Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca10-88-02482/USCOURTS-ca10-88-02482-0/pdf.json

Nature of Suit Code: 890
Nature of Suit: Other Statutory Actions
Cause of Action: 

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PUBLISH 

UNITED STATES COURT OF APPEALS 

TENTH CIRCUIT 

AMISUB (PSL), INC., d/b/a AMI ST. LUKE'S ) 

HOSPITAL, INC., AMI PRESBYTERIAN DENVER ) 

HOSPITAL, INC., and AMI PRESBYTERIAN AURORA ) 

HOSPITAL, INC., ) 

) 

Plaintiffs/Appellants, ) 

) 

v. ) 

) 

THE STATE OF COLORADO DEPARTMENT OF SOCIAL ) 

SERVICES, and IRENE M. IBARRA, EXECUTIVE ) 

DIRECTOR OF THE STATE OF COLORADO, ) 

DEPARTMENT OF SOCIAL SERVICES, ) 

) 

Defendants/Appellees. ) 

JUL 111969 

ROBERT L. HOECKER 

Clerk 

No. 88-2482 

ON APPEAL FROM THE UNITED STATES DISTRICT COURT 

FOR THE DISTRICT OF COLORADO 

(NO. 88-F-1024) 

Patric Hooper (L. Richard Freese, Jr., and Sharon E. Caulfield of 

Davis, Graham & Stubbs, Denver, Colorado, with him on the briefs), 

Hooper, Lundy & Bookman, Inc., Los Angeles, California, for 

Plaintiffs/Appellants. 

Wade S. 

Attorney 

Richard 

State of 

Livingston, Assistant Attorney General (Duane Woodard, 

General, Charles B. Howe, Deputy Attorney General and 

H. Forman, Solicitor General, with him on the brief) 

Colorado, for Defendants/Appellees. 

Wayne J. Fowler of Saunders, Snyder, Ross & Dickson, P.C., Denver, 

Colorado, on the briefs for Amicus Curiae American Hospital 

Association and Amicus Curiae Colorado Hospital Association; 

Michael F. Anthony, Jeffrey M. Teske, Lawrence E. Singer, Chicago, 

Illinois, on the brief for Amicus Curiae American Hospital 

Association. 

Before ANDERSON, BARRETT, and BRORBY, Circuit Judges. 

BRORBY, Circuit Judge. 

Appellate Case: 88-2482 Document: 01019568479 Date Filed: 07/11/1989 Page: 1 
Plaintiffs, three licensed Colorado hospitals (hereinafter 

"appellants'' or "Hospitals") appeal from a final judgment against 

them. As Medicaid providers, they challenged the State of 

Colorado's system for reimbursement of inpatient hospital services 

as violative of 42 u.s.c. § 1396 et~ (1989 Supp.) (hereinafter 

"Medicaid Act"). On appeal, appellants allege the district court 

had jurisdiction based on 28 u.s.c. § 1331, 28 u.s.c. § 1361, and 

42 U.S.C. § 1983. The district court correctly held jurisdiction 

was based on 28 u.s.c. § 1331 since plaintiffs were challenging 

Colorado's compliance with the Medicaid Act in a 42 u.s.c. § 1983 

action. 1 We are in accord with the district court on the 

jurisdictional basis, and, furthermore, hold that 28 u.s.c. § 1361 

(1976), the federal mandamus statute, is not a jurisdictional 

basis in this case. The named defendants in the district court 

and appellees here are the State of Colorado Department of Social 

Services (CDSS) and Irene M. Ibarra, its Executive Director. No 

relief against state officials or state agencies is afforded by § 

1361. 2 

On appeal, appellants present the following issues: 

1 Appellants may be confused on this issue because the Joint 

Pre-Trial Order stated that 28 u.s.c. § 1361 was a jurisdictional 

basis. 

2 28 U.S.C.A. § 1361 (1976) grants federal courts "jurisdiction 

of any action in the nature of mandamus to compel an officer or 

employee of the United States or any agency thereof to perform a 

duty owed to the plaintiff." Although this jurisdictional grant 

may apply to the federal Medicaid agencies -- the Department of 

Health and Human Services (DHSS), and the Health Care Financing 

Administration (HCFA) it does not apply to the state 

defendants. 

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Appellate Case: 88-2482 Document: 01019568479 Date Filed: 07/11/1989 Page: 2 
1. Did the District Court improperly limit its review 

of the agency decision by determining only whether the 

Medicaid payment rates in question were arbitrarily and 

capriciously established? 

2. Were the Medicaid payment rates in question 

established by Appellees ("the State Medicaid Agency") 

in accordance with the procedures required by the 

governing federal Medicaid statute and regulations? 

3. Are the Medicaid payment rates in question 

authorized by and consistent with the governing federal 

Medicaid statute and regulations? 

4. Are the Medicaid payment rates in question 

established by the State Medicaid Agency arbitrary and 

capricious? 

In response, the appellees contend that (1) the Hospitals 

have no statutory right to a particular Medicaid rate, i.e., "42 

u.s.c. § 1396a(a)(l3)(A) is not the kind of statute that creates 

enforceable rights under 42 u.s.c. § 1983"; (2) the Hospitals are 

not the "intended beneficia.ries of the federal medicaid statutes"; 

(3) the reimbursement rates set by CDSS are not arbitrary and 

capricious; and (4) CDSS made the "findings" and "assurances" 

required by federal law. 

First, we hold that, pursuant to 42 u.s.c. § 1396 et ~' 

the Hospitals have enforceable rights under 42 u.s.c. § 1983; 

second, we hold that the Hospitals have standing to challenge the 

reimbursement rates under the Colorado Medicaid Plan; third, we 

hold that the district court improperly limited its review of the 

agency decision by determining only whether the Colorado 

reimbursement plan was arbitrary and capricious; fourth, the 

Colorado Medicaid payment rates were not in accordance with the 

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Appellate Case: 88-2482 Document: 01019568479 Date Filed: 07/11/1989 Page: 3 
procedures 

regulations; 

required 

fifth, 

by 

the 

the federal Medicaid statute and 

Medicaid reimbursement rates as 

established are violative of federal law; and sixth, the Medicaid 

payment rates as established are arbitrary and capricious. 

