Appendix — Belmont v. United States

Vitice- supreme Court, US,

FILED

88 - “7638 WOY 4 1983

IN THE pap hit,

Supreme Court of the United States

October Term, 1983

St. FRANCIS HOSPITAL CENTER, ET AL.,

Petitioners,

vs.

MARGARET HECKLER, Secretary, Department

of Health and Human Services and

PROVIDER REIMBURSEMENT AND REVIEW BOARD,

THOMAS TIERNEY, Chairman,

Respondents.

APPENDIX TO

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE SEVENTH CIRCUIT

Geoffrey Segar, Attorney of Record

James D. Kemper

Richard J. Thrapp

IcE MILLER DONADIO & RYAN

One American Square

P.O. Box 82001

Indianapolis, Indiana 46282

Telephone: (317) 236-2100

William S. Hall

HALL RENDER & KILLIAN

3921 North Meridian Street ing

Indianapolis, Indiana 46208 4

Telephone: (317) 926-2326 a

Attorneys for Petitioners

TABLE OF CONTENTS

Page

Opinion and Judgment of the United States Court of

Appeals for the Seventh Circuit

’ Opinion and Judgment of the United States District

Court for the Southern District of Indiana ..... A-33

Decision of the Administrator, Health Care Financ-

IENINEOOI, cc cc cect ccceseccececeteees A-76

Decision of the Provider Reimbursement Review

EE ERE CON pct caccccccesvecetecse A-104

Baylor University Medical Center v. Schweiker, No.

3-82-0986-H, slip op. (N.D. Tex. Sept. 13, 1983) .. A-136

In The

United States Court of Appeals

For the Seventh Circuit

No. 82-2458

ST. FRANCIS HOSPITAL CENTER, et al.,

Plaintiffs-A ppellants,

U

MARGARET HECKLER,* Secretary, Department of Health

and Human Services, & PROVIDER REIMBURSEMENT

REVIEW Boarr, THOMAS TIERNEY, Chairman,

Defendants-A ppellees.

Appeal from the United States District Court for the

Southern District of Indiana, Indianapolis, Division.

Nos. 80 C 500, 80 C 89, 80 C 206, 80 C 272—S. Hugh Dillin, Judge.

ARGUED FEBRUARY 10, 1988—DECIDED AUGUST 12, 1983

Before BAUER, WooD and ESCHBACH, Circuit Judges.

PER CURIAM. Sixty-eight nonproprietary hospitals (“the

Hospitals”) appeal from the district court’s decision

denying them reimbursement under the Medicare Act, 42

U.S.C. §§1395 through 1395pp, for a return on equity

capital and for certain bad debt and charity expenses. 544

F. Supp. 1167(S.D. Ind. 1982). We affirm the decision of the

district court and adopt those portions of the court’s

* The name of the present Secretary is ordered substituted for the name

of her predecessor, Richard S, Schweiker, according to Rule 43(c) of the

Federal Rules of Appellate Procedure.

A-l

excellent opinion reproduced as an appendix to our opinion.

We have deleted certain portions of the opinion, primarily

those dealing with a separate suit that was not appealed

and those addressing issues not raised on appeal. We add

the supplemental sections immediately below to address

arguments raised on appeal that are not specifically an-

swered by the district court’s opinion.

Standard of Review

In their attempt to secure a return on equity capital, the

Hospitals were successful in convincing the Provider Re-

imbursement Review Board (“PRRB”) that such a return

was a “reasonable cost” for nonproprietary facilities. The

Secretary, through the Deputy Administrator of the

Health Care Financing Administrator, reversed this

ruling and held that the Hospitals could not recover a

return on equity. On appeal, the Hospitals contend that the

district court erred in giving deference to the Secretary’s

interpretation of the statute and in failing to give adequate

weight to the decision of the PRRB.

The standard of review for reimbursement decisions

rendered under 42 U.S.C. §139500 is found in “the appli-

cable provisions under chapter 7 of Title 5.” 42 U.S.C.

§139500(f). Thus the standards of the Administrative

Procedure Act, 5 U.S.C. §§701-706, govern. Section 706

provides that “the reviewing court shall decide all relevant

questions of law, [and] interpret constitutional and

statutory provisions....” The court must “hold unlawful

and set aside agency action, findings, and conclusions

found to be. ..arbitrary, capricious, an abuse of discretion,

or otherwise not in accordance with law... .” Jd.

In the instant case, we do not have a challenge to any

findings of fact—the facts are essentially undisputed.

Neither do we have a dispute over the interpretation of an

agency regulation. The present regulatory scheme denying

return on equity for nonproprietary hospitals has been

firmly and unambiguously in place since 1969. The

A-2

challenge the Hospitals raise is that the regulatory scheme

is in violation of the Medicare statute and the Constitution.

We note at the outset that to the extent the Hospitals

challenge the constitutionality of the statute or the

regulatory scheme, their non-deference argument is un-

necessary. Deference to administrative expertise does not

extend to judging the constitutionality of a statute or

regulatory scheme. As far as construing the Medicare

statute, a court should give deference to the interpretation

of the agency charged with administration of the statute.

See Blum v. Bacon, 457 U.S. 132, 141 (1982); Griggs v. Duke

Power Co., 401 U.S. 424, 433-34 (1971). Congress has

charged the Secretary of Health and Human Services

(“HHS”) with administration of the Medicare program. 42

U.S.C. §1395kk. Nevertheless, deference to the Secretary

must yield to the clear meaning of the statute as revealed by

its language, purpose and history. See Southeastern

Community College v. Davis, 442 U.S. 397, 411 (1979).

The Hospitals suggest that these well established

principles are altered in this case because the Secretary

reversed the PRRB on the issue of return on equity capital.

For support they point to St. John’s Hickey Memorial

Hospital v. Califano, 599 F.2d 803 (7th Cir. 1979), in which

we declined to defer to the Secretary's determination that

the costs of a certain educational program were not

reimbursible [sic] under the Medicare regulations. In

particular, the Hospitals point to the following passage:

This special provision for judicial review [42 U.S.C.

§139500(f)] is not surprising in light of the statutory

scheme. Here the plaintiff is not the beneficiary of the

government program, but a necessary participant in

carrying out the program. The Secretary is obligated

by statute to reimburse all reasonable costs of such

providers. It would be inappropriate to allow his sub-

ordinates to be the final arbiter of what is reasonable,

particularly when they have overruled the decision of

the Provider Reimbursement Review Board which

A-3

ve

was set up to mediate disputes between providers and

intermediaries acting for the agency.

Id. at 813 n.18.

This does not support the Hospitals’ argument that the

district court should have deferred to the PRRB’s decision.

Final responsibility for rendering a decision lies in the

agency itself, not with subordinate hearing officers, and it

is this decision that the district court reviewed. See

American Medical International, Inc. v. Secretary of

Health, Education and Welfare, 466 F. Supp. 605, 611

(D.D.C. 1979), aff'd, 677 F.2d 118 (D.C. Cir. 1981). The

decision of the PRRB can be considered no more expert

than the decision of the Secretary.

Under 42 U.S.C.A. §139500(f) and 42 C.F.R.

§405.1875 (1979), the Secretary, on her own motion

and at her discretion, may review a decision of the

PRRB and on review has all the powers she would have

if making the initial determination. 5 U.S.C.A.

§557(b). Thus the decision of the PRRB carries no

more weight on review by the Secretary than any

other interim decision made along the way in an

agency where the ultimate decision of the agency is

controlling. The argument that the court should

recognize the expertise of the members of the PRRB

must be met with the assumption that those persons

within the agency who assisted the Secretary in a

contrary decision must be regarded as being equally

expert.

Homan & Crimen, Inc. v. Harris, 626 F.2d 1201 (5th Cir.

1980).

The Hospitals argue that the prior contrary decision of

the PRRB lessens the degree of the deference due the

Secretary's decision. We note first that the passage from St.

John’s, quoted above, is primarily a comment on the

propriety of judicial review, and does not directly address

the question of whether deference is lessened when the

Secretary has reversed the PRRB. We did state in that case

A-4

that the degree of deference accorded the Secretary in

implementing regulations varies with the circumstances of

each case. Si. John's Hickey Memorial Hospital v. Califano,

supra, 599 F.2d at 812. In that case, we found extreme

deference inappropriate when the court merely disagreed

with an unofficial interpretation of a regulation. Jd. In

contrast, in the instant case, we are faced with the

Secretary’s judgment that her regulatory scheme denying

a return on equity capital to nonproprietary hospitals, in

place since 1969, is consistent with the statute she is

charged with administering. In these circumstances, we

believe the district court’s deference to the Secretary’s

decision was appropriate.

Supplement—Is a Return on Equity Capital a Rea-

sonable Cost for Nonproprietary Providers Under 42

U.S.C. §1395x(v)(1)(A)?

While we have adopted the district court’s analysis on

this point and the point following, we add these supple-

mental sections to answer arguments raised on appeal and

not specifically addressed by the district court.

All providers are entitled to reimbursement of the

“reasonable cost” of the services provided. 42 U.S.C.

§1395f(b). Reasonable costs are defined generally in 42

U.S.C. §1395x(v)(1)(A), with authorization for the Sec-

retary to prescribe regulations further defining reasonable

costs. 42 U.S.C. §1395x(v)(1)(B), added in 1966, directs the

Secretary to include in the regulations a provision for

return on equity capital for ertended care services provided

by proprietary facilities. The Hospitals contend that the

services of proprietary hospitals do not fit the literal

language of §1395x(v)(1)(B), and therefore their return on

capital must come under the general provisions for reason-

able costs, §1395x(v)(1)(A). If a return on equity capital isa

reasonable cost under this section for proprietary hospitals,

the appellants argue that it is also a reasonable cost for non-

proprietary hospitals.

A-5

The reasons Congress had for singling out proprietary

facilities providing extended care service (i.e., skilled

nursing facilities) are not clear. The legislative history is

scant. There is some indication, however, that Congress

intended a return on equity capital to be extended to all

proprietary providers. The Managers on the Part of the

House submitted a statement to explain the recommended

action of the committee of conference considering the

proposed 1966 amendment. The committee recommended

the amendment, which is now codified at §1395x(v)(1\B),

the house managers explaining:

The conferees expect that the Secretary of Health,

Education, and Welfare will apply similar or

comparable principles in determining reasonable

costs for reimbursement of proprietary hospitals for

services furnished by them.

H. R. Rept. No. 2317, 89th Cong., 2d Sess., 166, reprinted in

1966 U.S. Code Cong. & Ad. News 3676, 3692-93.

The legislative enactments at issue here are not a model

of clarity. However, they do not alter our conclusion that

Congress did not intend a return on equity capital for non-

proprietary providers to be reimbursable as a “reasonable

cost” under §1395x(v\ 1A). Any ambiguity we find goes to

‘the issue of whether proprietary hospitals are entitled to

such a return under either §1395x(v\1)A) or (B), an issue

we need not decide at this point. We agree with the

Secretary, the district court, and the other courts that have

faced the issue presently before us—Congress did not

intend nonproprietary facilities to collect a return on

equity capital as part of the “reasonable cost” of providing

services.

