Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-cand-4_05-cv-03143/USCOURTS-cand-4_05-cv-03143-0/pdf.json

Parties Involved:
Kaiser Foundation Hospitals
Plaintiff
Kaiser Permanente San Francisco Medical Center
Plaintiff
Michael O. Leavitt
Defendant

Document Text:

United States District Court

For the Northern District of California

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IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF CALIFORNIA

KAISER FOUNDATION HOSPITALS, a

California Nonprofit Public Benefit

Corporation, d/b/a Kaiser Permanente

San Francisco Medical Center,

Plaintiff,

v.

MICHAEL O. LEAVITT, Secretary of the

United States Department of Health

and Human Services,

Defendant.

 /

No. C 05-3143 CW

ORDER ON CROSSMOTIONS FOR

SUMMARY JUDGMENT 

Plaintiff Kaiser Foundation Hospitals moves for summary

judgment. Defendant Michael O. Leavitt, Secretary of the United

States Department of Health and Human Services, opposes this motion

and cross-moves for summary judgment. Plaintiff opposes that

motion. As Defendant notes, although the parties have styled their

papers as cross-motions for summary judgment, this is a proceeding

for judicial review of a final administrative decision. Plaintiff

seeks to set aside Defendant's decision setting its Medicare

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1 As Plaintiff notes, the facts relating to this appeal

occurred before the HCFA was renamed Centers for Medicare and

Medicaid Services (CMS). For convenience, the Court will use HCFA

to refer to, and include, CMS. 

2

reimbursement rate for kidney dialysis treatment at $212.81;

Plaintiff contends that its reasonable cost is $476.15 per

treatment. The parties appeared before the Court on September 8,

2006, and agreed that the case should be decided on the record,

without a trial. Having considered the parties' papers, the record

and oral argument, the Court grants both Plaintiff's and

Defendant's motions in part and denies each in part.

BACKGROUND

Plaintiff is a non-profit public benefit corporation that

operates Kaiser Permanente San Francisco Medical Center, a 

Medicare-certified hospital located in San Francisco, California. 

The Kaiser Permanente San Francisco Medical Center treats patients

with End Stage Renal Disease (ESRD), an irreversible kidney

impairment requiring blood filtering dialysis or kidney transplant;

if untreated, ESRD is life-threatening. One of the services

covered under Medicare is outpatient kidney dialysis for patients

with ESRD. Persons with ESRD qualify for services under Medicare

regardless of their age; nearly all, if not all, ESRD patients are

Medicare patients.

Through the Health Care Financing Administration (HCFA),1

 the

agency that administers the Medicare program, Health and Human

Services provides Medicare reimbursements to providers, such as

Plaintiff, for outpatient ESRD treatments for qualifying Medicare

patients. Previously, providers were reimbursed by Medicare for

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2

All references to 42 U.S.C. § 1395rr and sections of Title 42

of the Code of Federal Regulations are to their respective versions

in effect at the time of the events at issue. 

3

outpatient ESRD services on a reasonable cost basis. But, under

the Omnibus Budget Reconciliation Act of 1981, the reasonable cost

reimbursement was replaced by a prospectively determined rate of

reimbursement for each dialyses treatment. Pub. L No. 97-35; 42

U.S.C. § 1395rr(b)(7) (1982).2 According to this new reimbursement

process:

The Secretary shall provide by regulation for a method (or

methods) for determining prospectively the amounts of payments

to be made for dialysis services furnished by providers of

services . . . . Such method (or methods) shall provide for

the prospective determination of a rate (or rates) for each

mode of care based on a single composite weighted formula

(which takes into account the mix of patients who receive

dialysis services at a facility or at home and the relative

costs of providing such services in such settings) for

hospital-based facilities and such a single composite weighted

formula for other renal dialysis facilities, or based on such

other method or combination of methods which differentiate

between hospital-based facilities and other renal dialysis

facilities and which the Secretary determines, after detailed

analysis, will more effectively encourage the more efficient

delivery of dialysis services and will provide greater

incentives for increased use of home dialysis than through the

single composite weighted formulas. The Secretary shall

provide for such exceptions to such methods as may be

warranted by unusual circumstances. 

Pub L. No. 97-35; 42 U.S.C. § 1395rr(b)(7).

Pursuant to this authority, Health and Human Services adopted

regulations for reimbursement of outpatient ESRD services based on

a "composite" or prospectively determined per-treatment rate. In

addition, HCFA promulgated various provisions in a Provider

Reimbursement Manual. Under these regulations and provisions,

providers have to accept the prospective payment determined by HCFA

as payment in full for covered outpatient maintenance dialysis. 

