec.Rep.Ser. 51, Medicare&Medicaid Gu 36,636 MEMORIAL HOSPITAL/ADAIR COUNTY HEALTH CENTER, INC., Appellant v. Otis R. BOWEN, M.D., Secretary of Health & Human Services, et al.
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 111

829 F.2d 111

264 U.S.App.D.C. 326, 19 Soc.Sec.Rep.Ser. 51,

Medicare&Medicaid Gu 36,636

MEMORIAL HOSPITAL/ADAIR COUNTY HEALTH CENTER, INC., Appellant v. Otis R. BOWEN, M.D., Secretary of Health & Human Services, et al.

Nos. 86-5572, 86-5573.

United States Court of Appeals, District of Columbia Circuit.

Argued April 13, 1987.

Decided Sept. 18, 1987.

Appeals from the United States District Court for the District of Columbia (D.C. Civil Nos. 82-3208 & 84-2518).

Patric Hooper, Los Angeles, Cal., with whom Robert A. Klein, Washington, D.C., was on the brief, for appellant.

Edgar C. Morrison, Jr., Atty., Health & Human Services, with whom Richard K. Willard, Asst. Atty. Gen., and Joseph E. diGenova, U.S. Atty., Washington, D.C., were on the brief, for appellees. Henry R. Goldberg, Atty., Health & Human Services, Baltimore, Md., also entered an appearance for appellees.

Before SILBERMAN, BUCKLEY, and D.H. GINSBURG, Circuit Judges.

BUCKLEY, Circuit Judge:

The Secretary of Health and Human Services issued two decisions denying a rural hospital in Oklahoma full reimbursement for pharmacy services rendered to Medicare patients in 1979 and 1980. The Secretary's decisions are based on findings of Medicare's Provider Reimbursement Review Board which found Memorial's pharmacy costs to be unreasonable. The hospital, Memorial Hospital/Adair County Medical Center, disagreed with the Board's conclusions and filed complaints challenging the two decisions. The district court consolidated the complaints and granted summary judgment for the Secretary. We now reverse, holding that the Board's findings disregarded the Secretary's Medicare reimbursement regulations. We remand these cases to the district court with instructions to set aside the Secretary's decisions.

I. BACKGROUND

In 1983 Congress changed the method of reimbursing hospitals for costs incurred in caring for Medicare patients. See Washington Hosp. Center v. Bowen, 795 F.2d 139, 141-42 (D.C.Cir.1986) (discussing Social Security Amendments of 1983). Under the new system the Department of Health and Human Services ("HHS" or "Department") reimburses Medicare health care providers, including hospitals like Memorial, according to standard national rates for particular therapies. Id. at 142.

This case arises under the Medicare reimbursement scheme previously in effect. In Part A of the Social Security Act, 42 U.S.C. Secs. 1395c-1395i (1982) (the "Act"), Congress permitted the Secretary of HHS to consider cost audits before approving hospital applications for Medicare reimbursement. Section 1395f(b) of the Act states:

The amount paid to any provider of services ... with respect to services for which payment may be made under this part shall, subject to the provisions of sections 1395e and 1395ww of this title, be-- (1) except as provided in paragraph (3) [not applicable here], the lesser of (A) the reasonable cost of such services, as determined under section 1395x(v) of this title and as further limited by section 1395rr(b)(2)(B) of this title, or (B) the customary charges with respect to such services;

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42 U.S.C. Sec. 1395f(b) (1982) (emphasis added). The Secretary did not base his decisions on the "customary charges" subsection of that provision. Rather, he premised them on the "reasonable cost" provision of section 1395f(b)(1)(A), which incorporates the definition of "reasonable cost" appearing in title 42 U.S.C. Sec. 1395x(v)(1)(A). This in turn provides that "[t]he reasonable cost of any services shall be the cost actually incurred, excluding therefrom any part of incurred cost found to be unnecessary in the efficient delivery of needed health services, and shall be determined in accordance with regulations...." 42 U.S.C. Sec. 1395x(v)(1)(A) (1982).

The Secretary published, among others, the following regulation:

Reasonable cost includes all necessary and proper costs incurred in rendering the services [covered under the Act], subject to principles relating to specific items of revenue and cost. However, ... payments to providers of services are based on the lesser of the reasonable cost of services ... or the customary charges to the general public for such services, as provided for in Sec. 405.455.

42 C.F.R. Sec. 405.451(a) (1985). The regulation further defines "reasonable cost" in a broad fashion:

The costs of providers' services vary from one provider to another and the variations generally reflect differences in scope of services and intensity of care. The provision in title XVIII of the Act for payment of reasonable cost of services is intended to meet the actual costs, however widely they may vary from one institution to another. This is subject to a limitation where a particular institution's costs are found to be substantially out of line with other institutions in the same area which are similar in size, scope of services, utilization, and other relevant factors.