Supplement— Does the Statutory or Regulatory Scheme

Violate the Just Compensation Provision of the Fifth

Amendment?

The Hospitals argue that those cases in which the

Supreme Court held government-prescrihed rates to be

A-6

confiscatory, e.g. Smyth v. Ames, 169 U.S. 466 (1898), are

directly analogous to the instant case. They correctly point

out that the government cannot prescribe rates so low that

the result is a taking of property without just compensa-

tion, see id. at 526, and that the government cannot defend

setting low rates in one market segment by arguing that

the regulated enterprise can set higher rates for another

segment and thus turn a net profit, see id. at 541.

The Hospitals’ argument might well prove persuasive if

participation in the Medicare program were mandatory.

However, Medicare is a federally sponsored insurance pro-

gram for the aged and disabled, 42 U.S.C. §1395c, and

provider participation is voluntary, 42 U.S.C. §1395cc.

Providers who opt not to participate are free to serve

persons not covered by Medicare and those potential

Medicare recipients who are willing to forego Medicare

benefits for the services provided. As a practical matter,

perhaps few of those persons eligible for Medicare would

choose a non-participating hospital, but the fact that

practicalities may in some cases dictate participation does

not make participation involuntary. Even those hospitals

that have an obligation to participate in the Medicare pro-

gram because of their receipt of funds under the Hill-

Burton Act, 42 U.S.C. §291; 42 C.F.R. §124, made a

voluntary choice to accept both the obligations and the

benefits of Hill-Burton funding. Cf. Johnson County

Memorial Hospital v. Schweiker, 698 F.2d 1347, 1350 (7th

Cir. 1983) (Medicare does not reimburse for charity costs

accrued under the Hill-Burton Act because “the govern-

ment has already paid through contractual agreements for

[that] indigent care”). We therefore find Smyth v. Ames,

supra, and its progeny to be inapposite, and conclude, with

the district court, that there has been no violacion of the

Fifth Amendment just compensation provision. Cf.

Pharmacist Political Action Committee v. Harris, 502 F.

Supp. 1235, 1242-43 (D. Md. 1980) (Maximum Allowable

Cost regulations for prescription drugs dispensed under

Medicare and Medicaid programs did not constitute taking

A-7

of property, in part because participation in programs is

voluntary).

Conclusion

The Hospitals and the amici curiae, the American

Hospital Association and the Catholic Health Association

of the United States, have presented strong arguments in

favor of allowing nonproprietary hospitals a return on

equity capital under Medicare. Those arguments, however,

are made to the wrong forum. This court cannot require

what may seem wise, but only what is required by the

Medicare statute and the Constitution. Having found that

neither the statute, due process or equal protection re-

quires a return on equity capital for nonproprietary

hospitals, we affirm the district court’s judgment and

adopt those portions of the district court’s opinion

reproduced below.

APPENDIX

UNITED STATES DISTRICT COURT

SOUTHERN DISTRICT OF INDIANA

INDIANAPOLIS DIVISION

St. FRANCIS HOSPITAL CENTER,

)

et al., )

)

Plaintiffs, )

)

v. ) No. IP 80-89-C

) No. IP 80-206-C

RICHARD S. SCHWEIKER, Secretary ) No. IP 80-272-C

Department of Health and ) No. IP 80-500-C

Human Services, )

PROVIDER REIMBURSEMENT REVIEW )

BOARD, )

THOMAS TIERNEY, Chairman, )

)

Defendants. )

MEMORANDUM OF DECISION

* * *

The facts and legal issues presented by these cases are

complex and will be dealt with in greater detail in the body

of this memorandum. In brief, these suits present

challenges to Medicare reimbursement statutes, regulations

and policies by 68 Indiana hospitals and the Indiana

Hospital Association, Inc., to which the 68 hospitals belong.

The hospitals claim that they are entitled to reimburse-

ment of the portion of their return on equity capital and bad

debt and charity costs that they claim are attributable to

A-9

the Medicare patients they treat. The Medicare Act was

passed in 1965. 42 U.S.C. §§ 1395, et seg. It provides for the

reimbursement of the reasonable cost of providing services

to Medicare beneficiaries. 42 U.S.C. §1395f(6). The

statutory definition of “reasonable cost” is found at 42

U.S.C. §1395x(v)(1)(A). Pursuant to the Medicare Act, the

Secretary of Health and Human Services (hereinafter “the

Secretary”) has promulgated regulations which define the

concept of reasonable cost more fully. 42 U.S.C. §1395hh;

and 42 C.F.R. §§405.401-405.488.

The 68 plaintiff hospitals have all made claims for re-

imbursement for return on equity capital and bad debt and

charity costs for a variety of fiscal years with the “fiscal

intermediary” which acts as the agent of the Secretary

pursuant to 42 C.F.R. §405.651. The fiscal intermediary

which rules upon claims made by Indiana hospitals

(termed “providers” under the Act) is Mutual Hospital In-

surance, Inc. d/b/a Blue Cross of Indiana.

These plaintiffs filed claims (“Cost Reports”) with Blue

Cross. Blue Cross, by “Notices of Program Reimburse-

ment” to each of the hospitals, denied payment under the

Medicare Act for the return on equity, bad debt and charity

claims. The hospitals then pursued the administrative

appeals outlined by the Act and the Secretary’s regula-

tions. 42 U.S.C. §139500(a); and 42 C.F.R. §405.1837. The

plaintiffs were granted permission to pursue their appeals

as a group appeal, since their claims presented common

questions of law.

The first level of appeal was to the provider Reimburse-

ment Review Board (“PRRB” or “Board” hereafter). The

PRRB ruled that the hospitals were entitled to a return on

the equity, but sustained Blue Cross’s denial of reimburse-

ment for the bad debt and charity costs.

The Deputy Administrator of the Health Care Financing

Administration, to whom the Secretary’s power to review

the PRRB’s decisions has been delegated, reversed the

A-10

Board’s findings in regard to the return on equity issue and

affirmed the decision to deny reimbursement of bad debt

and charity costs.

The hospitals filed suit in district courts for judicial

review of this decision. ...

* * *

(3) Return on Equity Capital

The return on equity issue has been raised in several

other courts. The hospitals’ basic contention is that they

should be reimbursed by the Medicare program for a

reasonable rate of return on their net assets used in the

treatment of Medicare patients. The plaintiffs rest their

argument on the following grounds: (A) the Deputy

Administrator had no power to reverse the PRRB’s deci-

sion to grant these plaintiffs return on equity costs, there-

fore the PRRB’s decision is final, [not at issue on appeal ](B)

great deference should be given to PRRB’s decision, (C) a

return on equity is a “reasonable cost” of providing services

under 42 U.S.C. §1395x(v)(1)(A), (D) the denial of

reimbursement for these costs constitutes a violation of the

just compensation clause of the Fifth Amendment, and (E)

since proprietary (for-profit) hospitals are given a return

on net assets reimbursement, these plaintiffs, non-

proprietary hospitals, are being denied their rights to

equal protection.

In order to understand the plaintiffs’ arguments, it is

necessary to review some background and legislative

history of the Medicare program. The terms “return on

equity,” “return on equity capital,” “return on net assets,”

and “imputed interest” are all used to describe the

hospitals’ claims of entitlement to reimbursement for the

opportunity cost of capital used in the treatment of

Medicare patients. Under Part A of the Medicare Act, 42

U.S.C. §§1395¢-1395i-2, which provides hospital insurance

benefits to qualified elderly and/or disabled recipients,

hospitals are reimbursed for the “reasonable cost” of

A-1l

providing services to these recipients. The thrust of the

plaintiffs’ position in this case is that a return on equity isa

reasonable cost under the Act and should be reimbursed.

Title 42 U.S.C. §1395x(v)(1)(A) initially defines reasonable

cost, for provider reimbursement purposes, as:

(v1)(A) The reasonable cost of any services shall be

the cost actually incurred, excluding therefrom any

part of incurred cost found to be unnecessary in the

efficient delivery of needed health services, and shall

be determined in accordance with regulations

establishing the method or methods to be used, and the

items to be included, in determining such costs for

various types or classes of institutions, agencies, and

services;....

The section further provides the following principle which

is te be used to determine whether costs are or are not

reimbursable reasonable costs:

Such regulations shall (i) take into account both direct

and indirect costs of providers of services. ..in order

that, under the methods of determining costs, the

necessary costs of efficiently delivering covered

services to individuals covered by the insurance

programs established by this subchapter will not be

borne by individuals not so covered, and the costs with

respect to individuals not so covered will not be borne

by such insurance programs....

The gist of the “necessary costs” requirement is that

hospitals will be reimbursed for costs, either direct or

indirect, which are attributable to Medicare patients. The

Medicare Program is not to be responsible for costs

incurred on behalf of non-Medicare patients. If indirect

costs are attributable to both Medicare and non-Medicare

patients, the provider will be reimbursed for the propor-

tionate share of such indirect costs as are incurred for the

benefits of the Medicare patients. 42 C.F.R. §405.451(b)(1)

and (c\3)

The Secretary of Health and Human Services has the

responsibility for administering the Medicare Program. 42

A-12

U.S.C. §1395kk. The Secretary is authorized by Congress to

“prescribe such regulations as may be necessary to carry

out the administration of the insurance programs under

this [subchapter].” 42 U.S.C: §1395hh. These regulations

are found in the Code of Federai Regulations, Subchapter

B, Part 405 of 42 C.F.R. Chapter IV.

The regulations further delineate the types of costs which

will be allowable under the Program. These regulations

flesh out the general principles laid down in 42 U.S.C.

§1395x(v)(1A). One regulation which is at issue in this

case, at least indirectly, is 42 C.F.R. §405.429, which

specifically authorizes a proportionate reimbursement for

return on equity in the case of proprietary (for profit)

hospitals.

§405.429 Return on equity capital of proprietary

providers.

(a) Principle. (1) A reasonable return on equity

capital invested and used in the provision of patient

care is allowable as an element of the reasonable cost of

covered services furnished to beneficiaries by

proprietary providers....

(2) For the purposes of this subpart, the term “pro-

prietary providers” is intended to distinguish

providers, whether sole proprietorships, partner-

ships, or corporations, that are organized and

operated with the expectation of earning profit for the

owners, from other providers that are organized and

operated on a nonprofit basis.

(b) Application—(1) Computation of equity

capital. Proprietary providers generally do not

receive public contributions and assistance of Federal

and other governmental programs in financing

capital expenditures. Proprietary institutions

historically have financed capital expenditures

through funds invested by owners in the expectation of

earning a return. A return on investment, therefore, is

needed to avoid withdrawal of capital and to attract

additional capital needed for expansion....