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But the regulations and provisions also provide a process

through which providers can request an exception to the standard

composite rate, resulting in a higher per-treatment rate. The

provider begins the process by filing a request with its Medicare

fiscal intermediary, which then reviews and makes recommendations

on rate exception requests and forwards requests to HCFA. If HCFA

does not deny a rate exception request within sixty working days,

the rate exception request is deemed approved. Under 42 C.F.R.

§ 413.170(g), HCFA approves an exception to the prospective payment

rate when the provider "demonstrates with convincing objective

evidence that its total per-treatment costs are reasonable and

allowable under § 413.174, and that its per-treatment costs in

excess of its payment rate are directly attributable" to "atypical

service intensity." After approval, the exception rate is provided

for a predetermined period of time; then the provider has to file a

new exception request. HCFA's determinations on ESRD composite

rate exception requests are subject to review by the Provider

Reimbursement Review Board (the Board), consisting of five

individuals knowledgeable in reimbursement matters. The Board's

decision is subject to review by the HCFA Administrator, who can

reverse, modify or adopt the Board's decision. The Administrator's

decision is final, subject to district court review.

In 1987 and 1988, Plaintiff submitted exception requests,

contending that, because it exclusively treated an atypical patient

population, it was entitled to payment higher than the standard

composite rate. The HCFA denied most of Plaintiff's exception

requests. On review, however, the Board found that Plaintiff

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exclusively served an atypical patient population and had done so

since its inception in 1969 or 1970; it granted Plaintiff most of

the costs requested in the exception requests. As part of a

settlement agreement between Plaintiff and Aetna Life and Casualty

Company, HCFA agreed to pay Plaintiff $250 per dialysis from the

date of Plaintiff's first exception request, March 24, 1987. HCFA

continued to pay Plaintiff $250 per dialysis treatment until

April 29, 1994.

At the end of 1993, HCFA informed Plaintiff that it was

reopening the exception process and that Plaintiff could request a

new exception rate by submitting an exception request on or before

April 29, 1994. Providers which did not submit an exception

request would be limited to $139 per treatment.

On March 22, 1994, Plaintiff filed its seventh exception

request. It was returned by the intermediary who indicated that

additional and modified information was needed. On April 21, 1994,

Plaintiff submitted its revised exception request, seeking $337.15

over and above the composite rate of $139 for a total reimbursement

of $476.15 per treatment. The 1994 exception request, which is the

basis of Plaintiff's challenge, was based on the following:

1. Plaintiff projected that it would incur $187.67 in labor

costs per treatment, including the salary and employee benefits for

the registered nurses, nursing supervisor, clinical dietician, unit

assistant and physician medical director; the labor component of

the composite rate was $47.

2. Plaintiff projected that it would incur $51.82 in supply

costs; the supplies component of the composite rate was $33.

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3Section 2721.B of the manual provides: 

The facility must provide written justification for supporting

the facility's higher costs. The fact that a facility

projects costs higher than its composite rate payment is not

adequate documentation for granting an exception. The

facility must provide HCFA with supporting material

documenting the reasons that may justify its costs in excess

of its composite payment rate.

6

3. Plaintiff projected that it would incur $239.66 in

overhead costs; the overhead component of the composite rate was

$47.

HCFA found that Plaintiff "presented convincing evidence that

it rendered a substantial number of treatments to patients

requiring more intense care during outpatient maintenance dialysis

service, and that it incurs higher than average per-treatment costs

for rendering these intense services." AR 1037. But, HCFA only

granted Plaintiff a rate of $199.56. AR 1040. That rate consisted

of the $139.00 as the base composite rate plus $46.33 for

additional salaries, $8.66 for additional employee benefits, and

$5.57 for additional supplies. HCFA explained that, in accordance

with section 2721.B of the Provider Reimbursement Manual,3

when a facility submits documentation that does not identify

both the specific additional items and/or services rendered

which are in addition to a routine dialysis service and the

incremental costs of these items and/or services, that

facility will not qualify for an exception under the atypical

patient mix criterion. Therefore, we are unable to recognize

these high costs for an exception to the composite rate.

Id. 

Not satisfied with $199.56, which was less than half of what

it requested, Plaintiff appealed HCFA's determination to the Board. 

After an evidentiary hearing, the Board granted Plaintiff a rate of

$299.93. 

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Specifically, the Board found that, with respect to labor

costs, HCFA erred in calculating the cost of nursing hours. HCFA

divided nursing salaries by "nursing hours paid" to determine the

average hourly nursing rate. It then multiplied that rate times

the "nursing hours worked" on dialysis treatments to calculate the

costs per treatment for nursing salaries. While "nursing hours

paid" included hours worked, as well as hours of paid vacation,

holiday and sick time, "nursing hours worked" did not account for 

vacation, holiday and sick time earned for those hours. The Board

concluded that, by using nursing hours paid in calculating the

hourly rate and but using nursing hours worked in calculating the

reimbursement amount, the HCFA improperly failed to reimburse the

vacation, sick and holiday time Plaintiff paid to its nursing

staff. Correcting that error, the Board determined that Plaintiff

was entitled to an exception amount of $62.13 for nursing salaries,

$15.80 more than the additional $46.63 the HCFA granted. 

