IN THE SUPREME COURT OF IOWA

No. 11–1145

Filed June 28, 2013

SUNRISE RETIREMENT COMMUNITY, FRIENDSHIP HAVEN, 

PRESBYTERIAN VILLAGE, ROSE VISTA HOME, LONGVIEW HOME, 

UNITED PRESBYTERIAN HOME, RICEVILLE COMMUNITY REST 

HOME, HUBBARD CARE CENTER, and HAPPY SIESTA CARE 

CENTER,

Appellants,

vs.

IOWA DEPARTMENT OF HUMAN SERVICES,

Appellee.

On review from the Iowa Court of Appeals.

Appeal from the Iowa District Court for Polk County, Arthur E. 

Gamble, Judge.

The Iowa Department of Human Services requested further review 

of a decision of the court of appeals reversing the agency’s disallowance 

of certain expenses from cost reports submitted by nursing homes. 

DECISION OF COURT OF APPEALS AFFIRMED; DISTRICT COURT 

JUDGMENT REVERSED AND REMANDED WITH INSTRUCTIONS.

Patrick B. White of White Law Office, P.C., Des Moines, for 

appellants.

Thomas J. Miller, Attorney General, and Timothy L. Vavricek, 

Assistant Attorney General, for appellee.
2

HECHT, Justice.

Several nursing homes submitted annual reports disclosing their 

income and expenses to the Iowa Department of Human Services (DHS). 

The reports were used by DHS to calculate the Medicaid per diem 

reimbursement rates for the nursing homes. Some of the nursing homes’ 

expenses were disallowed by DHS, which adjusted those reports and 

reduced reimbursement rates accordingly. We must decide in this 

appeal whether DHS properly interpreted and applied its departmental 

rules in setting the rates. As we conclude the agency’s action was based 

on an incorrect interpretation of its rules, we reverse and remand.

I. Background Facts and Proceedings.

Sunrise Retirement Community, Friendship Haven, Presbyterian 

Village, Rose Vista Home, Longview Home, United Presbyterian Home, 

Riceville Community Rest Home, Hubbard Care Center, and Happy 

Siesta Care Center are long-term care facilities licensed in Iowa and 

approved by DHS as Medicaid providers. Each of these facilities accepts 

patients with different payment sources—e.g., private payment, 

Medicare, and Medicaid.

To participate in Medicaid, each facility must submit a “Financial 

and Statistical Report” annually to DHS. The report details the facility’s 

overall operating costs and sources of revenue. The information 

submitted on the report is used by DHS to calculate a per diem 

reimbursement rate for each participating facility.

The per diem rate is not designed to reimburse nursing facilities for 

their precise costs incurred in caring for Medicaid patients. Instead, 

DHS calculates rates after determining a facility’s allowable costs, which 

are derived from a facility-specific reporting system. In this system, each

facility reports all costs incurred and revenue received from all sources in 
3

its annual financial and statistical report. An accounting firm employed 

by DHS then reviews the reports to determine which costs are allowable

under the agency’s rules when calculating the appropriate Medicaid 

per diem rate.

In submitting their cost reports for the fiscal year ending 

December 31, 2008, the appellant care facilities included in their reports 

costs incurred for services provided to residents whose primary source of 

payment was Medicare Part A. DHS deemed some of these costs 

disallowed.

When a resident is admitted with Medicare Part A as a payor, a 

facility bears up front all costs of treatment and care for the resident. 

This is true even when the resident receives treatment or care outside the 

facility, such as when he or she is sent to a local provider for an x-ray or 

lab work. In these cases, the outside provider bills the nursing facility

directly for its services, including the three types of services at issue in 

this case—prescription drugs, x-rays, and lab work. The outside 

provider may not bill the resident directly and may not bill Medicare. 

Instead, Medicare provides a per diem payment to the nursing facility for 

each resident intended to cover all care, treatment, and services for that 

resident. Medicaid, by contrast, pays the Medicaid patients’ outside 

providers of prescription drugs, x-rays, and lab work directly.