A-13

Presumably for the reasons expressed in subsection (b),

above, the Secretary has made no analogous provision fora

return on investment costs in the cases of nonproprietary

providers. The plaintiffs in this case are challenging the

Secretary’s disallowance of a proportionate share of their

return on equity costs, primarily on the basis of their per-

ception of the general spirit of 42 U.S.C. §)395x(v)(1)(A)

and on some legislative history.

The first Medicare Regulations, issued by the Secretary

in 1966, authorized a reimbursement of ai: additional 2% of

total allowable costs for nonproprietary facilities as com-

pensation for otherwise unspecified costs. One of the costs

included in the 2% was a return on equity captial. (See

Proposed HEW Regulations, §§405.402(e) and 405.428(b)

(1966); statements of the Commissioner of Social Security,

Robert M. Ball in the Hearings on Reimbursement Guide-

lines for Medicare Before the Senate Committee on

Financing, 89th Congress, 2d Sess., at 55-56 (1966), R.

0501-2; and Mr. Ball’s comments in the 1966 Hearings at 72

[R. 0508].) Proprietary hospitals were only given a 1-to-14%

additional reimbursement. The regulation expressly

recognized that proprietary hospitals had already been

given a return on equity capital reimbursement under

§1395x(v)(1)(B) and 42 C.F.R. §405.429. 42 C.F.R. §405.428

(formerly 20 C.F.R. §405.428).

It is clear that the nonproprietary providers’ 2%

allowance did include a return on equity capital: it is

equally clear that Congress heard discussion of the return

on equity issue before these regulations were passed. The

problems at issue for the nonproprietary hospital plaintiffs

began in June, 1969, when the Secretary dropped both the

2% and the 144% allowances. 34 Fed.Reg. 9927 (June 27,

1969). As a result, the nonproprietary providers are left

with only the “reasonable cost” definition found in 42

U.S.C. §1395x(v)(1)(A). Proprietary providers may still be

reimbursed for return on equity capital costs pursuant to

42 C.F.R. §405.429, the regulatory counterpart of

§1395x(v)(1)(A).

A-14

The plaintiffs in this case now contend that a return on

equity is a “reasonable cost” and that it is anomalous to

grant a return on equity capital reimbursement to

proprietary but not to nonproprietary providers. The argu-

ments which shore up their contention that Congress

intended that all providers be reimbursed for return on

equity expenses are based primarily on post-enactment

legislative history and on more generalized arguments that

this expense is a “reasonable cost” within the meaning of 42

U.S.C. §1395x(v)(1)(A).

* * *

(c) Isa Return on Equity Capital a Reasonable Cost for

Nonproprietary Providers Under 42 U.S.C. §1395a(v)(1)(A)?

The stance of the Department of Health and Human

Services on this issue is that nonproprietary providers may

not recoup any Medicare funds for a return on equity. The

rationale of the Deputy Administrator is that there is no

regulation that authorizes the reimbursement, so if the

hospitals are to recover these amounts, it must be done as a

reasonable cost under §1395x(v)(1)A). The Department’s

analysis of this statute and its conclusions is set out in the

Deputy Administrator’s opinion in the group appeal now

before the Court:

It would appear that if a return on equity capital were

paid to non-profit hospitals, Medicare would be paying

a disproportionate share of provider costs. This is

because the return is a profit rather than a cost. Under

Section 1861(v)(1)(A) of the Act and the supporting

regulations, Medicare reimburses all of a provider’s

reasonable costs in caring for Medicare beneficiaries.

This includes a proportionate share of the cost of

capital investment related to patient care such as a

building or equipment.

In this case, the Board found that non-profit providers

need the funds from the return on equity capital for

capital investment purposes, and to cover the costs of

bad debts and charity allowances. However, under

A-15

these circumstances, Medicare would be paying an

amount in excess of its share of reasonable cost. This

excess would be used to satisfy the burden of non-

Medicare patients. This is contrary to the mandate in

Section 1861(v)(1)A) of the Act and the Board's

finding in this regard is clearly erroneous.

Based on the specific wording of Section 1861(v)(1)(B)

of the Act and 42 C.F.R. 405.429, and the

Congressional comments, the Deputy Administrator

finds that a return on equity capital is not an element

of reasonable cost for non-profit providers. It is not an

out-of-pocket cost and was not the type of cost

contemplated as reasonable, either direct or indirect,

when Section 1861(v)(1(A) was enacted. Section

1861(v)(148) was enacted because under Section

1861(v)(1)(A) alone a return on equity capital could not

be paid to proprietary providers. Therefore, the

Board’s reliance on Section 1861(v1A) in this

regard is erroneous.

The Secretary’s position in regard to 42 C.F.R. §405.429

(quoted above, concerning return on equity for proprietary

hospitals) is correct. The terms of this statute are explicit in

the distinction between proprietary and non-proprietary

providers insofar as the return on equity issue is concerned.

(In accord, Valley View Community Hospital v. United

States, No. 126-80C (Slip Op., U.S. Court of Claims, May 19,

1982), 931,978, CCH Medicare and Medicaid Guide.) The

rationale for the distinction expressed in the regulation is

that proprietary providers must raise capital through

funds invested by owners in the expectation of earning a

profit. Alternatively, non-proprietary hospitals have other

sources of funding, i.e., public contributions and

governmental programs. Jd. 431,978 Medicare and

Medicaid Guide, at 9748. The plaintiffs have not brought

forward any regulations which affirmatively authorize a

return on equity for nonprofit hospitals. They are relegated

to the very gereral reasonable cost standard defined in

§1395x(v)(1)(A).

A-16

As noted above, the Secretary’s position is that the intent

of Congress, as set forth in §1395x(v)(1)(A), in light of its

legislative history, is that a return on equity is not a

reasonable cost. This is also the position of the courts which

have viewed this issue.

The legislative history of the return on equity issue has

been quoted exhaustively by both parties to this litigation.

It has also been summarized in Hospital Authority of Floyd

County, Georgia v. Schweiker, 522 F. Supp. 569 (ND. Ga.

1981) [, aff-d, 707 F.2d 456 (11th Cir. 1983)].

The plaintiffs’ argument that a return on equity is a

reasonable cost under §1395x(v)1\A) is not borne out by

the legislative history. The bulk of the plaintiffs’ authority

is testimony from the transcript of the 1966 Senate Finance

Committee hearings on the issue of reimbursement

guidelines. These hearings were held nearly a year after

the Medicare Act was passed by Congress. “Such post-

enactment history is not the surest guide of the legislative

intent in initially passing the Act. Cf. Rogers v. Frito-Lay,

Inc., 611 F.2d 1074 (5th Cir. 1974) [cert. den., Moon v.

Roadway Express, Inc., 449 U.S. 889, 101 S. Ct. 246, 66

L.Ed.2d 115 (1980)]. Nevertheless, the testimony of the

witnesses and the remarks of the Senators are quite

instructive.” Floyd County, supra, 522 F. Supp. at [571).

The plaintiffs have placed great stock in statements

made by Robert Ball, the Commissioner of Social Security,

who agreed with the policy of including a return on equity

factor in the 2% allowance, because giving a return on

equity solely to proprietary hospitals would foster the

“anomalous result” of “reimbursing a_ profit-making

organization more than a nonprofit organization for

rendering exactly the same service—solely by reason of

allowing return on investment in one case but not the

other.” Reimbursement Guidelines for Medicare: Hearing

before the Committee on Finance, United States Senate,

89th Cong., 2d Sess. (Comm. Print, May 25, 1966), at 56

A-17

(hereinafter “Hearings”). Mr. Ball and Mr. Willcox, the

Genera! Counsel of Social Security agreed that a return on

investment was “some bit of this 2% item.” Jd., at 107. “The

Senate Committee, in short, was being told by the

Commissioner [Mr. Ball] that no return on equity capital

was allowed explicitly, but that a return on equity capital

was discreetly included in the 2% allowance.” Floyd

County, supra, at 572.

The idea that even the proponents of a return on equity

capital classified it as a portion of the 2% allowance rather

than as an automatic “reasonable cost” is significant.

Shortly after the hearings Congress amended the Act to

provide explicitly for a return on equity to proprietary

facilities.Title 42 U.S.C. §1395x(v)(1)(B), the statutory

counterpart of 42 C.F.R. §405.429, provides:

(B) Such regulations in the case of extended care

services furnished by proprietary facilities shall

include provision for specific recognition of a

reasonable return on equity capital, including

necessary working capital, invested in the facility and

used in the furnishing of such services, 1 lieu of other

allowances to the extent that they reflect similar items

[i.e., the 2% allowance]....

Section 1395x(v\1\B) and 42 C.F.R. §405.429 remained

after the 1969 decision to discontinue the 14% and 2%

allowances. The following lengthly portion of the Floyd

County analysis of the legislative history reveals that the

understanding of the Congress was that a return on equity

was not provided in the original Act and that is was not

within the ambit of a §1395x(v)(1A) reasonable cost:

Having traced the footprints on the trial of legislative

enactment, the Court concludes that it was not the

intent of Congress to provide an allowance for a return

on equity capital to all facilities. In reading the

transcript of the Senate hearing, itis apparent that the

Committee basically approved the Secretary’s

proposal to table the issue of providing such an

A-18

allowance. This is what the Health Insurance Benefits

Advisory Council recommended, and this recom-

mendation was passed on to the Committee. The

decision to amend the Act in October, 1966 to provide

for the allowance for proprietary facilities evidences

Congressional intent to reverse the former policy of

simply obscuring the allowance as a “bit” of the 2%

allowance.

The exchanges at the Hearing between various

Senators and Mr. Ball and other administrative

officials made it quite unequivocal that the Senate

Committee members believed that a return on equity

capital was not, and should not, be provided. For

example:

THE CHAIRMAN [Sen. Russell B. Long]. But did

you have the impression anywhere that the

congressional intent was that we should have

allowed imputed interest on capita!?

Mr. Myers [Chief Actuary, Social Security

Administration]. No. In making the cost esti-

mates, I had no thought that that would be done.

THE CHAIRMAN. What we are talking about is

an item neither you nor we had any idea of

allowing. I never had an idea we were going to

allow imputed interest. Nobody, so far as I know,

in your Department—did your Department have

any idea that we were going to allow imputed

interest?

Mr. BALL. No, Mr. Chairman. And I think one

of the main reasons that the staff resisted the

tendency of the Health Insurance Benefits

Advisory Council to move to this position was not

necessarily on the merits of the economic argu-

mert, but the fact that it had not been considered,

and that it therefore ought to be postponed. That

was the thought there.