With respect to non-nursing labor cost, the Board found that

Plaintiff submitted sufficient documentation to support some of its

claims. For example, the Board determined that Plaintiff was

entitled to an additional $1.55 per treatment for the services of a

clinical dietician and an additional $4.95 per treatment for

administrative support. But the Board denied any additional

reimbursement for management costs, finding that Plaintiff did not

provide convincing evidence that additional management costs were

attributed to patient atypicality. 

The Board further found that, in calculating the exception

amount for employee benefits, HCFA should not have used the

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national average employee benefit percentage and instead should

have used Plaintiff's actual employee benefit percentage. Using

the actual benefit percentage, the Board found that the exception

amount should be $15.28 per treatment. 

With respect to supply costs, the Board found that Plaintiff

provided specific rationale and data to support its additional

supply costs; it approved $51.82 in supply costs, the entire amount

Plaintiff requested. 

As for overhead costs, the Board found that, for Medicare cost

reporting purposes, the cost of delivering services includes the

direct costs incurred for labor and supplies and the indirect

costs, or overhead, incurred for such expenses as administrative

and general costs, housekeeping, equipment, laundry and linen. The

Board agreed with Plaintiff that Plaintiff had "presented evidence

that its overhead costs are related to the atypical patients, and

that there is no such incremental requirement in the Medicare

regulations and Manual provisions." AR 98. Concluding that it is

not possible to link overhead costs directly to a particular

service, the Board ruled that Plaintiff was entitled to a 56.5

percent overhead exception amount, totaling $105.20, for all

approved direct cost exception amounts. The Board calculated the

56.5 percent by dividing 47, which represents the $47 composite

rate for indirect overhead costs, by 83, which represents the $83

composite rate for direct costs.

HCFA requested review of the Board's decision, arguing that

the Administrator should reverse the decision. Plaintiff submitted

a letter to the Administrator requesting that the Administrator

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4

Neither party contests the Administrator's conclusion

regarding supply costs.

9

modify the Board's opinion to grant it the full amount of its

requested exception to the ESRD composite rate. The Administrator

agreed to review the Board's decision.

After reviewing the comments provided by Plaintiff and HCFA,

the Administrator issued his decision, the final agency decision, 

granting Plaintiff a $212.81 per-treatment ESRD exception rate. 

Like the Board, the Administrator found that the record supported

the finding that Plaintiff serves an atypical patient mix

population. After reaching that conclusion, however, the

Administrator stated that "in addition to demonstrating that it

serves an atypical patient mix, the Provider must also demonstrate,

inter alia, that the costs are reasonable and that the elements of

excessive costs are specifically attributable to the Provider's

atypical patient mix." AR 9. The Administrator concluded that,

for the most part, Plaintiff failed to show that the costs are

specifically attributable to the atypical patient mix, and affirmed

only the Board's determination on supply costs.4

With respect to nursing labor salary costs, the Administrator

disagreed with the Board's determination, stating that HCFA "has

consistently used 'nursing hours worked' to determine the average

nursing hours per treatment and 'nursing hours paid' to determine

the average hourly rate for an ESRD unit." AR 9. Concluding that

there is nothing inherently inconsistent in this methodology, the

Administrator determined that Plaintiff was entitled to an

exception of only $46.33 for nursing salaries. 

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The Administrator further determined that HCFA properly

concluded that the excess cost of non-nursing labor should not be

included in the exception because Plaintiff failed to provide

written justification supporting its higher costs.

With respect to employee benefits, the Administrator reversed

the Board's decision, concluding that HCFA did not improperly deny

Plaintiff's full exception for excess employee benefits. The

Administrator again concluded that Plaintiff failed to show that

the extra costs are specifically attributable to its atypical

population mix: "As reflected by the record, the Provider's

exception request is absent of documentation which links the

excessive employee benefits costs" above the 18.7 percent national

employee-benefits average. AR 10. 

The Administrator also reversed the Board's decision

concerning overhead costs, again concluding that Plaintiff failed

to substantiate its claims that excess overhead costs directly

relate to its atypical patients. The decision stated:

That Administrator finds that the Provider's general contention

that certain overhead costs must follow higher direct costs is

contrary to the specific requirements of the regulations and

manual and likewise is not supported by the record. Contrary

to the specific regulatory requirements and PRM instructions,

the Provider offered no documentation, other than general

statements, to identify its higher overhead costs and the link

to its atypical patient mix. Simply because the Provider has

an atypical patient mix does not demonstrate that its overhead

costs are "directly attributable" to the provision of atypical

services. 