Therefore, we REVERSE the district court. We declare the 

reimbursement rates to be in violation of federal law and prohibit 

their usage. 

I. 

FACTS 

Effective July 1, 1988, the Colorado Medicaid Agency (CDSS) 

implemented a new provider reimbursement plan. 10 C.C.R. 2505-10, 

§ 8.356 (1988). The new plan employs diagnostically related 

groupings (DRG's) to pay providers prospectively determined rates' 

based on the Medicaid patient's discharge diagnosis. The system 

classifies ailments or hospitalizations according to the discharge 

diagnoses and assigns to them a relative 

relative resource consumption. When 

Medicaid patient, the relative weight is 

weight, which reflects 

a provider has treated a 

multiplied by a base 

rate. A different base rate was determined for three peer groups 

of hospitals: (a) urban hospitals, (b) rural hospitals, and (c) 

rural referral centers. Hospitals within each group are presumed 

to have similar costs. 

To compute base rates, the new Colorado Medicaid plan employs 

the following steps: Reimbursable Medicare costs are determined 

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Appellate Case: 88-2482 Document: 01019568479 Date Filed: 07/11/1989 Page: 4 
by cost standards in 42 u.s.c. § 1395x(v)(l)(A) (1983) and 42 

C.F.R. § 413.1 et~ (1987). Medicare reasonable costs do not 

encompass actual costs, but rather provide standards for 

reasonable allowable costs for provider reimbursement, i.e., only 

allowable costs which are reasonable in amount are reimbursable. 

To calculate the Medicaid base rate, an average Medicare 

reimbursable cost per discharge for each peer group is calculated. 

Then, the average Medicare cost per discharge is multiplied by .88 

to determine the Medicaid average.3 Thus, the calculation 

presumes that Medicaid patients, in general, incur only 88% of the 

medical costs of Medicare patients with the same ailment. 

Finally, CDSS multiplies the .88 reduced payment by .54, i.e., it 

reduces provider reimbursement by 46%. 4 The .54 is known as the 

budget adjustment factor (BAF), and is based solely on the sums 

historically and currently appropriated by the Colorado 

legislature for provider reimbursement for inpatient hospital 

services. The BAF resulting in a 46% decrease in provider 

reimbursement rates "has no relation to the actual costs of 

hospital services." 

Because the BAF reduces provider reimbursement by 46%, the 

district court properly found that "no Colorado hospital recovers 

its actual costs." In addition, it properly found that "[s]ome of 

these 

3 

4 

Colorado hospitals 

MEDICARE REASONABLE 

ALLOWABLE COST 

MEDICARE REASONABLE 

ALLOWABLE COST 

are efficiently and economically 

x • 88 = 

x . 88 x . 54 = 

-5-

MEDICAID REASONABLE 

ALLOWABLE COST 

ACTUAL PROVIDER 

REIMBURSEMENT 

Appellate Case: 88-2482 Document: 01019568479 Date Filed: 07/11/1989 Page: 5 
operated." 

II. 

PRELIMINARY ISSUES 

Before we reach the merits of the case, we must address three 

preliminary issues: (1) whether this suit is barred by the 

Eleventh Amendment; 5 (2) whether 42 U.S.C. § 1396 et ~ creates 

enforceable rights under 42 u.s.c. § 1983; and, (3) appellants' 

standing to challenge Colorado's Medicaid plan. We address these 

issues at the start since any one of them could dispose of the 

case in toto. 

A. Eleventh Amendment 

In addition to Irene M. Ibarra, Executive Director of the 

State of Colorado, Department of Social Services, the hospitals 

have named the State of Colorado, Department of Social Services, 

as defendant. As previously noted, we raise the Eleventh 

Amendment issue sua sponte. 

In this case, we must decide whether the State of Colorado 

may be subject to suit in federal court for alleged violations of 

the Medicaid Act. The State presents no arguments in support of 

its Eleventh Amendment defense, presumably resting on its bald 

assertion of the defense in the Pre-Trial Order. The district 

court was completely silent on the issue. However, we must 

5 We raise the Eleventh Amendment issue sua sponte. Appellees 

raised the defense in the Pre-Trial Order, but did not address it 

in their brief. 

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Appellate Case: 88-2482 Document: 01019568479 Date Filed: 07/11/1989 Page: 6 
address it since the Eleventh Amendment may be a jurisdictional 

bar to this- court with respect to the State of Colorado as named 

defendant. 

The Eleventh Amendment provides: 

The Judicial power of the United States shall not be 

construed to extend to any suit in law or equity, 

commenced or prosecuted against one of the United States 

by Citizens of another State, or by Citizens or Subjects 

of any Foreign State. 

Even though the clear language does not so provide, the Eleventh 

Amendment has been interpreted to bar a suit by a citizen against 

the citizen's own State in Federal Court. Hans v. State of 

Louisiana, 134 U.S. 1, 10 (1890). In essence, the fundamental 

principle of sovereign immunity embodied in the Eleventh Amendment 

limits the grant of federal jurisdiction in Article III. Welch v. 

Texas Dept. of Highways and Pub. Transp., 483 U.S. 468, 472, 107 

S.Ct. 2941, 2945 (1987), citing Pennhurst State School & Hosp. v. 

Halderman, 465 U.S. 89, 98 (1984). 

The sovereign immunity afforded by the Eleventh Amendment is 

not absolute. In Clark v. Barnard, 108 U.S. 436, 447 (1883), the 

Supreme Court held that if a State waives immunity and consents to 

suit in federal court, the Eleventh Amendment is not a bar. 