A-19

Mr. BALL. Senator, I think the language of the

law “reasonable cost” is open to a great variety of

interpretations. The discussion, the legislative

history, the committee report, pinned that down

considerably....I was answering literally the

question of whether the term “reasonable cost”

could have included such things [e.g. return on

equity capital].

But I don’t think it would have been reasonable

to so interpret the term in the light of the discus-

sions and the legislative history.

* * *

SENATOR WILLIAMS. In computing the costs

incurred, how can you get an estimate for interest

which is not owed, not paid? How can you get an

allowance for an interest charge not owed and not

paid, if you are going to stick to the formula of

actual costs incurred?

MR. BALL. We did not accede to this argument

for allowing an interest return on equity capital.

Hearings, 49-51.

Mr. CoHEN [Under Secretary]. I think the

point, Senator, is that Congress did, in setting up

the concept of reasonable cost, intend for us to

reflect what the economic cost of hospital care

was. And as Mr. Gordon says, if you were going to

pay for the interest on borrowing the money it

seems to us to be reasonable to try to reflect in the

cost what is actually the incurred cost of a hospital

when it has to operate. So while it was not

discussed in those specific terms, I think it is

absolutely consistent with the intent of Congress

that what the program should pay should really

reflect what the economic cost is for a hospital in

providing these services.

SENATOR ANDERSON. I just could not disagree

with you more. We discussed this over and over

A-20

and over agin, and rejected that in the comittee. I

just call your attention to the committee report,

page 33:

The cost of hospital services varies widely

from one hospital to another, and the

variations reflect differences in quality and

cost. The same thing is true with respect to

the cost of services provided. The provision in

this bill for the payment of reasonable cost of

services is intended to meet the actual cost.

“Actual.” This is not economic or fanciful or

anything else. We put it in there so they could not

bring in the various things you are talking about

now. How do you get around this?

Mr. CoHEN. Well I think this is the actual cost. I

think when you are talking about economic

costs—

* * *

SENATOR ANDERSON. Just one more question

from page 37 of the report which I think should

have some importance to you. I really believe

when a committee goes to the extent of preparing

a report, and filing it, and telling the Congress

and the people that this is what they mean, it is

wrong to try to reinterpret it some other way.

In paying reasonable cost, it should be the

policy of the insurance program to so

reimburse a hospital or other provider that

an accounting may be made at the end of

each cost period for costs actually incurred.

Not beneficiarily incurred, or anything else—

“actually incurred.” And if you don’t pay interest

on a debt, that is not a cost that it actually

incurred.

id. at 69-70.

At the outset of the hearing, Senator Long, the

Chairman, outlined the various topics to be discussed:

A-21

Three. Can the reasonable cost include a return on

investment for proprietary institutions without a

similar payment to the nonprofit facilities. And

that is a fair question to be raised. It seems to me

that it was intended that there should be a return

on investment to proprietary institutions—and

that there is no similar requirement that they be

made to public or nonprofit groups. ;

id, at 43.

In addition, when the Act was amended in October,

Congressman John W. Byrnes of Wisconsin stated,

[(“Under existing law] the amount that will be paid to

the individual nursing home or facility—shall be, and

I quote, ‘the reasonable cost’ of furnishing such care. In

other words, as the law now stands, fundamentally all

the Social Security Administration can pay are the

costs, with no allowance for profits or a return on the

invested capital.” 112 Cong. Rec. 28220(1966). Senator

Long made a similar statement to the Senate, “As the

proposed Medicare regulations stood [an investor]

would only have been reimbursed for the actual costs

of providing services with no specific return given on

his investment.” 112 Cong. Rec. 27608 (1966).

Floyd County, supra, at 572-74.

This Court concludes, as did the district court for the

Northern District of Georgia, id., at 575, that a payment for

a return on equity capital is not within the scope of

§1395x(v)(1)(A). The plaintiffs have brought forward no

cases which stand as authority for the proposition that a

return on equity is a §1395x(v)(1)A) reasonable cost.

Rather, they have relied on: (1) the PRRB’s decision, (2)

general policy statements which assert that a policy of

nonreimbursement for nonproprietary providers would

violate the mandate of §1395x(v)(1)(A) in that a heavier

share of costs would be borne by non-Medicare patients,

and (3) analogies to indirect costs which are reimbursed

(i.e., straight line depreciation, 42 C.F.R. §405.415, the

1966-1969 2% allowance, 20 C.F.R. §405.428, interest on

A-22

some loans, 42 C.F.R. §405.[419], and return on net assets to

proprietary hospitals, 42 C.F.R. §405.429).

None of these arguments addresses the critical question:

did the Secretary misconstrue the statute in denying a

return on equity? Given the legislative history quoted

above, it is clear that not only did Congress not consider a

return on equity when it passed the Medicare Act, it

specifically viewed this item during the 1966 Hearings as

an expense which did not fall within the purview of

§1395x(v)(1)(A). When the 2% allowance, some “bit” of

which was a return on equity, was abandoned in 1969, the

expense, as to nonproprietary providers, return to its status

as a nonreimbursable expense. In light of its legislative

history, 42 U.S.C. §1395x(v)(1)(A) cannot be stretched to

cover this item of cost.

Another district court which has considered this issue of

whether a return on equity is a reasonable cost was

recently upheld by the Court of appeals for the District of

Columbia Circuit. American Medical International, Inc. v.

Secretary of Health, Education and Welfare, 466 F. Supp.

605 (D.D.C. 1979), aff'd, 677 F.2d 118 (D.C. App. 1981). In

American Medical International the court discussed

return on equity capital because the plaintiffs had

analogized it to the stock maintenance costs for which they

sought reimbursement. The district court stated:

Plaintiffs argue that stock maintenance costs,

though related to investment, should be reimbursed

because Medicare allows proprietary providers a

return on equity capital. 42 U.S.C. §1395x(v)(1)(B).

[Footnote omitted.] By allowing this payment,

plaintiffs contend, the Medicare program expressly

recognized that costs related to investment may be

reimbursed. This argument assumes that the return

on equity capital in §1395x(v)(1)B) is a reasonable cost

within the meaning of §1395x(v)(1A). However, this

return on equity provisions was added subsequent to

the passage of the Medicare Act and it constitutes the

sole exception to the basic Medicare principle that

A-23

reimbursement be limited to those costs actually

incurred in providing patient care services. It is clear

from the purpose behind the return on equity

provision (§1395x(v)(1)(B)), its legislative history, and

the provision itself that the return on equity capital

provision cannot be used by plaintiffs to support the

position that reasonable costs under 42 U.S.C.

§1395x(v)(1)(A) was meant to include costs for

investment.

Id., 466 f. Supp. at 613. (In accord, Valley View, supra.)

Therefore, the Secretary did not misinterpret

§1395x(v)(1)(A), nor do the regulations conflict with the

statutory scheme. Although the plaintiffs’ policy

arguments might have been convincing during the initial

stages of legislative debate on the Medicare legislation,

they were not accepted by Congress. It is beyond the

province of the Court to do more than discern the will of

Congress on this issue. A return on equity was not within

the definition of reasonable cost originally. Since Congress

has done nothing to change the statute in the 13 years since

the demise of the 2% allowance, this Court cannot proclaim

a return on equity capital to be a §1395x(v)(1)A)

reasonable cost.

(d) Does the Statutory or Regulatory Scheme Violate the

Just Compensation Provision of the Fifth Amendment?

The plaintiffs contend that if the statutory or regulatory

schemes deny a return on equity to nonproprietary

providers, they are constitutionally infirm. The hospitals

urge that such provisions would violate the Fifth

Amendment's mandate that “private property. ..[not] be

taken for public use without just compensation.” The

plaintiffs have presented the Court with no cases which

support this position. They urge that being denied

compensation for the opportunity cost of the assets used in

furnishing care to Medicare patients is unjust compensation.

If the United States does not pay them for the opportunity

cost, the plaintiffs claim that the government is not

A-24

compensating them sufficiently for property it has taken.

These opportunity cost arguments go to the compensation

element and do not need to be answered since the “taking”

element of the just compensation clause has not been

violated. The plaintiffs have stated that the hospitals are in

positions akin to those of public utilities. (Relying on Smyth

v. Ames, 169 U.S. 466, 18 S. Ct. 418, 42 L.Ed. 819 (1898).)

The basic principle of Smyth, as stated by the plaintiffs, is

that when a business dedicates a portion of its property to

activities deemed to be affected with a public interest, the

Constitution guarantees that the property will not be used

for the public benefit without just compensation being paid

for the services rendered.

There has been no taking in this case. The utilities cases

relied upon by plaintiffs are analogous to the case at bar,

but there are important distinctions which prevent the

application of the just compensation clause to this issue.

Smyth was a case in which the state regulated railroad

charges. The parties in Smyth were railroads and

stockholders of railroads, which were for-profit

corporations. The plaintiffs in the instant case are

nonprotit hospitals: the payment distinctions on the return

on equity issue are made on the basis of the differences

between profit-making and nonprofit organizations (see 42

C,F.R. §405.429 and the equal protection discussion below.)

The Court identified as unconstitutional takings of

property in which property is “wrested” from its owner for

the benefit of another or for the public. Jd., 169 U.S. at 524-

25, 42 L.Ed. at 841. The prohibition was against “a tariff of

rates which is so unreasonable as to practically destroy the

value of property of companies engaged in the carrying

business....” Jd., 169 U.S. at 525, 42 L.Ed. at 841. This

“wresting away” and “practically destroying the value of

the property” has evolved into a standard which demands

at a minimum some loss of use.

The plaintiffs in this case have not demonstrated this

type of loss. They have volunteered to participate in the

A-25

Medicare program. They can terminate their participation

now. They may sell their physical plant at any time.

A district court for the Eastern District of New York

recently dealt with the just compensation clause’s “taking”

requirement in a similar case involving Medicaid

reimbursement provisions. Hempstead General Hospital v.

Whalen, 474 F. Supp. 398 (E.D.N.Y. 1979), affd without

opinion, 622 f.2d 573 (2 Cir. 1980). The plaintiffs in that

case challenged federally approved state limitations on

capital cost reimbursements to potential purchasers of

health care facilities. They contended that these capital

reimbursement limitations constituted a taking because

they eliminated many potential buyers of health care

facilities. The Medicaid regulations at issue limited capital

reimbursement of purchasers to the next depreciated value

of the property rather than to either the purchase price or

the fair market value. After reviewing the recent just

compensation cases, the Court held that there was no

taking in spite of the fact that there was a greatly lessened

market for hospital facilities and the regulations “impose

upon plaintiffs a constantly diminishing potential sale

price.” /d., 474 F. Supp. at 411.

The reasoning of the Hempstead court for the finding of

no taking is that critical elements of governmental invasion

were missing:

As before, plaintiffs have full right to use the medical

center property. The challenged regulations impose

no direct legal restraint upon the property or upon its

use. There has been no physical entry by the state, no

ouster of the owner, no legal interference with

plaintiffs’ physical use, possession or enjoyment of the

medical center, nor any legal interference with the

owner’s power of disposition of the property.