AR 13.

Plaintiff now seeks judicial review of this final decision,

and requests that the Court overturn that decision and grant the

full amount of the exception it seeks, $476.15 per treatment.

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STANDARD OF REVIEW

The Court reviews Plaintiff's challenge to the final decision

under the Administrative Procedure Act (APA). 42 U.S.C.

§ 1395oo(f)(1); 5 U.S.C. § 706. Under the APA, courts “hold

unlawful and set aside” only agency action that is “arbitrary,

capricious, an abuse of discretion, or otherwise not in accordance

with law.” 5 U.S.C. § 706(2)(A); Thomas Jefferson University v.

Shalala, 512 U.S. 504, 512 (1994). The Supreme Court instructs

that courts "must give substantial deference to an agency's

interpretation of its own regulations." Thomas Jefferson

University, 512 U.S. at 512. In reviewing a plaintiff's challenge,

a court's "task is not to decide which among several competing

interpretations best serves the regulatory purpose. Rather, the

agency's interpretation must be given controlling weight unless it

is plainly erroneous or inconsistent with the regulation.” Id.

(inner quotations and citation omitted). Thus, the Supreme Court

requires courts to "defer to the Secretary's interpretation unless

an 'alternative reading is compelled by the regulation's plain

language or by other indications of the Secretary's intent at the

time of the regulation's promulgation.'” Id. (quoting Gardebring

v. Jenkins, 485 U.S. 415, 430 (1988)). 

Although a court's review of a plaintiff's challenge is a

“narrow one,” it is required to “engage in a substantial inquiry"

and conduct "a thorough, probing, in-depth review.” Native

Ecosystems Council v. U.S. Forest Serv., 418 F.3d 953, 960 (9th

Cir. 2005) (quoting Citizens to Preserve Overton Park, Inc. v.

Volpe, 401 U.S. 402, 415-16 (1971), overruled on other grounds by

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Califano v. Sanders, 430 U.S. 99, 105 (1977)). To determine

whether an agency action was arbitrary and capricious, the court

must “determine whether the agency articulated a rational

connection between the facts found and the choice made.” Ariz.

Cattle Growers’ Ass’n v. U.S. Fish and Wildlife, 273 F.3d 1229,

1236 (9th Cir. 2001). As long as the agency decision was based on

a consideration of relevant factors and there is no clear error of

judgment, the reviewing court may not overturn the agency’s action. 

Id. (citing Am. Hosp. Ass’n v. NLRB, 499 U.S. 606 (1991)). In

particular, the reviewing court must defer to the agency’s decision

when the resolution of the dispute involves issues of fact or when

a complex and highly technical regulatory program, like Medicare,

is involved. Thomas Jefferson Univ., 512 U.S. at 512; see also

Marsh v. Or. Natural Res. Council, 490 U.S. 360, 377 (1989). 

Accordingly, the court may set aside only those conclusions that do

not have a basis in fact, not those with which it merely disagrees. 

Ariz. Cattle Growers’ Ass’n, 273 F.3d at 1236. 

DISCUSSION

Plaintiff argues that it has met all the requirements for

receiving an ESRD exception in the full amount it requested by

showing that its increased costs are reasonable and directly

attributable to its atypical patients. Its argument rests, in

part, on the definition of the phrase "directly attributable." The

Court first addresses Plaintiff's challenge to the meaning of that

phrase before addressing the two categories of contested costs:

labor and overhead. The Court will then address Plaintiff's

argument that Defendant's decision to grant Plaintiff an exception

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of less than $250 per treatment is arbitrary and capricious.

I. "Directly attributable"

To be granted an exception, a provider must demonstrate "with

convincing objective evidence" that its per-treatment costs are

reasonable and "directly attributable" to an atypical patient mix. 

42 C.F.R. § 413.170(f)(6). The phrase "directly attributable,"

which is used synonymously with the phrase "specifically

attributable," however, is not expressly defined in the Medicare

regulations or provisions. Plaintiff argues that, because

"directly attributable" is not defined, the Court should construe

the term in accordance with its "common meaning," and as Plaintiff

believes it should be construed. See Cleveland v. City of Los

Angeles, 420 F.3d 981, 989 (9th Cir. 2005) ("To determine the

meaning of a term in a federal regulation, we look to the common

meaning of the word."). 

Plaintiff minimizes the deference owed to Defendant's

interpretation, especially in cases involving Medicare's "complex

and highly technical regulatory program." Alhambra Hospital v.

Thompson, 259 F.3d 1071, 1074 (9th Cir. 2001). Instead, citing

Alhambra Hospital, Plaintiff argues that an agency is not entitled

to deference where a regulation is plain on its face. In Alhambra

Hospital, the Ninth Circuit instructed that courts "must defer to

an agency's interpretation unless an 'alternate reading is

compelled by the regulation's plain language.'" 259 F.3d at 1074

(quoting Thomas Jefferson Univ., 512 U.S. at 512). Here, an

alternate reading is not compelled by the plain language of the

term. 