However, a State may waive immunity "only where stated 'by the 

most express language or by such overwhelming implications from 

the text as [will] leave no room for any other reasonable 

construction.'" Edelman v. Jordan, 415 U.S. 651, 673 (1974) 

(quoting Murray v. Wilson Distilling Co., 213 U.S. 151, 171 

(1909)). Furthermore, "constructive consent" is not sufficient to 

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Appellate Case: 88-2482 Document: 01019568479 Date Filed: 07/11/1989 Page: 7 
overcome sovereign immunity. Edelman, 415 U.S. at 673. In 

addition, the Supreme Court has held that Congress may abrogate 

Eleventh Amendment sovereign immunity without the State's consent. 

Fitzpatrick v. Bitzer, 427 U.S. 445, 456 (1976). However, 

"Congress must express its intention to abrogate the Eleventh 

Amendment in unmistakable language in the statute itself." 

Atascadero State Hosp. v. Scanlon, 473 U.S. 234t 243 (1985). A 

fortiori, the Supreme Court will not infer Congressional 

abrogation of the Eleventh Amendment. Pennhurst, 465 U.S. at 99. 

In this case, the State of Colorado raised the Eleventh 

Amendment defense at the district court level. Despite the fact 

that its reply brief is silent on the issue, we cannot say that 

this is an effective waiver to satisfy the standard in Edelman. 

The State has not "expressly stated'' by its silence that it has 

waived Eleventh Amendment immunity. Neither can we say that 

participation in this suit is an effective waiver. In Ford Motor 

Co. v. Department of Treasury of State of Ind., 323 U.S. 459, 466-

67 (1945), the State of Indiana, by its Attorney General, appeared 

in the federal district court and the circuit court of appeals and 

defended the suit on the merits. The Eleventh Amendment issue was 

addressed for the first time by the Supreme Court and held to be a 

bar. Id. at 468. Thus, we hold that the State of Colorado's 

participation in this suit is not an effective waiver of its 

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Appellate Case: 88-2482 Document: 01019568479 Date Filed: 07/11/1989 Page: 8 
sovereign immunity. 6 

Next we consider whether Congress has abrogated the States' 

sovereign immunity by "unmistakable language" in the Medicaid Act 

to satisfy the standard in Atascadero. We find no such 

"unmistakable language" in the Act. 

Therefore, we hold that the Eleventh Amendment is a bar to 

the suit against the State of Colorado, Department of Social 

Services, and, hereby, dismiss the State as named defendant. 

However, because the district court properly had jurisdiction over 

Irene M. Ibarra, as Executive Director,7 the case is properly 

before us, and we will proceed to the merits. 

B. 42 u.s.c. S 1396 and Federally Enforceable Rights 

Appellee maintains that Colorado hospitals have no statutory 

right to any Medicaid rate since 42 u.s.c. § 1396a(a)(l3)(A) is 

not the kind of statute that creates enforceable rights under 42 

u.s.c. § 1983. While readily admitting that in Colorado Health 

Care this circuit held that 42 U.S.C. § 1396 creates enforceable 

rights under 42 U.S.C. § 1983, appellee asks us to revisit the 

6 In Clallam Cty. v. Department of Transp. of the State of 

Wash., 849 F.2d 424, 426-27 (9th Cir. 1988), cert. denied, 109 

S.Ct. 790 (1989), the Ninth Circuit dismissed the State as a defendant over the State's willingness to proceed in federal court, 

because the statements used were not "unequivocally expressed" to 

satisfy the standard in Pennhurst, 465 U.S. at 99. Clallam Cty. 

849 F.2d at 427. 

7 Plaintiffs seek no monetary award, and so, under Ex Parte 

Young, 209 U.S. 123 (1908), the suit is properly brought against 

Irene M. Ibarra. 

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Appellate Case: 88-2482 Document: 01019568479 Date Filed: 07/11/1989 Page: 9 
issue in light of the Supreme Court analysis in Middlesex Cty. 

Sewerage Auth. v. National Sea Clammers Ass'n, 453 U.S. 1 (1981), 

and Pennhurst State School and Hosp. v. Halderman, 451 U.S. 1 

(1981). 

In Virginia Hosp. Ass'n v. Baliles, 868 F.2d 653, 656-58 (4th 

Cir. 1989), the Fourth Circuit, en bane, has viewed precisely this 

issue and applied precisely the analysis proposed by appellee. We 

are in complete accord with the Fourth Circuit's reasoning and 

determination that 42 u.s.c. § 1396a(a)(l3)(A) implies a private 

right of action under § 1983. Id •. at 656-60. Therefore, we 

reaffirm our previous holding that § 1396a(a)(l3)(A) creates 

enforceable rights to health care providers under 42 u.s.c. § 

1983, and adopt the reasoning of the Fourth Circuit as set forth 

in Virginia Hosp. Ass'n. 

C. STANDING 

It is axiomatic that only a party with a legally cognizable 

interest in a case or controversy has standing to obtain judicial 

resolution in federal court. To some extent ''standing" is derived 

from the "case or controversy" requirement of Article III, § 2. 