In this case, most of the facilities included in their Medicaid cost 

reports costs incurred on behalf of Medicare patients for x-rays, lab 

work, and prescription drugs. DHS contends that including these 

categories of costs in reports used to calculate the Medicaid per diem 

reimbursement rate would result in “double-counting.” The facilities

maintain that DHS regulations allow, if not require, the inclusion of 

these costs.
4

In 2008, DHS determined these costs were not allowable and 

therefore excluded them from the cost reports. This marked a departure 

from prior practice. Until the 2008 adjustments, DHS had allowed the 

facilities to include in the cost reports the costs paid to third parties for 

lab services, x-rays, and prescription drugs provided to Medicare 

patients.

1 The facilities appealed the adjustments, and a contested case 

hearing was held. A proposed decision was issued by an administrative 

law judge who concluded the costs incurred by the facilities for x-rays, 

lab work, and prescription drugs provided to Medicare patients were 

properly reported by the nursing homes. The ALJ elaborated:

At the hearing, the Department opined that [Medicare] Part A 

costs should be excluded because the costs are covered/paid 

for by the Medicare per diem and if the costs were included 

in the Medicaid per diem calculation, it would artificially 

inflate the Medicaid rate. This argument by the Department 

lacks merit however since the Medicare Part A revenue is 

also reported by the facility as a part of the cost report and 

already part of the equation. Moreover, the Department 

conceded that it could perform an offset to account for the 

costs/revenue associated with costs for a Part A resident. As 

such, the Department has a methodology for dealing with 

this perceived “enrichment” without disallowing the costs on 

the Medicaid cost report.

DHS requested intra-agency review, and the director of human 

services issued a final decision which accepted the ALJ’s fact findings 

but concluded the costs should be disallowed on the cost reports. The 

facilities sought judicial review, and the district court affirmed the 

director’s decision. The facilities appealed. The court of appeals reversed 

the district court, concluding the DHS rules did not support the agency’s 

 

1Although DHS had never objected to the reporting of prescription drug 

expenses incurred for Medicare patients prior to 2008, it had apparently excluded those 

expenses from its Medicaid per diem calculations for prior years.
5

determination that the costs in question were not allowable. DHS 

sought, and we granted, further review.

II. Standard of Review.

Final agency action is reviewed for corrections of errors at law. 

Eyecare v. Dep’t of Human Servs., 770 N.W.2d 832, 835 (Iowa 2009). We 

apply the standards of chapter 17A of the Iowa Administrative Procedure 

Act to agency action to determine if our conclusions are the same as the 

district court’s conclusions. Id. We are bound by the agency’s findings 

of facts if they are supported by substantial evidence. Id. We will not, 

however, defer to DHS’s interpretation of its rules and regulations, as it 

has not been clearly vested with the authority to interpret them. Id. at 

836; see also Iowa Code § 17A.19(10)(c) (2009).

III. Discussion.

Iowa Code chapter 249A governs Iowa’s Medicaid program. 

Section 249A.4(1) instructs the director of DHS to 

make rules, establish policies, and prescribe procedures to 

. . . [d]etermine the greatest amount, duration, and scope of 

assistance which may be provided, and the broadest range of 

eligible individuals to whom assistance may effectively be 

provided, under this chapter within the limitations of 

available funds.

Iowa Code § 249A.4(1). Section 249A.4(9) directs DHS to adopt rules for

determining the method and level of reimbursement for all medical and 

health services specified in section 249A.2 after considering the following 

goals:

a. The promotion of efficient and cost-effective delivery 

of medical and health services.

b. Compliance with federal law and regulations.

c. The level of state and federal appropriations for 

medical assistance.
6

d. Reimbursement at a level as near as possible to 

actual costs and charges after priority is given to the 

considerations in paragraphs “a”, “b”, and “c”.

Id. § 249A.4(9).

All nursing facilities wishing to participate in and receive funds 

from the Medicaid program must submit an annual “Financial and 

Statistical Report” to facilitate DHS’s calculation of the Medicaid 

per diem rate. See Iowa Admin. Code r. 441—81.6 (2009). The report 

must detail both revenues and costs associated with patient care

according to the subrules of rule 81.6. Id. Subrule 81.6(10) requires 

that facilities report all revenues, as recorded in their general books and 

records, associated with their provision of any routine daily services and 

any ancillary services to patients. Id. r. 441—81.6(10)(a)–(b). The costs 

portion of the report must be divided into categories of direct patient care 

costs and support care costs.2 Id. r. 441—81.6. Subrule 81.6(11)

further provides that certain costs “not normally incurred in providing 

patient care shall be eliminated or limited” according to a long list of 

limitations, none of which make reference to direct care or Medicarerelated costs.3 Id. r. 441—81.6(11).