Id., at 410-11. ‘

The New York court held that the regulations did not

constitute a de facto taking, which requires a “physical

A-26

entry by the condemnor, a physical ouster of the owner, a

legal interference with the physical use, possession or

enjoyment of the property or a legal interference with the

owner’s power of disposition of the property.” Jd., at 410,

citing city of Buffalo v. J.W. Clement Company, 28 N.Y.2d

241, 253; [821 N.Y.S.2d 345, 357; 269 N.E.2d 895, 903]

(1971). Neither did the regulations come within the ambit

of the cases which deal with unconstitutional regulation of

utilities since the plaintiffs “have not lost any existing right

of property or contract.” Hempstead, supra, at 410. Within

the context of the utility overregulation cases, the court set

forth the following rule:

Many kinds of legislative and administrative action

affect property values, but, without some diminution

in the owner’s right of use, do not constitute a taking

within the purvue of the Fourteenth Amendment.

Chacon v. Granata, 515 F.2d 922, 925 (CA5 1975), cert.

denied, 423 U.S. 930, 96 S. Ct. 279, 46 L.Ed.2d 258

(1975).

Id.

The instant case also lacks elements necessary for a

taking. The return on equity rules may not be what the

hospitals would design for themselves, but since these

plaintiffs retain full rights and control over their net

investment, the statutory scheme is not constitutionally

deficient.

(d) Does the Statutory or Regulatory Scheme Violate the

Equal Protection Clause of the Fifth Amendment?

The plaintiffs claim that the Fifth Amendment is

violated if the Medicare statutes and regulations allow or

disallow a return on equity solely on the basis of whether a

provider is proprietary or nonproprietary. This equal

protection argument can only be proved under the Fifth

Amendment if the discrimination is “so unjustifiable as to

be violative of due process.” Shapiro v. Thompson, 394 U.S.

618, 642, 89 S. Ct. 1322, 22 L.Ed.2d 600, 619 (1969);

Schneider v. Rusk, 377 U.S. 163, 168, 84 S. Ct. 1187, 12

A-27

L.Ed.2d 218, 222 (1964). Therefore, the due process clause

of the Fifth Amendment guarantees equal protection.

United States Department of Agriculture v. Moreno, 413

U.S. 528, 533 n.5, 93 S.Ct. 2821, 37 L.Ed.2d 782, 787 n.5

(1973).

The plaintiffs have attempted to support its claims that

this distinction is discriminatory with statements by

Robert Ball (the “anomalous result” testimony from the

Hearings, quoted above), a 1966 Memorandum of the

Comptroller General of the United States in favor of the 2%

allowance and unsupported assertions that the distinction

between proprietary and nonproprietary providers is

neither rational nor reasonable insofar as the return on

equity issue is concerned.

The standard to be applied in cases in which the constitu-

tionality of a social welfare program is challenged is the

same low level of scrutiny that is applied to legislation

regulating business. Weinberger v. Salfi, 422 U.S. 749, 771-

72, 95 S. Ct. 2457, 45 L.Ed.2d 522, 542-43 (1975). Salfi cited

with approval social welfare legislation cases (Richardson

v. Belcher, 404 U.S. 78, 92 S. Ct. 254, 30 L.Ed.2d 231 (1971);

Dandridge v. Williams, 397 U.S. 471, 90 S. Ct. 1158, 25

L.Ed.2d 491 (1970); and Flemming v. Nestor, 363 U.S. 603,

80 S. Ct. 1367, 4 L.Ed.2d 1435 (1960) ) which “establish that

a statutory classification violates due process only if it is

‘patently arbitrary. .., utterly lacking in rational justifica-

tion.’ 363 U.S. at 611. They establish that a classification

violates equal protection only if it lacks a reasonable basis;

there is no violation merely because the classification is

‘imperfect,’ or “‘not made with mathematical nicety or

because in practice it results in some inequality.”’ 397 U.S.

at 485-86.” Caylor-Nickr! Hospital, Ine. v. Califano, Civil

No. F 77-83 (N.D.Ind. Sept. 10, 1979) 420,718, CCH

Medicare and Medicaid Guide. In Caylor-Nickel, Judge

Eschbach, with specific reference to the return on equity

provisions, held that the regulations which “provide for

profit institution’ but not to nonprofit institutions” are

A-28

sufficiently rationally based to satisfy Salfi. Id., 930,718,

Medicare and Medicaid Guide at 9098. The reasons for this

finding of sufficient rationality to sustain the constitu-

tionality of the statutory and regulatory scheme are that:

It is certainly rational that profit institutions receive

this advantage when nonprofit institutions receive

numerous other advantages, such as various grants

and contributions, and tax-exempt status. The

purpose and rationality of this classification is made

clear in 42 U.S.C. §1395x(v)(1)(A) and in the legisla-

tive history.... The distinction drawn between profit

and nonprofit institutions violates nothing in the fifth

amendment. See Am. Med. Int'l, Inc. v. Sec. of H.E. W.,

466 F. Supp. 605, 615 (D.C. Dist. Columb. 1979).

Other cases which have accepted the rationality of the

distinction between proprietary and nonproprietary pro-

viders in the context of equal protection challenges are

Valley View, supra; Stevens Park Osteopathic Hospital,

Inc. v. United States, 633 F.2d 1373 (Ct.Cl. 1980); and Floyd

County, supra. Another explanation of the rationality of

this distinction, which relies upon the section of Judge

Eschbach’s opinion quoted above, states:

Both the Senate Finance Committee staff report and

G.A.O. report outline various reasons why profit and

nonprofit institutions should be treated differently.

Nonprofit institutions have various benefits which are

unavailable to proprietary institutions: tax benefits,

Hili-Burton grants, charitable donations, and

numerous other advantages created by the state and

federal governments.

Floyd County, supra, 522 F. Supp. at 575-76.

The plaintiffs have brought forward no cases which

refute these findings of rationality. The Court must agree

that the distinction between proprietary and non-

proprietary providers is rationally based.

All of the plaintiffs’ return on equity capital claims fail.

A-29

As to these issues, the Court must grant the defendant’s

motion for summary judgment.

(4) Bad Debts and Charity Costs

The hospitals ask the Court either to declare a regulation

with respect to bad debts, charity, and courtesy allowances

to be inconsistent with the “reasonable cost” requirement of

§1395x(v)(1)(A), or to rule that it violates the due process

clause of the Fifth Amendment. The hospitals claim that

because bad debts and charity not attributable to Medicare

patients are categorized by accountants as economic costs

of running a hospital, the Medicare program should

reimburse them for a proportionate share of these costs.

The Secretary has great leeway to formulate standards

for the determination of which are “reasonable costs” under

42 U.S.C. §1395x(v)(1)(A). In 1966, the Secretary

promulgated the following regulation, now challenge by

the plaintiffs:

§405.420 Bad debts, charity, and courtesy allowances.

(a) Principle. Bad debts, charity, and courtesy

allowances are deductions from revenue and are not to

be included in allowable cost; however, bad debts

attributable to the deductibles and coinsurance

amounts are reimbursable under the program.

(b) Definitions—(1) Bad debts. Bad debts are

amounts considered to be uncollectible from accounts

and notes receivable which were created or acquired

in providing services. “Accounts receivable” and

“notes receivable” are designations for claims arising

from the rendering of services, and are collectible in

money in the relatively near future.

(2) Charity allowances. Charity allowances are

reductions in charges made by the provider of services

because of the indigence or medical indigence of the

pr tient.

_ (8) Courtesy allowances. Courtesy allowances

indicate a reduction in charges in the form of an

A-30

allowance to physicians, clergy, members of religious

orders, and others as approved by the governing body

of the provider [, for services received from the

provider]. Employee fringe benefits, such as hospitali-

zation and personnel health programs, are not

considered to be courtesy allowances.

(c) Normal accounting treatment: Reduction in

revenue. Bad debts, charity, and courtesy allowances

represent reductions in revenue. The failure to collect

charges for services rendered does not add to the cost

of providing the services. Such costs have already been

incurred in the production of the services.

(g) Charity allowances. Charity allowances have

no relationship to beneficiaries of the health insurance

program and are not allowable costs. The cost to the

provider of employee fringe-benefit programs is an

allowable element of reimbursement.

From the above it will be noted that plaintiffs are specif-

ically allowed to collect every penny of bad debts

attributable to the deductibles and coinsurance amounts

which Medicare patients fail to pay. In other words, pay-

ments are reduced in the first instance by applicable

deductibles and coinsurance amounts, 42 U.S.C. §1395e; 42

C.F.R. §405.110(b). Notwithstanding such fact, the amount

of these reductions is eventually paid to plaintiffs to the

extent that plaintiffs are not otherwise able to collect the

same. 42 C.F.R. §405.420(a). Since the exact amount of the

bad debts incurred by Medicare patients in the foregoing

areas is reimbursed, it is logical to deny reimbursement,

either directly or as an item of overhead, of similar losses of

revenue attributable to non-Medicare patients, in keeping

with the congressional policy as expressed in 42 U.S.C.

§1395x(v)(1)(A).

* * *

The Congress has said that costs attributable to non-

Medicare patients are not to be borne by the Medicare

A-31

program. All of the items excluded by 42 C.F.R. §405.420

(a) are just such costs or, more accurately, lack of revenue.

The challenged regulation appears to be in complete

harmony with both the letter and the spirit of the statute,

and the decision of the Board with respect thereto is

correct.

... The final decision of the Secretary is affirmed, and

summary judgment will be rendered in favor of the

defendants in the consolidated cases.

Dated this 12 day of August, 1982.

/s/ SS. HuGH DILLIN

S. Hugh Dillin, Judge.

A true Copy:

Teste:

Clerk of the United States Court of

Appeals for the Seventh Circuit

A-32

UNITED STATES DISTRICT COURT

SOUTHERN DISTRICT OF INDIANA

INDIANAPOLIS DIVISION

INDIANA HOSPITAL ASSOCIATION, INC.,

Plaintiff.

-Vs- NO. IP 76-522-C

RICHARD S. SCHWEIKER, Secretary,

Department of Health and

Human Services,

JOHN A. SVAHN, Commissioner

of Social Security,

Defendants.