Warth v. Seldin, 422 U.S. 490, 498 (1975). If a party does not 

have standing, i.e., does not have a legally cognizable interest 

in the outcome of the case, no live controversy exists any 

issuing federal opinion 

prohibited by Article 

Constitution. 

would be purely advisory, and, as such, 

III, Section 2 of the United States 

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Appellate Case: 88-2482 Document: 01019568479 Date Filed: 07/11/1989 Page: 10 
Appellee contends that the hospitals, as Medicaid providers, 

do not have standing to challenge Colorado's Medicaid plan. She 

asserts that hospitals are not the intended beneficiaries of 42 

u.s.c. § 1396, i.e., only Medicaid patients have standing to 

challenge Colorado's Medicaid plan. This issue was squarely 

presented in Colorado Health Care Ass'n v. Colorado Dept. of 

Social Servs., 842 F.2d 1158, 1164, n.5 (10th Cir. 1988). Based 

on the Medicaid patients' and Medicaid providers' "parallel 

interests with respect to Medicaid funding and reimbursement," 

this circuit held that Medicaid providers had standing to 

challenge the state Medicaid plan. Id. (citing Edgewater Nursing 

Center v. Miller, 678 F.2d 716 (7th Cir. 1982); Minnesota Ass'n of 

Health Care Facilities v. Minnesota Dept. of Pub. Welfare, 602 

F.2d 150 (8th Cir. 1979); California Hosp. Ass'n v. Obledo, 602 

F.2d 1357 (9th Cir. 1979); Massachusetts Gen. Hosp. v. Weiner, 569 

F.2d 1156 (1st Cir. 1978); National Union of Hosp. and Health Care 

Emp., RWDSU, AFL-CIO v. Carey, 557 F.2d 278 (2d Cir. 1977)). With 

no arguments to support the request, appellee has asked us to 

revisit the issue, and so we have. We find no reason to overrule 

our original decision in Colorado Health Care. 8 Medicaid 

providers have standing to challenge a state Medicaid plan. 

8 It should be noted that a panel decision can 

overruled by the decision of this court sitting en bane. 

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only be 

Appellate Case: 88-2482 Document: 01019568479 Date Filed: 07/11/1989 Page: 11 
III. 

· FEDERAL MEDICAID LAW 

Title XIX of the Social Security Act, 42 U.S.C. § 1396 

(1983), the Medicaid law, authorizes federal grants to States for 

medical assistance to low-income persons who are aged, blind, 

disabled, or members of families with dependent children. The 

program is financed by both the federal and state governments. 

State participation in the federal Medicaid program is purely 

voluntary; however, once a State chooses to participate, it must 

comply with the federal Medicaid laws and regulations. Harris v. 

McRae, 448 U.S. 297, 301 (1980); Colorado Health Care Ass'n v. 

Colorado Dept. of Social Servs., 842 F.2d 1158, 1164 (10th Cir. 

1988). 

Under the Medicaid law, each State is required to submit its 

Medicaid plan to the federal government, specifically the Health 

Care Financing Administration (HCFA}. 42 U.S.C.A. § 1396. 9 The 

State plan must satisfy the requirements of 42 u.s.c. 

§ 1396a(a)(l3}(A} and the relevant federal regulations with 

respect to the setting of Medicaid payment rates. 42 C.F.R. § 

447.200 (1987). Change in payment rates under the State plan 

requires the State Medicaid Agency to submit the plan amendment to 

HCFA for approval. 45 C.F.R. § 205.5 (1988). HCFA's review of 

the proposed State Plan is cursory at best. In essence, its 

review is limited to whether the "documentation submitted by the 

9 HCFA is the agency within the federal Department of Health 

and Human Services designated by Congress to administer the 

Medicaid program at the federal government level. 

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Appellate Case: 88-2482 Document: 01019568479 Date Filed: 07/11/1989 Page: 12 
State Medicaid Agency complies with procedural requirements." 

Under 42 u.s.c. § 1396a(a)(l3)(A), a state plan must, inter 

alia, provide for hospital services through the use of rates that 

the state "finds," and makes "assurances" satisfactory to HCFA: 

(A]re reasonable and adequate to meet the costs which 

must be incurred by efficiently and economically 

operated facilities in order to provide care and 

services in conformity with applicable State and Federal 

laws, regulations, and quality and safety standards and 

to assure that individuals eligible for medical 

assistance have reasonable access (taking into account 

geographic location and reasonable travel time) to 

inpatient hospital services of adequate quality. 

Id. In addition, the state plari must "take into account the 

situation of hospitals which serve a disproportionate number of 

low income patients with special needs." Id. 

The State need not submit the "findings'' required by § 

1396a(a} (13) (A); it. need only submit "assurances" that based on 

its "findings" all requirements of § 1396a(a)(l3)(A) have been 

met. Therefore, HCFA approval is based on state "assurances" of 

the state's "findings" that the state Medicaid plan is in 

compliance with federal Medicaid laws and regulations. 

Aside from the requirements of§ 1396a(a)(l3)(A), HCFA has 

implemented regulations which require state Medicaid agencies to 

establish payment rates consistent with, inter alia, the federal 

efficiency and economy requirement. 42 C.F.R. §§ 447.250 et ~ 

(1987). These regulations also require that the state Medicaid 

agencies make "findings" and submit "assurances" to HCFA that the 

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Appellate Case: 88-2482 Document: 01019568479 Date Filed: 07/11/1989 Page: 13 
State plan conforms with Federal laws and regulations. 42 C.F.R. 

§ 447.250(a} (1987). Whenever the State Medicaid Agency makes a 

change in its payment methods and standards, it must make 

"findings" and submit "assurances" to HCFA for approval. 42 

C.F.R. § 447.253(a}, (b} and (c} (1987}. In the event of a change 

in payment rates, but not less than annually, the state agency 

must, inter alia, make the following findings: 

(1) Payment Rates. The state agency's payment rates 

are "reasonable and adequate to meet the costs that must 

be incurred by efficiently and economically operated 

providers to provide services in conformity with 

applicable State and Federal laws, regulations, and 

quality and safety standards." (42 C.F.R. § 

447.253(b} (1).} 

(2} The payment rates must "take into account the 

situation of hospitals which serve a disproportionate 

number of low income patients with special needs." (42 

C.F.R. § 447.253(ii}(A}.) 

(3} "The payment rates are adequate to assure that 

recipients have reasonable access, taking into account 

geographic location and reasonable travel time, to 

inpatient hospital services of adequate quality.'' (42 

C.F.R. § 447.253(ii}(C}.) 