42 C.F.R. Sec. 405.451(c)(2) (1985) (emphasis added).

In addition to this regulation, section 2103 of the Secretary's Provider Reimbursement Manual (HCFA Pub. 15-1) ("Manual") informs Medicare health care providers of their responsibilities. The Secretary relies in part on that section of the Manual to support his decisions. Paragraph A of section 2103 states that "[t]he prudent and cost-conscious buyer not only refuses to pay more than the going price for an item or service, he also seeks to economize by minimizing cost." Paragraph B adds that intermediaries may "employ various means for investigating and detecting" excessive spending. "Included may be such techniques as comparing the prices paid by providers to the prices paid for similar items or services by comparable purchasers, spotchecking, and querying providers about indirect, as well as direct, discounts." Manual, J.A. Exhibit D.

Memorial is a fifty-bed general hospital located in Stilwell, Oklahoma. It is not operated for profit. During the fiscal year ending on September 30, 1979, "[i]ts percent of occupancy was 63.76 and its Medicare utilization was 62.2 percent." Memorial Hospital (Stilwell, Okla.) v. Blue Cross Assoc./Blue Cross/Blue Shield of Oklahoma, [1982-83 Transfer Binder] Medicare & Medicaid Guide (CCH) p 32,272 at 9350 (Sept. 22, 1982) ("Memorial I "). Two weeks before it was ready to open in 1977, Memorial's administrator requested Oklahoma State Health Department personnel, then under contract with the Secretary, to " 'survey' [Memorial's] facilities to determine whether ... Medicare standards are satisfied." Brief for Appellees at 6, 6 n. 4. "This team found [Memorial's] pharmacy to be very deficient in pharmacy services." Memorial I at 9350 (citation omitted). When Memorial's administrator asked how that deficiency could be corrected,

[t]he surveyor told him to come to Oklahoma City (Doctors Hospital of Oklahoma) to observe an acceptable pharmacy operation. He observed a contract pharmacy, HPI [Hospital Pharmacies, Inc.], for the first time. He requested HPI to survey the provider [sic] and provide it with a proposal for operating the pharmacy.

Id. (citation omitted).

HPI's proposal offered Memorial's patients the most advanced of three commonly used methods for administering medications. Some hospitals keep a stock of drugs in each ward or floor, permitting nurses to retrieve and administer supplies without supervision by a pharmacist. According to Memorial, that system "poses a threat to patient safety ... [and] can result in decreased care to patients and financial loss to hospitals employing this procedure." Brief for Appellant at 10. Other hospitals use a second method. They store drugs in a pharmacy where a pharmacist places each patient's medications in prescription containers and distributes them to nurses for dispensation. These may contain large quantities of medication for use over several days. In HPI's proposal an HPI pharmacist would prepare each single dose for each patient and, whenever prescribed, mix drugs in intravenous solutions for particular patients under sterile conditions ("intravenous" or "IV admixture"). In exchange Memorial would compensate HPI an amount equal to forty-five percent of the gross inpatient billings of the pharmacy department, less five percent of said billings to cover bad debts. Memorial I at 9351.

After HPI presented this proposal, Memorial's administrator obtained an oral report from a certified public accountant who estimated that HPI's services would be two to three percent more expensive than those the Medicare survey team found inadequate. Id. at 9350. The next day the administrator presented this estimate and HPI's proposal to Memorial's board of directors, which agreed to enter into a pharmacy services contract with HPI. Id. at 9351. Memorial's board of directors reached that decision without information about the cost at other hospitals of the services HPI would provide. "It only had total operating costs to compare with other hospitals." Id. Moreover, Memorial did not advertise or request competitive bidding. Id. Memorial nevertheless accepted HPI's proposal.

At the end of fiscal year 1979, Memorial requested reimbursement for that portion of HPI's charges relating to pharmacy services for Medicare patients. The Act entrusts the initial determination of the reimbursement a hospital may receive to an intermediary agency or organization appointed by the Secretary. See 42 U.S.C. Sec. 1395h (1982). The Secretary appointed Blue Cross of Oklahoma ("Blue Cross"), a private insurer, as intermediary to audit Memorial's Medicare reimbursement claim for 1979. Using a cost-per-patient-per-day ("per diem") method of accounting, Blue Cross compared Memorial's total pharmacy costs and those of "peer" hospitals. All the hospitals in this peer group had between forty-six and sixty patient beds, were located in Oklahoma, and used drug-dispensation methods different from those HPI furnished Memorial's patients. For instance, not one of the peer...