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As Plaintiff acknowledges, there are numerous definitions for

the word "directly," and thus various "common meanings." Plaintiff

uses the definition "without anyone or anything intervening" found

in the American Heritage College Dictionary (3d Ed. 1997), noting

that the word is synonymous with immediately. Another definition

for "directly" is "exactly; precisely." See Random House College

Dictionary (1982). Plaintiff states that the plain meaning of the

term "directly attributable" requires that providers demonstrate a

cause for increased per-treatment costs that is immediate, as

opposed to remote. The plain meaning, however, could also require

that providers demonstrate a cause for increase per treatment that

is exact and precise. Plaintiff's argument, that the Court owes no

deference to Defendant's interpretation of the regulation and

phrase "directly attributable" because they are plain on their

face, fails.

Plaintiff's argument that Defendant's interpretation of

"directly attributable" is unreasonable is similarly unpersuasive.

Plaintiff states that Defendant requires providers to submit

documentation that incrementally links the particular cost item to

the atypicality of patients in order to show that increased costs

are directly attributable to an atypical patient mix. According to

Plaintiff, general Medicare cost reporting principles do not

require that providers directly link certain costs with the precise

service rendered and, thus, Defendant's interpretation is

unreasonable. 

The Court, however, finds that Defendant's stringent

definition of "directly attributable" is not inconsistent with the

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prospective rate reimbursement scheme Congress designed to create

more efficient delivery of dialysis services, or with any Medicare

regulation or provision. Plaintiff's definition, under which a

provider's costs would be deemed "directly attributable" to its

atypical service intensity as long as the provider demonstrated

more than just a tenuous causal relationship between its increased

costs and atypical patients, is inconsistent with Congress' intent

to revamp the former reasonable cost system and implement a costsavings system, under which exceptions are warranted only in

unusual circumstances. Because Plaintiff does not show that

Defendant's interpretation of "directly attributable" and

"specifically attributable" is unreasonable or inconsistent with

the plain meaning of the phrases, the Court finds that Defendant's

interpretation, albeit exacting, is entitled to deference.

II. Labor costs

In its exception request, Plaintiff projected that it would

incur a total of $137.67 in labor costs per treatment, attributable

to its atypical service intensity. These additional labor costs

include salary and employee benefits for registered nurses, and for

a nursing supervisor, clinical dietician, unit assistant and

physician medical director. Plaintiff argues that Defendant's

denial of the majority of Plaintiff's requested amount was

arbitrary and capricious because Defendant used an improper

methodology to calculate nursing salary costs, refused to include

any labor costs for Plaintiff's non-nurse employees, and limited

Plaintiff's employee benefits costs based on an unsupported

national average for employee benefit costs.

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A. Nursing salary

In calculating the cost per treatment for nursing salaries,

the HCFA used "nursing hours paid" to determine the "average

nursing hours rate" and then multiplied that rate by the "nursing

hours worked." As explained above, the hourly rate was calculated

based on "nursing hours paid" which included the amount paid to the

nursing staff for time worked as well as for vacation, holiday and

sick time. "Nursing hours worked," however, included only the

hours actually worked. 

As noted above, Defendant approved that methodology. 

Plaintiff, however, argues that there is no rational basis for

excluding the additional vacation, sick and holiday time for which

it must pay because of the additional hours worked. It notes that

Defendant's methodology is not called for by any Medicare statute,

regulation or manual provision. 

Defendant's argument, that vacation, sick and holiday time is

unrelated to patient care, is not persuasive. Even considering its

limited scope of review, the Court finds that the HCFA's

calculation is arbitrary, capricious and an abuse of discretion. 

Therefore, the Court overturns Defendant's determination concerning

nursing salary costs. The Board correctly determined that using

the correct calculation results in an exception amount of $62.13

for nursing salaries, $15.80 per treatment more than the $46.33

approved by Defendant. 

B. Additional salaries

Defendant granted excess labor costs only for nursing labor,

not for the other labor costs Plaintiff contends it incurs in

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caring for its atypical patients. The final decision stated that,

while Plaintiff "identified its actual and projected costs," it

"failed to identify or document the incremental costs associated

with the additional items or services rendered." AR 11. 

Concluding that Plaintiff failed to provide written justification

supporting its higher labor costs, Defendant denied all additional

labor costs Plaintiff incurred for nursing supervision, unit

assistants, a clinical dietician and a physician medical director.

Plaintiff's contention, that its non-nurse salary costs are

attributable to its atypical service intensity and thus should be

reimbursed, rests largely on its argument that "directly

attributable" does not require a provider to link the incremental

labor costs at issue with its atypical patient mix. That argument,

however, is unpersuasive; it again ignores the deference this Court

must give to Defendant's interpretation of the regulations.