IV. 

Federal Court Review of State Medicaid Plan 

The Hospitals contend that the district court, misreading 

this court's decision in Colorado Health Care Ass'n v. Colorado 

Dept. of Social Servs., 842 F.2d 1158, 1164 (10th Cir. 1988), 

improperly limited its review of the Colorado Medicaid plan by 

determining only "whether the findings of the State Medicaid 

Agency were arbitrary and capricious." We agree. 

In passing on the validity of a state Medicaid plan under 

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federal law, the court must determine whether the plan is 

procedurally and substantively in compliance with the requirements 

of the Federal Medicaid Act and its implementing regulations, and 

not limit its analysis to whether the nonadjudicatory agency 

findings are arbitrary and capricious. In Colorado Health Care, 

presented with a challenge to the validity of the change in the 

Colorado Medicaid payment rates, this circuit held that "(i]f the 

appellees have met the specific requirements of federal and state 

law, then we must defer to the agency's exercise of discretion 

unless the DSS acted arbitrarily or capriciously." Id. at 1165 

(emphasis added) (citing Citizens to Preserve Overton Park v. 

Volpe, 401 U.S. 402, 416 (1971); Mississippi Hosp. Ass'n v. 

Heckler, 701 F.2d 511, 516 (5th Cir. 1983); Mary Washington Hosp. 

v. Fisher, 635 F. Supp. 891, 897 (E.D. Va. 1985)). 10 Quoting from 

Colorado Health Care, "Our first inquiry is whether the payment to 

the appellants resulted in noncompliance with the federal 

statute and regulations." Id. (emphasis added). This is an issue 

of law, subject to de novo review in federal court. The state 

agency's determination of procedural and substantive compliance 

with federal law is not entitled to the deference afforded a 

federal agency. Turner v. Perales, 869 F.2d 140, 141-42 (2d Cir. 

1989) (distinguishing Chevron U.S.A. v. Natural Resources Defense 

Council, 467 U.S. 837, 843-44 (1984), in which the Supreme Court 

held that the federal agency set up to implement the federal law 

was entitled to deference so long as its interpretation was not 

10 In addition, we cite West Virginia University Hospitals v. 

Casey, 701 F. Supp. 496, 512 (M.D. Pa. 1988); Thomas v. Johnston, 

557 F. Supp. 879, 901 (W.D. Tex. 1983). 

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Appellate Case: 88-2482 Document: 01019568479 Date Filed: 07/11/1989 Page: 15 
arbitrary or capricious or manifestly contrary to law.) Indeed, 

the district court improperly limited its review as to whether the 

Colorado Medicaid Agency's findings and assurances were arbitrary 

and capricious to determine whether the state plan violated 

federal law. 

v. 

COLORADO MEDICAID PLAN'S COMPLIANCE WITH PROCEDURAL 

REQUIREMENTS OF FEDERAL LAW AND REGULATIONS 

To assure state compliance, the Federal Medicaid Act and 

implementing regulations require two separate procedur~s to be 

performed annually or any time a new state Medicaid plan is 

instituted: First, the State Medicaid Agency must engage in a 

"finding" process that all federal requirements have been met to 

substantiate its assurances, including the assurances that its 

payment rates satisfy the "efficiency and economy'' requirement. 

Second, the State Medicaid Agency must supply HCFA with 

"assurances" that all federal requirements have been met, 

including the "efficiency and economy" requirement. 42 U.S.C. § 

1396a(a)(l3)(A); 42 C.F.R. § 447.205; 42 C.F.R. § 447.250(a); 42 

C.F.R. § 447.253(a) and (b). 

The plain language of federal Medicaid law mandates the State 

Medicaid Agency, at a minimum, to make "findings" which identify 

and determine (1) efficiently and economically operated hospitals; 

(2) the costs that must be incurred by such hospitals; and, (3) 

payment rates which are reasonable and adequate to meet the 

reasonable costs of the state's efficiently and economically 

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operated hospitals. Appellee argues that federal law does not 

mandate these findings. We disagree with appellee's construction 

of federal law. The courts are the final authorities on issues of 

statutory construction and "must reject administrative 

constructions of the statute that are inconsistent with the 

statutory mandate." Federal Election Comm'n v. Democratic 

Senatorial Campaign Comm., 454 U.S. 27, 32 (1981). We reject 

appellee's construction of the requirements of the federal 

Medicaid Act and its implementing regulations and hold that the 

federal Medicaid Act mandates the above enumerated findings. 

Appellee's evidence at trial is flagrantly devoid of any 

effort to make the federally required findings. David West, the 

Director of the Division of Programs for the Colorado Medicare 

Program, readily admitted the State did not determine which 

hospitals are efficiently and economically run, and made no 

efforts to do so. In addition, he readily admitted the State did 

not determine the costs that must be incurred by the efficiently 

and economically operated hospitals. However, on appeal, appellee 

illogically insists that the State found and assured HCFA that its 

hospital rates are reasonable and adequate to meet the costs which 

must be incurred by efficiently and economically operated 

facilities in compliance with 42 u.s.c. 1396a(a)(l3)(A) and 42 

C.F.R. § 447.253(a) and (b). Furthermore, appellee argues that 

since the federal government does not prescribe the steps to be 

taken in making the required findings, the State can simply comply 

with the federal requirements by assuring HCFA that it found its 

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Appellate Case: 88-2482 Document: 01019568479 Date Filed: 07/11/1989 Page: 17 
new plan to be in compliance with federal law. 