ST. FRANCIS HOSPITAL CENTER,

THE JOHNSON COUNTY MEMORIAL HOSPITAL,

THE METHODIST HOSPITAL OF GARY, INC.,

ST. ELIZABETH HOSPITAL MEDICAL CENTER,

ST. MARGARET HOSPITAL,

HENDRICKS COUNTY HOSPITAL,

LaPORTE HOSPITAL,

HOWARD COMMUNITY HOSPITAL,

ST. CATHERINE HOSPITAL OF EAST CHICAGO,

INDIANA, INC.,

CLARK COUNTY MEMORIAL HOSPITAL,

ST. JOSEPH MEMORIAL HOSPITAL OF KOKOMO,

INDIANA, INC.,

ST. ANTHONY HOSPITAL,

THE LUTHERAN HOSPITAL OF FORT WAYNE,

INDIANA,

ELKHART GENERAL HOSPITAL,

PARKVIEW MEMORIAL HOSPITAL,

WILLIAM N. WISHARD MEMORIAL HOSPITAL,

GOSHEN GENERAL HOSPITAL,

PUTNAM COUNTY HOSPITAL,

ST. JOSEPH HOSPITAL OF MISHAWAKA,

INDIANA, INC.,

HENRY COUNTY MEMORIAL HOSPITAL,

ST. MARY MEDICAL CENTER, INC.,

PORTER MEMORIAL HOSPITAL,

WHITE COUNTY MEMORIAL HOSPITAL,

HANCOCK COUNTY MEMORIAL HOSPITAL,

MORGAN COUNTY MEMORIAL HOSPITAL,

NO. IP 80-89-C

NO. IP 80-206-C

NO. IP 80-272-C

NO. IP 80-500-C

a ee a re et ee ee ee ee ee ee ee ee ee ee ee ee ee ee ee ee ey ey ee ee ee ee”

SCOTT COUNTY MEMORIAL HOSPITAL,

TIPTON COUNTY MEMORIAL HOSPITAL,

RANDOLPH COUNTY HOSPITAL,

METHODIST HOSPITAL OF INDIANA, INC.,

MEMORIAL HOSPITAL OF SOUTH BEND,

RIVERVIEW HOSPITAL,

DAVIESS COUNTY HOSPITAL,

DECATUR COUNTY MEMORIAL HOSPITAL,

WELLS COMMUNITY HOSPITAL,

JACKSON COUNTY SCHNECK MEMORIAL

HOSPITAL,

GREENE COUNTY GENERAL HOSPITAL,

DUKES MEMORIAL HOSPITAL,

THE KING'S DAUGHTERS’ HOSPITAL

PERRY COUNTY MEMORIAL HOSPITAL,

ORANGE COUNTY HOSPITAL,

MEMORIAL HOSPITAL OF LOGANSPORT,

McCRAY MEMORIAL HOSPITAL, INC.,

MARSHALL COUNTY PARKVIEW HOSPITAL,

JASPER COUNTY HOSPITAL,

DEACONESS HOSPITAL, INC.,

DEARBORN COUNTY HOSPITAL,

HUNTINGTON MEMORIAL HOSPITAL,

MERCY HOSPITAL, INC.,

LaGRANGE COUNTY HOSPITAL,

WILLIAM S. MAJOR HOSPITAL,

WASHINGTON COUNTY MEMORIAL HOSPITAL,

WHITLEY COUNTY MEMORIAL HOSPITAL,

STARKE MEMORIAL HOSPITAL,

WHITHAM MEMORIAL HOSPITAL,

WABASH COUNTY HOSPITAL,

ADAMS COUNTY MEMORIAL HOSPITAL,

LAFAYETTE HOME HOSPITAL, INC.,

WOODLAWN HOSPITAL,

BARTHOLOMEW COUNTY HOSPITAL,

COMMUNITY HOSPITAL OF ANDERSON AND

MADISON COUNTY, INC.,

BLACKFORD COUNTY HOSPITAL,

BROADWAY METHODIST HOSPITAL,

Plaintiffs

-Vs-

RICHARD S SCHWEIKER, Secretary,

Department of Health and

Human Services,

PROVIDER REIMBURSEMENT REVIEW BoarD,

THOMAS TIERNEY, Chairman,

Defendants.

Dm mr ee ee ee ee ee et ee ee ee

JUDGMENT

The Court having this day filed its Memorandum of Deci-

sion in the above entitled consolidated causes of action,

reading as follows: (H. I.), now therefore,

ITISCONSIDERED AND ADJUDGED that Cause No.

IP 76-522-C is dismissed for lack of jurisdiction over the

subject matter of the action.

IT IS FURTHER CONSIDERED AND ADJUDGED

that the plaintiffs in Cause Nos. IP 80-89-C, IP 80-206-C, IP

80-272-C, and IP 80-500-C take nothing by their

complaints, and summary judgment is hereby entered for

the defendants in such actions.

IT IS FINALLY CONSIDERED AND ADJUDGED

that plaintiffs pay the costs of these actions.

Dated this 12 day of August, 1982.

/s/ S. HuGu DILLIN

S. Hugh Dillin, Judge

A-35

INDIANA HOSPITAL ASSOCIATION, INC.,

Plaintiff.

NO. IP 76-522-C

-VS-

RICHARD S. SCHWEIKER, Secretary,

Department of Health and

Human Services,

Joun A. SVAHN, Commissioner

of Social Security,

Defendants.

ST. FRANCIS HOSPITAL CENTER,

THE JOHNSON COUNTY MEMORIAL HOSPITAL,

THE METHODIST HOSPITAL OF GARY, INC.,

ST. ELIZABETH HOSPITAL MEDICAL CENTER,

ST. MARGARET HOSPITAL,

HENDRICKS COUNTY HOSPITAL,

LaPORTE HOSPITAL,

HOWARD COMMUNITY HOSPITAL,

ST. CATHERINE HOSPITAL OF EAST CHICAGO,

INDIANA, INC.,

CLARK COUNTY MEMORIAL HOSPITAL,

ST. JOSEPH MEMORIAL HOSPITAL OF KOKOMO,

INDIANA, INC.,

ST. ANTHONY HOSPITAL,

THE LUTHERAN HOSPITAL OF FORT WAYNE,

INDIANA,

ELKHART GENERAL HOSPITAL,

PARKVIEW MEMORIAL HOSPITAL,

WILLIAM N. WISHARD MEMORIAL HOSPITAL,

GOSHEN GENERAL HOSPITAL,

PUTNAM COUNTY HOSPITAL,

ST. JOSEPH HOSPITAI OF MISHAWAKA,

INDIANA, INC.,

HENRY COUNTY MEMORIAL HOSPITAL,

ST. MARY MEDICAL CENTER, INC.,

PORTER MEMORIAL HOSPITAL,

WHITE COUNTY MEMORIAL HOSPITAL,

HANCOCK COUNTY MEMORIAL HOSPITAL,

MORGAN COUNTY MEMORIAL HOSPITAL,

GOOD SAMARITAN HOSPITAL,

CLINTON COUNTY HOSPITAL,

MEMORIAL HOSPITAL OF FLOYD COUNTY,

ST. JOSEPH HOSPITAL OF FORT WAYNE, INC.,

REID MEMORIAL HOSPITAL, INC.,

DUNN MEMORIAL HOSPITAL,

A-36

NO. IP 80-89-C

NO. IP 80-206-C

NO. | P 80-272-C

NO. IP 80-500-C

ee a a ee ee SO OS Se eee

SCOTT COUNTY MEMORIAL HOSPITAL,

TIPTON COUNTY MEMORIAL HOSPITAL,

RANDOLPH COUNTY HOSPITAL,

METHODIST HOSPITAL OF INDIANA, INC.,

MEMORIAL HOSPITAL OF SOUTH BEND,

RIVERVIEW HOSPITAL.

DAVIESS COUNTY HOSPITAL,

DECATUR COUNTY MEMORIAL HOSPITAL,

WELLS COMMUNITY HOSPITAL,

JACKSON COUNTY SCHNECK MEMORIAL

HOSPITAL,

GREENE COUNTY GENERAL HOSPITAL,

DUKES MEMORIAL HOSPITAL,

THE KING'S DAUGHTERS’ HOSPITAL,

PERRY COUNTY MEMORIAL HOSPITAL,

ORANGE COUNTY HOSPITAL,

MEMORIAL HOSPITAL OF LOGANSPORT,

McCRAY MEMORIAL HOSPITAL, INC.,

MARSHALL COUNTY PARKVIEW HOSPITAL,

JASPER COUNTY HOSPITAL,

DEACONESS HOSPITAL, INC.,

DEARBORN COUNTY HOSPITAL,

HUNTINGTON MEMORIAL HOSPITAL,

MERCY HOSPITAL, INC.,

LaGRANGE COUNTY HOSPITAL,

WILLIAM 8. MAJOR HOSPITAL,

WASHINGTON COUNTY MEMORIAL HOSPITAL,

WHITLEY COUNTY MEMORIAL HOSPITAL,

STARKE MEMORIAL HOSPITAL,

WHITHAM MEMORIAL HOSPITAL,

WABASH COUNTY HOSPITAL,

ADAMS COUNTY MEMORIAL HOSPITAL,

LAFAYETTE HOME HOSPITAL, INC.,

WOODLAWN HOSPITAL,

BARTHOLOMEW COUNTY HOSPITAL,

COMMUNITY HOSPITAL OF ANDERSON AND

MADISON COUNTY, INC., °

BLACKFORD COUNTY HOSPITAL,

BROADWAY METHODIST HOSPITAL,

Petitioners

-Vs-

RICHARD S. SCHWEIKER, Secretary,

Department of Health and

Human Services,

PROVIDER REIMBURSEMENT REVIEW BOARD,

THOMAS TIERNEY, Chairman,

Defendants.

A-37

ee a a ee eee SS OS OS OS SS OS SO IS OS Oe er ee

MEMORANDUM OF DECISION

These cases come before the Court on a variety of mo-

tions. The original plaintiff, Indiana Hospital Association,

Inc., has moved for partial summary judgment as to Cause

No. IP 76-522-C. The defendants have moved to dismiss No.

IP 76-522-C, claiming that the Court lacks jurisdiction over

the subject matter of that suit. The plaintiffs and the

defendants of the four consolidated suits have moved for

summary judgment. In accordance with the reasons which

follow, the Court will dismiss the Hospital Association suit,

No. IP 76-522-C, for lack of subject matter jurisdiction, and

enter summary judgment for the defendants on the merits

in the four consolidated cases, Nos. IP 80-272-C, IP 80-500-

C and IP 76-522-C insofar as it encompasses former Nos. IP

80-89-C and IP 80-206-C.

The facts and legal issues presented by these cases are

complex and will be dealth with in greater detail in the

body of this memorandum. In brief, these suits present

challenges to Medicare reimbursement statutes, regula-

tions and policies by 68 Indiana hospitals and the Indiana

Hospital Association, Inc., to which the 68 hospitals belong.