Plaintiff points to evidence that it claims shows that its

excess labor costs are directly attributable to its atypical

patient population, but that evidence is not clear and convincing

or objective. Rather, it consists of conclusory statements that,

because Plaintiff sees more atypical patients, it has higher

management and administrative salary costs. While it seems likely

that such is the case, Plaintiff failed to provide data to

demonstrate that increased direct nurse service hours also required

increased management and administrative support. 

Defendant's decision regarding non-nursing labor costs was not

arbitrary, capricious, unreasonable or contrary to the law, and,

therefore, it cannot be overturned. 

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C. Employee benefits

Plaintiff sought to recover employee benefits at the level it

pays: 24.59 percent of total salary. Defendant, however, found

that Plaintiff failed to prove that any benefit percentage in

excess of the 18.7 percent national average is attributable to

Plaintiff's atypical patient mix. Therefore, Defendant limited

Plaintiff's employment benefit reimbursement to the 18.7 percent

national average. Plaintiff contends that this is improper for

several reasons, none of which is persuasive.

Plaintiff relies on University of Cincinnati v. Shalala, 867

F. Supp 1325 (S.D. Ohio 1994). In University of Cincinnati, the

court found that, because the plaintiff did not demonstrate that

its atypical patient mix exacerbated its employee benefits, it was

not arbitrary, capricious, an abuse of discretion or contrary to

law for the Secretary of Health and Human Services to limit the

plaintiff's fringe benefits reimbursement to the national benefits

average. 867 F. Supp. at 1331. But the court did find that the

Secretary's unjustified use of 18.7 percent as the national average

was arbitrary and capricious; the figure had not changed for over a

decade. Id. at 1332. The court remanded the question to HCFA to

determine and apply a national benefits average that was "more

appropriately time-based." University of Cincinnati v. Shalala,

1995 WL 599188 (S.D. Ohio 1995). 

Defendant reports that, on remand, the HCFA re-evaluated the

18.7 percent employee benefits rate and found it still valid. See

Palomar Medical Center, CCH Medicare and Medicaid Guide, ¶ 56,546

(CMS Admin. Dec. Oct. 2, 1997). Plaintiff does not deny this

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finding. Nonetheless, it argues that, because the HCFA's reevaluation decision was not part of the administrative record, it

is not properly before the Court. Judicial review of agency action

is generally limited to review of the record on which the

administrative decision was based. The Ninth Circuit, however, has

recognized exceptions to that general rule, including reviewing

additional material to explain the basis of the agency's actions

and the factors the agency considered. Love v. Thomas, 858 F.2d

1347, 1356 (9th Cir. 1988). The Court considers the HCFA's reevaluation of the 18.7 percent national average. Plaintiff's

argument, that the 18.7 percent employee benefits rate is arbitrary

and capricious because it is stale, is unavailing.

Plaintiff has failed to prove that Defendant's decision on

this point was arbitrary, capricious, unreasonable or contrary to

the law. Nor did Plaintiff show that Defendant's decision was

unsupported by substantial evidence. Therefore, the Court cannot

overturn Defendant's determination of employee benefits costs.

III. Overhead costs

Plaintiff projected that it would incur $239.66 in overhead

costs per treatment, almost $200 above the composite rate, for

laundry and linen, extra square footage, equipment depreciation and

administrative and general costs. The Administrator found that

Plaintiff failed to offer documentation, other than general

statements, to link its higher overhead costs to its atypical

patient mix. Because Plaintiff did not directly attribute its

overhead costs to its atypical patient mix, Plaintiff's exception

request for overhead costs was denied in its entirety. 

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Plaintiff contends that this decision was erroneous because

Plaintiff proved that all of the increased overhead costs it sought

were "directly attributable" to the atypical services it provides

to its atypical patients. Plaintiff, however, uses a different

definition of "directly attributable" than that employed by

Defendant, and, as noted above, Plaintiff fails to show that

Defendant's definition, placing a high burden on providers, is not

entitled to deference. 

 Section 2725.1 of the Provider's Reimbursement Manual

provides:

Overhead Costs -- There are infrequent instances, (i.e.,

hepatitis) when an isolated area is required and where higher

overhead costs may be justifiable. For those costs to be

considered under this exception criteria, documentation must

be submitted that identifies the basis of higher overhead

costs, the specific cost components to be impacted and the

incremental pretreatment costs. General statements regarding

a facility's higher overhead costs are not acceptable in

meeting the criteria.

Plaintiff argues that, to the extent this provision requires

incremental cost attribution with respect to overhead costs, it

must be disregarded as inconsistent with ESRD payment regulations. 