The evidence at trial was that the bases for the State 

Medicaid Agency's so-called findings were the consistency between 

the current expenditure for Medicaid provider reimbursement and 

the amount of money historically appropriated by the Colorado 

legislature, and HCFA's acceptance of the previous Colorado 

Medicaid Plan submitted prior to 1980. We hold that neither bases 

or the combination of the two identify and determine: (1) the 

efficiently and economically operated hospitals; (2) the costs 

that must be incurred by such hospitals; and, (3) the payment 

rates which are reasonable and adequate to meet the reasonable 

costs that must be incurred by the efficiently and economically 

operated hospitals. The State's reliance on the HCFA's acceptance 

of a ten year old Medicaid plan is misplaced. The federal 

requirement is that the findings discussed supra be done annually 

or in the event of the implementation of a new plan. 42 u.s.c. § 

1396a(a) (13) (A) and 42 C.F.R. 447.253(b) et ~ Furthermore, 

nowhere in the federal Medicaid Act or the implementing 

regulations does it even imply that a state may rely solely on a 

previously accepted state Medicaid plan or the fact that the 

monetary appropriations under the old plan are the same as under 

the new plan. In fact, reliance on HCFA's approval of a previous 

plan is completely undercut by the requirement that the state make 

annual findings or even more frequently in the event of 

implementation of a new plan. 

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While it is true that a state is free to create its own 

method for arriving at the required findings, this does not 

absolve the state from making the required findings. Appellee's 

argument confuses this. Mere recitation of the wording of the 

federal statute is not sufficient for procedural compliance. 

There is a presumption that a state will engage in a bona fide 

finding process before it makes assurances to HCFA that the 

required findings have been made. To rule otherwise would 

completely eviscerate the federal requirements so long as the 

magic words are submitted to HCFA. 

Based on our analysis of the governing federal law and the 

evidence at trial, we hold that appellee did not comply with the 

procedural requirements of 42 u.s.c. § 1396a(a)(l3)(A). As such, 

we hold the Colorado Medicaid Plan, effective July 1, 1988, to be 

violative of the procedural requirements of the controlling 

federal law. 

VI. 

PAYMENT RATES UNDER NEW DRG PLAN VIOLATE THE 

"EFFICIENCY AND ECONOMY REQUIREMENT" OF FEDERAL LAW 

As discussed earlier in this opinion, under Colorado's new 

DRG plan, payment rates to Medicaid providers are calculated by 

the application of a .88 reduction factor to average Medicare 

costs11 given the same DRG, as determined by cost standards in 42 

u.s.c. § 1395x(v)(l)(A) (1983) and 42 C.F.R. § 413.1 et ~ 

11 Medicare reimbursement does not cover all actual hospital 

costs. It compensates only.allowable costs which are reasonable. 

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(1987}. Then the budget adjustment factor (BAF}, .54, is 

multiplied by the already reduced payment rate, thus cutting 

provider reimbursement 46% across the board. 

Appellants do not challenge the DRG system of reimbursement 

or the application of the .88 reduction factor. They challenge 

the actual payment rates produced under the new DRG system because 

the base rates used to calculate DRG payments have been 

drastically reduced by the application of the BAF, a factor based 

solely on budget constraints. More importantly, they maintain 

that the application of the BAF is violative of 42 u.s.c. § 

1396a(a)(l3)(A) and its implementing regulations since under the 

new plan, no Colorado hospital, 

economically operated, will be 

no matter how efficiently and 

reasonably and adequately 

compensated to meet the costs which must be incurred. 

Based on uncontradicted evidence at trial, the district court 

found that no Colorado hospital will receive actual reimbursement 

for its costs as a result of the application of the BAF to the 

base rates. In addition, the district court found that some 

Colorado hospitals are efficiently and economically operated. 

Appellants contend that these two findings compel the conclusion 

that the Colorado Medicaid Plan violates the substantive 

requirements of the federal Medicaid Act. We hesitate to take the 

logical leap which appellants urge since federal Medicaid law does 

not require actual reimbursement. However, after review of the 

evidence at trial and ~ontrolling federal law, we agree that the 

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Colorado Medicaid Plan violates the substantive provisions of 

Federal Medicaid law, but for the reasons set out below. 

Kathleen Means, appellants' expert witness, testified at 

trial as an independent consultant in health care financing. She 

was qualified as an expert based on sixteen years of employment 

with the federal Medicare program and two years at Blue Cross/Blue 

Shield as National Director of Provider Payment System. She 

previously testified in two federal trials on behalf of HCFA 

regarding the same statutes and regulations in question here. She 

spent two years as a member of the federal task force that 

designed the Medicare DRG system. She co-authored the federal 

Medicaid regulations pertaining to Medicaid payment rates for 

inpatient hospital services. Her specific responsibility at HCFA 

was to review state Medicaid agencies' plans for reimbursing 

hospital services. 

At trial, Ms. Means testified that under the new Colorado 

Medicaid Plan, no Colorado hospital, no matter how efficiently and 

economically operated, would be adequately and reasonably 

reimbursed for inpatient hospital services. The basis for her 

opinion was the requirements of federal Medicaid law and her 

familiarity with the methodologies used by other states in 

computing reimbursement rates using peer groupings as used by the 

Colorado plan, and her familiarity with the Colorado Medicaid Plan 

in question. She testified that for each peer group, hospitals 

are usually ranked from lowest to highest cost. Then the state 

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chooses a certain percentile of the peer group and each hospital 

at or below the chosen percentile will have its costs met. Those 

hospitals at or below the percentile cut-off are designated the 

efficiently and economically operated hospitals. In other words, 

if a state chooses the sixtieth percentile, sixty percent of the 

hospitals will be reimbursed for the expenses they have incurred. 