The hospitals claim that they are entitled to reimburse-

ment of the portion of their return on equity capital! and bad

debt and charity costs that they claim are attributable to

the Medicare patients they treat. The Medicare Act was

passed in 1965. 42 U.S.C. §§1395, et seq. It provides for the

reimbursement of the reasonable cost of providing services

to Medicare beneficiaries. 42 U.S.C. §1395f(b). The

statutory definition of “reasonable cost” is found at 42

U.S.C. §1395x(v)(1)(A). Pursuant to the Medicare Act, the

Secretary of Health and Human Services (hereinafter “the

Secretary”) has promulgated regulations which define the

concept of reasonable cost more fully. 42 U.S.C. §1395hh;

and 42 C.F.R. §§405.401-405. 488.

The 68 plaintiff hospitals have all made claims for re-

imbursement for return on equity capital and bad debt and

A-38

charity costs for a variety of fiscal years with the “fiscal

intermediary” which acts as the agent of the Secretary pur-

suant to 42 C.F.R. §405.651. The fiscal intermediary which

rules upon claims made by Indiana hospitals (termed

‘ “providers” under the Act) is Mutual Hospital Insurance,

Inc. d/b/a/ Blue Cross of Indiana.

These plaintiffs filed claims (“Cost Reports”) which Blue

Cross. Blue Cross, by “notices of Program Reimbursement”

to each of the hospitals, denied payment under the

Medicare Act for the return on equity, bad debt and charity

claims. The hospitals then pursued the administrative

appeals outlined by the Act and the Secretary’s regula-

tions. 42 U.S.C. §139500(a); and 42 C.F.R. §405.1837. The

plaintiffs were granted permission to pursue their appeals

as a group appeal, since their ciaims presented common

questions of law.

The first level of appeal was to the Provider Reimburse-

ment Review Board (“PRRB” or “Board” hereafter). The

PRRB ruled that the hospitals were entitled to a return on

equity, but sustained Blue Cross’s denial of reimbursement

for the bad debt and charity costs.

The Deputy Administrator of the Health Care Financing

Administration, to whom the Secretary’s power to review

the PRRB’s decisions has been delegated, reversed the

Board’s findings in regard to the return on equity issue and

affirmed the decision to deny reimbursement of bad debt

and charity costs.

The hospitals filed suit in district courts for judicial

review of this decision. The original Hospital Association

suit, No. IP 76-522-C, which in essence asks for declaratory

and injunctive relief for these same two issues, was in this

court. Therefore, the other four cases representing a

request for review of the administrative decision were sent

to this Court for consolidation. The Court will treat the

following major issues in this memorandum: (1) subject

matter jurisdiction, (2) venue, (3) return on equity capital,

and (4) bad debts and charity.

A-39

Discussion

(1) Subject Matter Jurisdiction

The defendants have moved to dismiss IP 76-522-C, the

Hospital Association suit, for lack of subject matter juris-

diction. The plaintiff claims that the Court has jurisdiction

over this case pursuant to 28 U.S.C. §§1331, 1337, 1361,

2201 and the Administrative Procedure Act, 5 U.S.C.

§§701, et seg. The defendants in the other cases have not

challenged the power of the Court to review the Secretary’s

decisions under 42 U.S.C. §139500(f1). Jurisdiction over

all of these cases except the Hospital Association suit does

lie by virtue of this section, which provides, in pertinent

part:

(f)(1) A decision of the Board shali be final unless

the Secretary, on his own motion, and within 60 days

after the provider of services is notified of the Board’s

decision, reverses, affirms, or modifies the Board’s

decision. Providers shall have the right to obtain

judicial review of any final decision of the Board, or of

any reversal, affirmance, or modification by the

Secretary, by a civil action commencing within 60

days of the date on which notice of any final decision by

the Board or of any reversal, affirmance, or modifica-

tion by the Secretary is received. ...

Therefore, the only question to be determined now is

whether the Hospital Association suit, which requests

declaratory relief, falls within some jurisdictional grant.

This area of federal subject matter jurisdiction has been

murky for years, so it is necessary to present a brief his-

torical overview.

Plaintiffs have tried a variety of statutory pathways to

get judicial review of decisions made or positions taken by

the PRRB or by HHS. Until recently the most successful

was.28 U.S.C. §1331. In 1975, however, the Supreme Court

announced its decision in Weinberger v. Salfi, 422 U.S. 749,

95 S.Ct. 2457, 45 L.Ed.2d 522, which, read with later

A-40

interpretive cases, prohibits a finding of jurisdiction over

the Hospital Association case.

The critical section discussed in Salfi, supra, is §205(h) of

the Social Security Act (42 U.S.C. §405(h)), which provides

that:

The findings and decisions of the Secretary after a

hearing shall be binding upon all individuals who

were parties to such hearing. No findings of fact or

decision of the Secretary shall be reviewed by any

person, tribunal or governmental agency except as

herein provided. No action against the United States,

the Secretary, or any officer or employee thereof shall

be brought under Section 41 of Title 28 [which

includes 28 U.S.C. §1331] to recover on any claim

arising under this subchapter.

Section 405(h) is expressly incorporated into the Medicare

Act by 42 U.S.C. §1395ii, which states that the section

applies to the “same extent” as it is applicable with respect

to Title II of the Act.

Salfi dealt with a Social Security benefit entitlement re-

quirement. The Supreme Court held that the language of

the third sentence of 42 U.S.C. §405(h) barred §1331 juris-

diction of a constitutional challenge to the Social Security

requirement. See Trinity Memorial Hospital of Cudahy,

Inc. v. Associated Hospital Services, 570 F.2d 660, 664 (7

Cir. 1977). The plaintiffs have attempted to avoid the bar of

Salfi by stressing the differences between the Social

Security and Medicare systems, but the Seventh Circuit

has applied Salfi expansively in both provider reimburse-

ment disputes (Trinity, supra) and to a case of termination

of a provider agreement (Northlake Community Hospital v.

United States, 654 F.2d 1234, 1240 (7 Cir. 1981)).

The most im} ortant point decided by the Supreme Court

in Salfi, for the purposes of this discussion, is “[t]hat the

third sentence of §405(h) is more than a codified require-

ment of administrative exhaustion.” /d., 422 U.S. at 757, 45

A-41

L.Ed.2d at 534. The Court noted that the “sweeping and

direct” language of this third sentence “states that no action

{[Court’s emphasis] shall be brought under §1331, not

merely that only those actions shall be brought in which

administrative remedies have been exhausted.” /d.

According to the Court, the first two sentences of §405(h)

require exhaustion of administrative remedies, so the third

sentence must mean something more if it is not to be

rendered superfluous.

The Supreme Court then stated that the fact that the

Salfi plaintiffs were raising constitutional issues did not

mean that the action did not arise under the Social Security

Act. “To contend that such an action does not arise under

the Act whose benefits are sought is to ignore both the

language and substance of the complaint and judgment.”

Id., 422 U.S. at 761, 45 L.Ed.2d at 536.

The plaintiff contends that its case should be heard be-

cause: (1) it presents constitutional challenges, and/or (2)

its claims are outside the scope of Salfi because there is no

administrative procedure under Medicare comparable to

that which exists for challenges to the Social Security

program.

The plaintiff insinuates that if the Court does not have

jurisdiction over its claims, they will be bereft of judicial

review. This position is incorrect. The same legal questions

posed in the form of disputed claims for reimbursement (as

opposed to this request for equitable relief) are now

consolidated with the Hospital Association suit. The

plaintiff hospitals in the consolidated suits have presented

their arguments to the appropriate officials as they ran the

course of prescribed administrative procedure. They have

complied with the requirements of Salfi and therefore, fall

within the jurisdictional grant of 42 U.S.C. §139500.

The Seventh Circuit has held that “Salfi ‘precludes the

use of 28 U.S.C. §1331 as a jurisdictional basis’ for

Medicare provider reimbursement disputes.” Northlake

A-42

Community Hospital v. United States, 654 F.2d 1234, at

1240 (7 Cir. 1981), quoting Cudahy, supra. The plaintiff

attempts to avoid this ruling by stating that it, as an

association of providers, is not a provider per se and there-

fore, is not subject to the administrative review process. It

stresses that it is not seeking to recover on a claim, but is

asking for aruling on the legality of the Act and regulations

promulgated thereunder.

This argument, however, is similar to the contention

rejected in Salfi: it isan attempt to evade the §405(h) ban by

recharacterization. In essence, this suit was brought in

order to have regulations declared void so that the

plaintiff's member hospitals could recover more Medicare

expenses. The Hospital Association suit is, in fact if not in

form, an action on a claim arising under the Medicare Act

and as such, is within the ban of §405(h).

The plaintiff's more substantial argument is vnat even if

§405(h) is applicable, there is still jurisdiction because the

Medicare Act contains no provisions for judicial review of

the constitutionality of either the statute or of the

Secretary’s regulations. The plaintiff argues that the

Supreme Court surely did not intend that the Salfi decision

preclude nonstatutory review in cases in which the Act does

not provide a review mechanism. In support of its position,

the plaintiff points to the Salfi Court's treatment of Johnson

v. Robinson, 415 U.S. 361, 94 S.Ct. 1160, 39 L.Ed.2d 389

(1974).

The Court in Salfi noted that in Johnson it considered 38

U.S.C. §211(a) which provides:

[T]he decisions of the | Veterans’] Administration on

any question of law or fact under any law adminis-

tered by the Veterans’ Administration providing

benefits for veterans...shall be final and conclusive

and no other official or any court of the United States

shall have power or jurisdiction to review any such

decision by an action in the nature of mandamus or

otherwise. Salfi, supra, 422 U.S. at 761, 45 L.Ed.2d at

536.

A-43

The Johnson Court found that the provision did not

preclude an attack on the constitutionality of a statutory

limitation in that such limitation was nota “decision” of the

Administrator, but had been made by Congress. The Court

found Salfi to be inapposite to the Johnson case for two

main reasons. The Court first observed that the language of

§405(h) is quite different in that:

Its reach is not limited to decisions of the Secretary on

issues of law or fact. Rather, it extends to any “action”

seeking “to recover on any [Social Security] claim” —

irrespective of whether resort to judicial processes is

necessitated by discretionary decisions of the

Secretary or by his nondiscretionary application of

allegedly unconstitutional statutory restrictions.

Salfi, supra, 422 U.S. at 762, 45 L.Ed.2d at 536.

The Court also found Johnson inapposite in that if §211(a)

precluded “constitutional challenges to statutory limits

tions then absolutely no judicial consideration of the issue

would be available.” The Court continued:

Not only would such a restriction have been extra-

ordinary, such that “clear and convincing” evidence

would be required before we would ascribe such intent

to Congress... but it would have raised a serious con-

stitutional question of the validity of the statute as so

construed. Salfi, supra, 422 U.S. at 762, 45 L.Ed.2d at

537.

The Court noted that this was not a problem in Salfi as the

Social Security Act, pursuant to §405(g), provided for

constitutional challenges to its provisions.

The plaintiff contends that this second difference is a

problem in this case as no provision is made in the Medicare

Act for judicial review of the constitutionality ofthe statute

or the regulations promulgated thereunder.