But it fails to show that this provision, or requiring incremental

cost attribution with respect to overhead costs, is inconsistent

with ESRD payment regulations. Although this provision in the

manual "does not have the binding effect of law or regulation," the

Court considers it as "clarifying existing regulations." National

Medical Enterprises v. Bowen, 851 F.2d 291, 293 (9th Cir. 1988).

Relying on County of Los Angeles v. Sullivan, 969 F.2d 735,

740-41 (9th Cir. 1992), Plaintiff further argues that Defendant's

denial of all of its overhead costs violates the prohibition

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against cost-shifting. By statute, Defendant is required to

promulgate reimbursement regulations which assure that the

necessary costs of efficiently delivering covered services to

patients covered by Medicare "will not be borne by individuals not

so covered." 42 U.S.C. § 1395x(v)(1)(A). County of Los Angeles,

however, is distinguishable. Plaintiff's argument that Defendant

violated the prohibition on cost-shifting is not persuasive. 

Nonetheless, as the Court discusses below, denying all

administrative and general costs is arbitrary and an abuse of

discretion, even if it does not violate the prohibition on costshifting. 

A. Laundry and linen

Plaintiff contends that it demonstrated that it uses more

linen and laundry than a typical dialysis facility because of its

atypical patients. In its exception request, it stated:

Nearly half of our patients have problems with bowel/bladder

disfunction; half of our patients required dressing changes at

some time during the treatment; half of our patients were

dialyzed with some sort of vascular access other than the

normal fistula which resulted in excess blood on surfaces on

the bed or chair; 79% of our patients were beset with vomiting

during the treatment. All of these atypical problems resulted

in the use of 6 to 10 times more linens than the typical

dialysis population. Therefore, our laundry and linen amount,

which may be 6 to 10 times that of the typical cost for this

item, is justified.

AR 540.

Defendant points out that this general statement does not

quantify the extent to which increased costs were incurred, nor

does it provide detailed objective evidence and specific cost

components. While it seems likely that Plaintiff indeed incurs

atypical laundry and linen expenses, it does not identify any

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evidence in the record quantifying these costs. Instead, it argues

that Defendant's approval of its request for excess supply costs

demonstrates that Defendant's denial of its request for excess

linen and laundry costs is arbitrary. Plaintiff's request for

excess supply costs, however, contains evidence quantifying

Plaintiff's additional costs for gloves and linking the additional

cost to Plaintiff's atypical patients. While Plaintiff contends

that its cost for linen and laundry was $23.55 per treatment, it

fails to analyze or break down the specific cost components, or the

corresponding incremental per-treatment costs, as required. 

The Court finds that Defendant's decision denying an exception

for laundry and linen costs was not arbitrary, capricious, an abuse

of discretion or contrary to law.

B. Square footage

Plaintiff argues that it demonstrated that its dialysis unit

requires more space than a typical dialysis unit because of the

atypical nature of its patient population. For example, many of

its patients have psychological and behavior disorders which

necessitate that they be isolated from the remaining patients;

other patients require isolation for medical reasons, such as

chronic infection or acute complications such as diarrhea. 

Therefore, Plaintiff has a separate isolation room, which contains

a bed for treatment for these patients. Other patients are unable

to sit up in a dialysis chair and require a bed, which takes up

more space in a dialysis area than a chair. 

Defendant does not dispute that Plaintiff's ESRD unit utilizes

more space than a typical unit. Nonetheless, Defendant denied

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Plaintiff any excess overhead cost based on its extra square

footage because Plaintiff failed to quantify specifically the

difference in space, such as the space needed for the isolation

room or for a bed as opposed to a dialysis chair. 

Plaintiff does not argue that, with respect to excess square

footage costs, it identified "the basis of higher overhead costs,

the specific cost components to be impacted and the incremental

pretreatment costs," as required by section 2725.1.B.4 of the

Provider's Reimbursement Manual. Rather, it again argues that

Defendant is requiring providers to comply with a too-stringent

definition of "directly attributable." Defendant has put in place

an exacting standard providers must meet in order to receive an

exemption; this standard applies to overhead costs based on square

footage. As explained above, because Defendant's standard is

neither contrary to the plain language of the regulation nor to

Congressional intent, the Court must afford it deference. 

Defendant's decision denying an exception for overhead costs based

on square footage was not arbitrary, capricious, an abuse of

discretion or contrary to law. 

C. Capital equipment depreciation

Plaintiff argues that it demonstrated that it utilizes more

expensive equipment than a typical unit due to its atypical patient

population; unlike typical dialysis patients, Plaintiff's atypical

patients routinely require the use of EKG machines, infusion pumps

for antibiotics or chemotherapy and cardiac monitors. Again,

Defendant does not dispute that Plaintiff incurred higher costs for

this equipment. Defendant instead responds that, as noted by the

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intermediary, Plaintiff failed to submit "an incremental analysis

of the breakdown of the equipment and the related depreciation

expense which are required for typical and atypical patients." AR

1002. Plaintiff does not refute this.

The Court finds that Defendant's decision denying an exception

for overhead costs based on capital equipment depreciation was not

arbitrary, capricious, an abuse of discretion or contrary to law. 