If a hospital's expenses are above the sixtieth percentile, they 

will only be reimbursed for the costs incurred by a hospital at 

the sixtieth percentile. If a hospital is below the sixtieth 

percentile, that hospital may even be reimbursed above its actual 

costs. So, the hospital at the sixtieth percentile more or less 

sets the payment rate for that peer group. An alternate method 

used to set reimbursement rates is the average cost per discharge 

diagnosis of all the hospitals in the peer group. In effect, this 

is the system which Colorado uses prior to the application of the 

budget adjustment factor, .54, resulting in reimbursement of only 

54% of the average cost. Due to the effect of this BAF, provider 

reimbursement has been brought down to the zero percentile for 

each peer group. Therefore, no Colorado hospital, no matter how 

efficiently and economically operated, is reasonably and 

adequately reimbursed for costs which must be incurred in 

violation of 42 U.S.C. § 1396a(a)(l3)(A). In comparing the zero 

percentile of reimbursement with percentiles of other states, Ms. 

Means testified that the lowest percentile she had ever seen was 

the fiftieth percentile. Furthermore, she testified that in one 

third of the states, the states pay the peer group averages; in 

the other third, states pay statewide averages; and in the final 

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third, states pay facilities specific DRG rates. Ms. Means' 

testimony went unrebutted at trial. 

In addition to Ms. Means, Mr. Hart, Vice-President for Fiscal 

Services of the· Colorado Hospital Association, 12 testified that no 

hospital in Colorado would be reimbursed its reasonable costs 

under the new system. Mr. Hart was a member of the DRG Advisory 

Task Force which was formulated to provide recommendations to the 

Colorado Department of Social Services, the state agency 

responsible for Colorado's Medicaid program. 

David West, the Director of the Division of Programs for the 

Colorado Medicaid Program, admitted at trial that he had no data 

that shows that the actual payment rates being made to Colorado 

hospitals under the new DRG system will reimburse any Medicaid 

providers reasonable costs. However, he testified that the proper 

findings and assurances were made and the new state plan complied 

with federal law. His assurances at trial and to HCFA rested 

solely on the historical trends concept, i.e., since the old 

system was adequate, and the same amount of dollars are paid out 

under the new system, the new system must be adequate. The 

r 

problem with his reasoning is twofold: first, the state Medicaid 

Agency must make the required findings annually or in the event of 

the implementation of a new plan; and, second, the findings upon 

which the new plan is based were made prior to the enactment of 

12 Specifically, Mr. Hart was responsible for the financial 

issues dealing with hospital reimbursement issues for the Colorado 

Medicare program, Medicaid program. There are one hundred 

Colorado hospitals in the Colorado Hospital Association. 

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the Omnibus Budget Reconciliation Act of 1981, which mandated a 

state payment rate to be reasonable and adequate to meet the costs 

which must be incurred by efficiently and economically operated 

providers. See, ~' Colorado Health Care Ass'n v. Colorado 

Dept. of Social Servs., 842 F.2d 1158, 1165-66; Illinois Hospital 

Ass'n v. Illinois Dept. of Public Aid, 576 F. Supp. 360, 362 (N.D. 

Ill. 1983). 

Aside from the expert testimony at trial, we independently 

conclude that based on the application of the BAF, resulting in a 

46% reduction of the Medicaid reasonable cost as calculated by the 

88% reduction of the Medicare reasonable cost, no Colorado 

hospital is reasonably or adequately compensated. The reasonable 

Medicaid cost would be .88 x reasonable Medicare cost, given the 

same DRG. Under Colorado's new plan, all hospitals are reimbursed 

only about half their reasonable costs. In addition, we agree 

with the district court's finding that some Colorado hospitals are 

efficiently and economically operated; therefore, pursuant to § 

1396a(a)(l3)(A), those hospitals must be compensated for their 

reasonable costs for the plan to comply with federal Medicaid law. 

After a careful review of the record, we find that appellee 

offered no credible evidence to support the "finding" that the new 

Medicaid reimbursement rates comply with federal law. Now on 

appeal, appellee baldly "assures" us that the State Medicaid plan 

complies with federal law. Perhaps "assurances" are adequate for 

HCFA, but at trial a party must offer evidence, which supports its 

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position. Since we find no evidence admitted at trial to support 

appellee's "assurances'' on appeal, and find overwhelming evidence 

to the contrary, we hold that the Colorado Medicaid Plan, 

effective July 1, 1988, is violative of the substantive provisions 

of federal Medicaid law. Specifically, we hold that the 

application of the BAF resulting in an across the board 46% 

reduction such that no Colorado hospital, no matter how 

efficiently and economically operated, is reasonably and 

adequately reimbursed violates 42 u.s.c. § 1396a(a)(l3)(A) and its 

implementing regulations. Therefore, we prohibit the use of this 

BAF. However, in so doing, we do not prohibit the use of any BAF 

in the future. This court is mindful of state budgetary 

constraints and would approve of the application of a BAF so long 

as the resulting reimbursement rates complied with controlling 

federal law. 

VII. 

FINDINGS AND ASSURANCES--ARBITRARY AND CAPRICIOUS 

Appellants allege that the payment rates produced under the 

new DRG system are arbitrary and capricious as a result of the 

application of the budget adjustment factor. The district court 

found that: 

The fact that the State Medicaid Agency adjusted 

repayment rates according to State budgetary constraints 

does not invalidate the agency's findings. In Colorado 

Health, the Tenth Circuit Court of Appeals construed the 

same provision of law at issue here, 42 u.s.c. § 

1396a(a)(l3)(A). Id. at 1165. The court held that 

states can consider budgetary constraints as a factor in 

amending medicaid payment methods. Id-.- -at 1168. 

Similarly, the State Medicaid Agency is entitled to rely 

on budgetary considerations in setting repayment rates. 

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(Emphasis added.) We agree with the district court's conclusions, 

but nevertheless hold that the State Medicaid Agency's findings 

and assurances that the new Colorado Medicaid plan complies with 

federal law were arbitrary and capricious. 

In reviewing 

determine whether 

nonadjudicatory agency actions, the court must 

the agency action was based upon "a 

consideration of the relevant factors and whether there has been a 

clear error of judgment." 

Volpe, 401 U.S. 402, 

Citizens to Preserve Overton Park v. 