DHS determines per diem reimbursement rates based on a multistep calculation. Id. r. 441—81.6(16). First, DHS establishes per diem 

direct care and nondirect care component cost bases for the facilities

based on the costs reported. Id. DHS then adjusts those component 

bases for various purposes in subsequent steps having no bearing on the 

 

2The parties appear to agree that costs incurred for x-rays, prescription drugs, 

and labs constitute direct care costs.

3The enumerated limitations include, but are not limited to, federal and state 

income taxes, fees paid to directors, bad debts, personal travel and entertainment, loan 

acquisition fees, management fees, depreciation, and legal fees. Iowa Admin. Code r. 

441—81.6(11).
7

types of costs to be incorporated in establishing the bases. See id. To 

establish the component cost bases, subrule 81.6(16) provides that each

facility’s “per diem allowable cost shall be arrived at by dividing total 

reported allowable costs by total inpatient days during the reporting 

period.” Id. r. 441—81.6(16)(a). Rule 81.1 defines “allowable costs” as 

“the price a prudent, cost-conscious buyer would pay a willing seller for 

goods or services in an arm’s-length transaction, not to exceed the 

limitations set out in rules.” Id. r. 441—81.1. As we have noted, subrule 

81.6(11) identifies fifteen different “limitations” of expenses—expenses 

that must be limited or disallowed in some way—but fails to mention 

Medicare expenses. See id. r. 441—81.6(11). In fact, no provision 

anywhere in rule 81.6 makes any reference to Medicare in association 

with the annual cost reports required of the nursing facilities.

4 See id. r. 

441—81.6. Instead, rule 81.6 tersely and generally directs that “costs for 

patient care services shall be reported.” Id.

Interpreting these rules in the final agency action below, the 

director of DHS affirmed the agency’s cost report adjustments disallowing 

x-ray, lab, and prescription drug expenses on two grounds. First, the 

director concluded the list of allowable cost limitations in subrule 

81.6(11) did not constitute “an all-inclusive list of expenses disallowed in 

the facility’s cost report.” Thus, the director concluded he could also 

 

4Subrule 81.6(20) authorizes facilities’ claims “for Medicaid payment for 

Medicare-covered nursing facility services rendered to a Medicare beneficiary who is 

also eligible for Medicaid.” See id. r. 441—81.6(20)(a). This provision aims to insure 

that (1) claims are adequately reimbursed if the Medicaid-allowable amounts for the 

claims exceed the actual Medicare payments made, and (2) claims for services fully 

reimbursed by Medicare receive no additional Medicaid reimbursement. See id. r. 

441—81.6(20). The record does not reveal and the parties do not address what, if any, 

bearing this provision may have on the propriety of incorporating costs for services 

provided to Medicare patients that are not fully covered by Medicare reimbursement in 

determining a facility’s Medicaid component cost bases under subrule 81.6(16).
8

disallow costs for x-rays, labs, and drugs provided to Medicare patients 

because Medicaid pays third-party vendors directly for those kinds of 

services when they are provided to Medicaid patients. Second, the 

director concluded that costs associated with x-rays, labs, and 

prescription drugs for Medicare patients do not meet rule 81.1’s 

definition of allowable costs because “they are not costs a prudent, costconscious buyer would pay a willing seller.” The district court affirmed 

the director’s decision, agreeing that x-rays, labs, and drugs “are not 

properly included in the cost that a prudent, cost-conscious buyer would 

pay for nursing care services at [appellants’] facilities in an arm’s-length 

transaction.”