D. Administrative and general 

Plaintiff explains that administrative and general costs are

those related to the operation of health care facilities and

include such items as accounting, billing, administrative salaries

and insurance. Plaintiff contends that it is entitled to

additional administrative and general costs as part of its

exception request because its ESRD unit incurs increased direct

costs as a result of its treatment of atypical patients. According

to Plaintiff, under Medicare rules, administrative and general

costs follow direct costs and, therefore, it did not need to make

an additional showing to link the administrative and general costs

to the atypical patient services provided. 

Defendant disagrees. He argues that requiring Plaintiff to

prove independently that its excess administrative and general

costs are directly attributable to its atypical patient mix is not

contrary to the law. The Court finds that Defendant's decision

denying any exception for administrative and general expenses

overhead expenses is arbitrary and an abuse of discretion. As the

Board explained, administrative and general costs are residual

costs, not specifically and reasonably identified with any

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particular area of a provider's operation. Some of Plaintiff's

increased administrative and general costs are undoubtedly, and

undisputedly, directly attributable to its atypical patient

population. 

Unlike Defendant's refusal to grant any exception for excess

administrative and general costs, the Board's approval of a 56.5

percent overhead exception amount for all approved direct cost

exception amounts is reasonable. The Board based this decision on

its reasonable assumption that the $47 composite amount for

overhead costs represents general and administrative costs incurred

by ESRD facilities and was calculated in accordance with longstanding Medicare principles. Thus, it would be reasonable and

non-arbitrary for Defendant to award Plaintiff a 56.5 percent

overhead exception amount for all approved direct cost exception

amounts, which would amount to $50.63. 

The Court remands this action to Defendant to determine an

exception for administrative and general costs that is reasonable

and non-arbitrary. 

IV. Granting less than $250 per treatment

Lastly, Plaintiff argues that it is entitled to continue

receiving $250 per treatment, as it has since 1987. Noting that it

continues to serve the same atypical patient mix, Plaintiff

contends that its costs have increased since 1987 and, therefore,

Defendant's decision to reduce Plaintiff's payment below $250 per

treatment was erroneous, arbitrary and capricious. 

Defendant responds first that Federal Rule of Evidence 408

requires exclusion of the evidence of the $250 payment rate because

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that rate was awarded as the result of a settlement. Rule 408

provides that evidence concerning an offer to compromise, or

acceptance of an offer to compromise, is not admissible "to prove

liability for or invalidity of the claim or its amount." Plaintiff

contends that the evidence is admissible because it is offered to

show that Defendant's decision was arbitrary and capricious, not to

prove liability. 

Even if it is considered, the $250 rate does not assist

Plaintiff. As Defendant notes, there is nothing in the regulatory

scheme that allows an exception rate to have any force after the

applicable period expires. Plaintiff must prove by "clear and

convincing objective evidence" that its excess costs are reasonable

and allowable and directly attributable to its atypical patient

mix. Plaintiff cannot prove that by pointing out that it

previously received $250. 

Therefore, the Court will not overturn Defendant's decision on

this ground. 

CONCLUSION

For the foregoing reasons, Plaintiff fails to demonstrate that

Defendant's final decision was arbitrary, capricious, an abuse of

discretion or otherwise not in accordance with the law, except with

respect to Defendant's calculation for nursing salary costs and his

denial of all administrative and general costs. Therefore, the

Court affirms the final decision on Plaintiff's ESRD rate exception

request in part and overturns it in part.

Both Plaintiff's Motion for Summary Judgment (Docket No. 13)

and Defendant's Cross-Motion for Summary Judgment (Docket No. 17)

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are GRANTED IN PART and DENIED IN PART. Specifically, the Court

finds that Plaintiff is entitled to an exception amount of $62.13

for nursing salaries, $15.80 per treatment more than the $46.33

approved by Defendant. This raises Plaintiff's Medicare

reimbursement rate to $228.61 per treatment. In addition, the

Court finds that Plaintiff is entitled to an exception for its

administrative and general overhead costs. It would be reasonable

for Defendant to award Plaintiff a 56.5 percent administrative and

general overhead exception amount, totaling $50.63, for all

approved direct cost exception amounts. The matter, however, is

remanded to Defendant to calculate an exception for administrative

and general overhead costs that is reasonable and non-arbitrary. 

Judgment shall enter accordingly. Each party shall bear its own

costs. 

IT IS SO ORDERED.

Dated: 10/17/06 

CLAUDIA WILKEN

United States District Judge

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