416 (1971). "The standard of review is 

highly deferential, presuming the agency action to be valid ... if 

a reasonable basis exists for its decision." California Hosp. 

Ass'n v. Schweiker, 559 F.Supp. 110, 116 (1982) (emphasis added). 

However, the court is still obliged "to engage in a substantial 

inquiry." Overton Park, 401 U.S. at 415. In other words, the 

presumption of validity "is not to shield [the agency's] action 

from a thorough, probing, in-depth review." Id. In essence, our 

task is to determine if there was a reasonable factual basis to 

support the State Medical Agency's findings and assurances that, 

under Colorado's new Medicaid plan, the efficiently and 

economically operated hospitals are reasonably and adequately 

reimbursed for the costs which must be incurred as mandated by 42 

u.s.c. § 1396a(a)(l3)(A). 

While Colorado Health does declare that a State Medicaid 

Agency may consider budgetary constraints, budgetary constraints 

cannot excuse noncompliance with federal Meoicaid law. Wisconsin 

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Hosp. Ass'n v. Reivitz, 733 F.2d 1226, 1236 (7th Cir. 1984}; 

Mississippi Hosp. Ass'n v .. Heckler, 701 F.2d 511, 518, 521; 

Illinois Hosp. Ass'n v. Illinois Dept. of Public Aid, 576 F. Supp. 

360, 368 (1983) (citing Alabama Nursing Home Ass'n v. Harris, 617 

F.2d 388, 396 (5th Cir. 1980}}. While Colorado Health allows the 

state to consider budgetary factors as a factor in amending 

Medicaid payments, consideration of budgetary factors alone does 

not translate to automatic compliance with the federally mandated 

findings that efficiently and economically operated hospitals are 

reasonably and adequately compensated for the costs which must be 

incurred. 42 U.S.C. § 1396a(a)(13)(A); 42 C.F.R. 447.200(a); 42 

C.F.R. § 447.253(a) and (b}. 13 A "state must articulate 'a 

rational connection between the facts found and the choice made."' 

Colorado Health, 842 F.2d at 1167, citing Baltimore Gas & Elect. 

v. Natural Resources Defense Council, 462 U.S. 87, 105 (1983). 

In Colorado Health, we upheld the elimination of the 

incentive or bonus-type payments to providers because the State 

Medicaid Agency made the proper findings that the amended plan was 

in compliance with controlling federal law, i.e., there was a 

reasonable basis for the Agency's findings. Id. at 1169. The 

Colorado Medicaid Agency had "considered some forty (40} different 

13 Quoting from the Finance Committee Recommendations as to 42 

u.s.c. § 1396 et ~: "The Committee continues to believe that 

States should have flexibility in developing methods of payment 

for their medicaid programs •••• The flexibility given the States 

is not intended to encourage arbitrary reductions in payment that 

would adversely affect the quality of care." S. Rep. No. 139, 

97th Cong., 2d Sess., reprinted in 1981 U.S. Code Cong. & Admin. 

News 744. 

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options for cutting the program costs." Id. at 1167. In 

addition, we found that the Agency considered "the relevant 

factors and data so that a rational relationship 

between'' the facts considered and the resulting findings. 

also specifically found that the factors relevant 

exist[ed] 

Id. We 

to the 

"efficiency and economy standard" were considered before the 

Agency's findings of compliance with federal Medicaid law. Id. 

The record in this case is blatantly devoid of any effort by 

the Colorado Medicaid Agency to make the federally mandated 

findings. Based solely on budgetary constraints, CDSS assured 

HCFA that the proper findings of federal compliance were made. We 

hold that there was no reasonable basis for its ''findings" or its 

assurances to HCFA. While budgetary constraints may be a factor 

to be considered by a state when amending a current plan, 

implementing a new plan, or making the annually mandated findings, 

budgetary constraints alone can never be sufficient. Illinois 

Hosp. Ass'n, 576 F. Supp. at 368. "If a state could evade the 

requirements of the [Medicaid] Act simply by failing to 

appropriate sufficient funds to meet them, it could rewrite the 

congressionally imposed standards at will." Alabama Nursing Home 

Ass'n v. Califano, 433 F. Supp. 1325, 1330 (M.D. Ala. 1977), rev'd 

and vacated in part on other grounds, sub nom., 617 F.2d 388 (5th 

Cir. 1980). 

Appellee argues that budgetary constraints were not the sole 

factor considered when making the required findings and 

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assurances; 

ten year 

findings. 

in fact, appellee relied on the prior approval of a 

old plan. This was not a reasonable basis for the 

Federal law mandates annual findings. 

Therefore, we hold Colorado Medicaid Agency's factual 

foundation and subsequent findings and assurances are not 

reasonably related. The evidence before us reveals arbitrary and 

capricious actions. Accordingly, we REVERSE the district court on 

this issue. 

CONCLUSION 

In sum, we declare the new Colorado Medicaid Plan, effective 

July 1, 1988, violative of the procedural and substantive 

requirements of the Federal Medicaid Act and its implementing 

regulations. In addition, we REVERSE the district court and hold 

that the findings made and assurances submitted to HCFA lacked any 

reasonable basis, and, 

Specifically, we hold 

as such, were arbitrary and capricious. 

that the application of the Budget 

Adjustment Factor, .54, resulting in an across the board 46% 

reduction in provider reimbursement, violates controlling federal 

Medicaid law under these facts, and prohibit its usage as of the 

date of this opinion. However, in so doing, we do not foreclose 

future application of a BAF so long as the resulting provider 

rates comply with federal law. 

We remand to the district court to order defendant, Irene M. 

Ibarra, Executive Director of the Colorado Department of Social 

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Services, to comply with the procedural and substantive 

requirements of the federal Medicaid Act and its implementing 

regulations, and to engage in a bona fide finding process before 

submitting any new plan and/or assurances to HCFA. 

REVERSED AND REMANDED. 

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