Addressing first the director’s subrule 81.6(11) justification, we 

take no position as to whether the expenses enumerated as excludable 

under the rule constitute an exhaustive list. Regardless, we cannot 

conclude that a determination of whether the list is exhaustive is 

dispositive of the cost question here. Instead, we note that the language 

of the subrule expressly limits the types of costs that shall be “eliminated 

or limited” in confining its reach to “[c]ertain expenses that are not 

normally incurred in providing patient care . . . .” Id. r. 441—81.6(11). 

We think it straightforward to conclude, and the parties agreed both 

below and on appeal, that the lab, x-ray, and drug expenses at issue here 

are normally incurred in providing patient care. Indeed, DHS’s 

accountant testified in the agency proceeding below that facilities do and 

must regularly provide these services, regardless of payor type, to meet 

DHS’s minimum requirements for provision of essential services to their 

patients. Thus, regardless whether subrule 81.6(11) may contemplate 

the elimination of costs not normally incurred in providing patient care 
9

and not expressly enumerated, we cannot conclude the subrule has any 

bearing on the question of the regularly incurred costs here.

If the director’s conclusion may be read to suggest implicitly that 

subrule 81.6(11) requires elimination of all expenses not normally 

incurred in providing “Medicaid patient care,” as opposed to the broader 

category of “patient care” expressly set forth in the subrule, we find no 

support for that contention in the language of the subrule, the language 

of rule 81.6 more generally, or in the standard practices of DHS. 

Subrule 81.6(11) mentions Medicaid only in the context of allowing legal 

fees related to defending threatened Medicaid decertification and, as 

noted, makes no mention of Medicare.

5 See id. r. 441—81.6(11). 

Further, given the specific references in rule 81.6 to Medicaid and 

Medicare where necessary to distinguish them as payment systems, we 

are not persuaded that the silence of subrule 81.6(11) envisages an 

unwritten Medicaid limitation. Instead, we think the structure of rule 

81.6 compels the broader reading—namely, that facilities report all 

revenues regardless of payor type, as conceded by the parties and 

contemplated by subrule 81.6(10), and likewise facilities report all costs

regardless of payor type as contemplated by the introductory paragraph 

of rule 81.6 before certain limitations are applied in accordance with 

subrule 81.6(11). Finally, we note that DHS concedes it does not exclude 

from cost reports expenses incurred for other services provided to 

Medicare patients, including, for example, various therapy services. We 

thus cannot conclude, as the director did, that rule 81.6 supports 

 

5The subrule also never distinguishes between types of payors in establishing its 

various limitations. See, e.g., id. r. 441—81.6(11)(f) (allowing expenses for 

entertainment provided for “participation of all residents who are physically and 

mentally able to participate” and eliminating only expenses for entertainment for which 

patient is required to pay); id. r. 441—81.6(11)(h) (allowing reasonable costs for services 

provided by immediate relatives and remaining silent regarding payor type).
10

excluding the costs of the challenged services provided to Medicare

patients.

Turning to the director’s second ground for affirming the 

elimination of the costs in question here, we find no support for the 

elimination in the definition of “allowable costs” in rule 81.1. Because 

the definition refers only to the “price a prudent, cost-conscious buyer 

would pay a willing seller for goods or services in an arm’s-length 

transaction” and specifies that the price cannot “exceed the limitations 

set out in rules,” we cannot conclude the definition has anything to say 

about elimination of the entire category of Medicare patient-related costs 

or, more importantly, a specific subset of that category of costs including 

x-ray, lab, and prescription drug costs. Id. r. 441—81.1 (emphasis 

added). The director supported his conclusion with the rationale—and 

DHS has raised the argument again on appeal—that because the x-ray, 

lab, and drug costs are costs for Medicare patients, “they are not costs a 

prudent, cost-conscious buyer would pay a willing seller” for services to 

Medicaid patients. This rationale, in our view, relies either on adding 

modifying language to the definition expressly set out in the rule, or on a 

general assumption that the definition applies only to costs of services

provided to Medicaid patients. Given the structure of rule 81.6 and the

Department’s concession that “allowable costs” in some instances

encompass non-Medicaid costs, we are not persuaded the definition can 

be read to imply a general limitation of its applicability to costs provided 

to Medicaid patients. As for the possibility of implicit modifying 

language, we note two additional problems with the position advanced by 

DHS.

First, the definition of “allowable cost” makes no distinction 

between Medicaid and Medicare services and no distinction between 
11

buyers and sellers of Medicaid and Medicare services. We find it 

instructive that various other definitions in rule 81.1 make no such 

distinction. For example, the definitions of “case mix” and “case-mix 

index,” integral to the per diem calculation in subrule 81.6(16), are silent 

regarding payor types. See id. r. 441—81.1. Moreover, as explained, rule

81.6 largely lumps all services together for reporting and per diem 

calculation purposes. We cannot discern any reason in the language or 

structure of rules 81.1 or 81.6 to import the director’s “buyer of Medicaid 

services” limitation into the definition.

Second, in adopting the ALJ’s conclusions of law, the director 

conceded both that (1) subrule 81.10(5)(c) expressly provides that the 

Medicaid program will provide direct payment to facilities for the 

provision of some services required by Medicare; and (2) subrule 81.10(2) 

expressly requires that a facility must, when applicable, first exhaust all 

Medicare benefits to remain eligible for any Medicaid payment. We 

cannot conclude, based on these rules, that the Medicaid program is to 

be treated as a buyer of strictly Medicare or strictly Medicaid services—

rather, we think the rules explicitly envision that the program may 

reimburse facilities for provision of both Medicare and Medicaid services

and that any specific instance of a service for which a facility receives 

reimbursement may simultaneously constitute a “Medicare” and 

“Medicaid” service. These propositions, taken together with the 

concession that facilities must provide lab, x-ray, and drug services 

regardless of payment type, compel our conclusion that the definition of 

“allowable costs” is silent regarding the inclusion or exclusion of a class 

of Medicare costs, and cannot be read to incorporate the Medicaid 

limitation the director advanced.
12

We think it prudent to note that whether an expense is reported 

may not be dispositive of whether DHS incorporates that expense in its 

component base-rate calculation. The ALJ noted the availability of an 

“offset” that could occur between facility cost reporting and DHS ratesetting.6 As we conclude here, however, the director’s interpretation of 

the rules as written cannot support the agency’s decision to exclude the 

Medicare costs at issue from the facilities’ cost reporting.

We recognize the cost-containment concerns driving the agency 

action here. We also acknowledge the significant challenges underlying 

the director’s statutorily prescribed duty to “[d]etermine the greatest 

amount, duration, and scope of assistance which may be provided, and 

the broadest range of eligible individuals to whom assistance may 

effectively be provided” in administering the Medicaid program. Iowa 

Code § 249A.4(1). The difference between the meaning the director has 

assigned to the rules and the meaning we are able to discern clearly 

engages these policy concerns and raises questions as to what costs 

should be considered in calculating Medicaid reimbursement rates. 

Nevertheless, our task in this case is to determine the meaning of the 

rules at issue and decide whether the director has erred in interpreting 

them. Given the agency’s abrupt about-face in its practice regarding 

exclusion of certain costs from reports, and the substantial disparity 

between what the rules plainly say and what the director now suggests 

they mean, we think DHS’s new interpretation of rule 81.6’s cost 

reporting and per diem calculation procedures is akin to the creation of a 

new rule. The appropriate course of action here cannot involve assigning 

 

6The nursing homes concede that to the extent Medicare prescription drug, xray, and lab costs are properly reportable, the reports should also include the 

corresponding Medicare revenue for those services.
13

new meanings to rules not fairly evident from the language of the rules 

themselves. Instead, in our view, the appropriate course requires new 

rulemaking according to the procedures set forth in Iowa Code chapter

17A, which allows all relevant stakeholders adequate notice and 

meaningful opportunity to address and help resolve the important policy 

questions at stake.

IV. Conclusion.

The director’s conclusion affirming the agency’s exclusion of the 

facilities’ lab, x-ray, and prescription drug costs from the nursing homes’ 

reports was erroneous. We affirm the decision of the court of appeals, 

reverse the district court judgment, and remand to the district court. 

The district court shall enter judgment remanding this matter to DHS for 

further proceedings consistent with this opinion.

DECISION OF COURT OF APPEALS AFFIRMED; DISTRICT 

COURT JUDGMENT REVERSED AND REMANDED WITH 

INSTRUCTIONS.