In order to be reimbursed, a provider must submit a “cost

report” to the fiscal intermediary. If the provider is dis-

satisfied with the intermediary's award, then it can have a

A-44

hearing. The hearing officer, however, must “comply with

all the provisions of Title X VIII of the [Medicare] Act and

regulations issued thereunder.” 20_C.F.R. §405.1829.

Congress also established the PRRB in 1973. The Board

has the authority to review many intermediary hearing

decisions. 42 U.S.C. §139500. It has the power to “affirm,

modify or reverse a final determination of the fiscal inter-

mediary with respect to a cost report....” 42 U.S.C.

§139500(d). The Board, however, is to comply with the Act

and regulations issued thereunder. 20 C.F.R. §405.1867.

The PRRB’s decision is final unless the Secretary, on his

own motion and within 60 days after the provider is

notified, “reverses, affirms or modifies the Board’s

decision.” 42 U.S.C. §139500(f)(1). The provider then has

the right to obtain judicial review of any final decision of

the Board or any affirmance, modification or reversal by

the Secretary.

The plaintiff argues that since the fiscal intermediary

and the Review Board are bound by the Act and the regula-

tions, there is no mechanism for review of its challenge.

This contention is analogous to one refuted in Salfi.

The administrative process considered by the Supreme

Court in Salfi was equally incapable of giving the relief

requested. See Aristocrat South, Inc. v. Mathews, 420

F.Supp. 23 (D.D.C. 1976). Nevertheless, the Supreme

Court held that resort to the administrative review process

was required and that §405(h) extended to “any ‘action’

seeking ‘to recover on any [Social Security] claim’ —

irrespective of whether resort to judicial processes is

necessitated by discretionary decisions of the Secretary or

by his nondiscretionary application of allegedly uncon-

stitutional statutory restrictions.” /d. 422 U.S. at 762, 45

_ L.Ed.2d at 536. The First Circuit has noted that the ad-

ministrative process is not made “inapplicable by reason of

a constitutional challenge, beyond the power of the

Secretary to take remedial action.” Milo Community

Hospital v. Weinberger, 525 F.2d 144, 147 (1 Cir. 1975).

A-45

Remedial action is not even beyond the Secretary’s

power. The Secretary promulgated these challenged

regulations: it is within his competence to provide the relief

sought. The Court in Salfi stressed the importance of

giving the Secretary an opportunity to review the claims

made:

[T]he Social Security Act itself provides jurisdiction

for constitutional challenges to its provisions. Thus the

plain words of the third sentence of §405(h) do not pre-

clude constitutional challenges. They simply require

that they be brought under jurisdictional grants con-

tained in the Act, @nd thus in conformity with the same

standards which are applicable to non-constitutional

claims arising under the Act. The result is not only of

unquestionable constitutionality, but it is also

manifestly reasonable, since it assures the Secretary

the opportunity prior to constitutional litigation to

ascertain, for example, that the particular claims

involved are neither invalid for other reasons nor

= under other provisions of the Social Security

ct.

Id. 422 U.S. at 762, 45 L.Ed.2d at 537. The Medicare Act,

pursuant to §139500(f1), also provides the courts with

jurisdiction over constitutional challenges to its provisions.

The Secretary must have an opportunity to examine the

provisions prior to such judicial review.

The Seventh Circuit discussed Salfi and its pre-

clusionary effect in a case involving a constitutional

challenge. Trinity Memorial Hospital v. Associated

Hospital Service, Inc., 570 F.2d 660 (7 Cir. 1977). It held

that 42 U.S.C. §405(h) precluded the use of 28 U.S.C. §1331

as a jurisdictional basis over a due process challenge to a

cost accounting hearing procedure. /d., 570 F.2d at 667.

. The court held, however, that jurisdiction over the constitu-

tional issue would vest in the Court of Claims. /d.

Because of §405(h), this Court has no jurisdiction under

§1331 to entertain the Hospital Association suit.

A-46

5 |

The alternative asserted bases for jurisdiction are

equally inappropriate for the Hospital Association suit.

The Supreme Court has held that 5 U.S.C. §702 (§10(a) of

the Administrative Procedure Act) does not represent a

grant of jurisdiction. Califano v. Sanders, 430 U.S. 99, 97

S.Ct. 980, 51 L.Ed.2d 192 (1977).

Title 28 U.S.C. §2201, the declaratory judgment statute,

does not provide the plaintiff with a separate jurisdictional

basis. The declaratory judgment provision may not be used

to evade a failure of jurisdiction or to avoid exhausting ad-

ministrative remedies. Hills v, Eisenhart, 156 F.Supp. 902

(D. Cal. 1957), affd 256 F.2d 609 (9 Cir. 1958), cert. den. 358

U.S. 832, 79 S.Ct. 53, 3 L.Ed.2d 70(1958), reh. den. 358 U.S.

914, 79 S.Ct. 228, 3 L.Ed.2d 235 (1958).

The allegation that the Court has jurisdiction over this

case pursuant to 28 U.S.C. §1337 is wholly unsupported.

Section 1337 provides that:

The district courts shal! have original jurisdiction of

any civil action or proceedings arising under any Act

of Congress regulating commerce or protecting trade

and commerce against restraints and monopolies.

Not only is there no authority for the proposition that the

Social Security Act regulates commerce, jurisdiction may

not be had under §1337 because the plaintiff has not

exhausted its administrative remedies.

Mandamus relief under 28 U.S.C. §1361 is similarly un-

available. Mandamus is reserved for extraordinary situa-

tions and “lies only to compel the performance of a legal

duty which is free from doubt.” Winningham v. HUD, 512

F.2d 617 (5 Cir. 1975). The “clear, ministerial and non-

discretionary” duty which the plaintiff claims the

defendants owe them is to pay the “reasonable cost” of the

services which they provide to Medicare patients. Neither

the reasonable cost nor the duty to pay is free from doubt, so

mandamus would be inappropriate. See Trinity Memorial,

supra, 570 F.2d at 666, n. 9.

A-47

The Hospital Association suit is therefore dismissed for

want of subject matter jurisdiction. The other consolidated

cases remain for consideration on the merits.

(2) Venue

The defendants have claimed that venue is improper as to

the plaintiffs which are located in the Northern District of

Indiana. All four of the consolidated areas arose out of the

administrative group appeal.

Cases No. IP 80-89-C and IP 80-272-C were filed

originally in the Southern District. Cases No. IP 80-206-C

and IP 80-500-C are parallel cases to the Southern District

suits. They were first filed in the Northern District of

Indiana, Hammond Division, as Nos. H 80-77 and H 80-218

and were transferred to this district by Judge McNagney

in 1980, pursuant to 28 U.S.C. §1404(a), which provides:

For the convenience of parties and witnesses, in the

interest of justice, a district court may transfer any

civil action to any other district or division where it

might have been brought.

The question raised by the transfers is whether they are

improper because they do not fall within the category of ac-

tions which “might have been brought” in the Southern

District. The plaintiff list for each of these four cases is

identical. Some of the plaintiff hospitals are located in the

Northern District, others in the Southern. The defendants

contend that claims of the Southern District plaintiffs

could not have been brought originally in the Southern

District and that therefore the transfers were wrongful.

The defendants have moved either to have all four of these

cases transferred to the District of Columbia, or for the

Northern District plaintiffs’ claims (as represented by Nos.

IP 80-206-C and IP 80-500-C) to be returned to the

Northern District. The defendants base this claim on the

venue provision which all parties agree is applicable, 42

U.S.C. §139500(f1), which states, in pertinent part:

A-48

Such action [to obtain judicial review over decisions by

the PRRB or the Secretary ]shal! be brought in the dis-

trict court of the United States for the judicial district

in which the provider is located or in the District Court

for the District of Columbia....

The essence of the defendants’ claims is that since some of

the plaintiffs are located in the Northern District, they do

not meet the requirement of §139500(f)(1) that actions must

be brought in the “judicial district in which the provider is

located.” Therefore, they assert that 28 U.S.C. §1404(a), the

transfer of venue statute, does not authorize a transfer to

this court.

A critical issue which has not been treated by the parties

is one of whether, in enacting §139500(f\1), Congress con-

sidered the issue of cases which had been consolidated for

purposes of the administrative appeals. The defendants,

pursuant to the Secretary’s regulation 42 C.F.R. §405. 1837,

allowed these plaintiffs to pursue their claims through the

entire administrative process as one case.

Now the government, based upon the venue statutes,

asserts that the plaintiffs may not proceeds with their

claims in the group which the defendants allowed before.

It is obvious that the Congress, in enacting §139500(f)1),

did not anticipate the possibilities of group appeals

pursuant to the regulations. 42 C.F.R. §405.1837. Rather

than invalidating the regulation which promotes the

efficient use of scanty administrative resources in the

resolution of disputes of this kind, it is more appropriate for

this Court to construe the language of §139500(f\1) to

accomplish the result Congress would most likely wish to

achieve if it were to consider this problem.

This was a group appeal throughout the administrative

appellate process. The same issues are presented now for

judicial review. It is most sensible to construe the singular

term “provider” in §139500(f\1) loosely, to encompass the

entire group. Therefore, since many of the group members

A-49

are located in the Southern District, the group could have

brought suit here. The transfers of venue under 28 U.S.C.

§1404(a) were appropriate.

As a practical matter, it would be a waste of judicial re-

sources to send roughly half of these plaintiffs to the

Northern District. The consolidated suit is ripe for a

decision on the merits. There is no reason, given chronically

crowded court dockets, to have another district court in the

Seventh Circuit wrestle with these issues. If an appeal is to

be made, the Seventh Circuit can render its decision on the

basis of this memorandum of decision. Therefore, the

defendants’ motions relating to severance and venue are

denied.

(3) Return on Equity Capital

The return on equity issue has been raised in several

other courts. The hospitals’ basic contention is that they

should be reimbursed by the Medicare program for a

reasonable rate of return on their net assets used in the

treatment of Medicare patients. The plaintiffs rest their

argument on the following grounds: (A) the Deputy Ad-

ministrator had no power to reverse the PRRB’s decision to

grant these plaintiffs return on equity costs, therefore the

PRRB’s decision is final, (B) great deference should be

given to PRRB’s decision, (C) a return on equity is a

“reasonable cost” of providing services under 42 U.S.C.

§1395x(v)(1)(A), (D) the denial of reimbursement for these

costs constitutes a violation of the just compensation clause

of the Fifth Amendment, and (E) since proprietary (for-

profit) hospitals are given a return on net assets reimburse-

ment, these plaintiffs, non-proprietary hospitals, are being

denied their rights to equal protection.

In order to understand the plaintiffs’ arguments, it is

necessary to review some background and legislative his-

tory of the Medicare program. The terms “return on

equity,” “return on equity capital,” “return on net assets,”

and “imputed interest” are all used to describe the

A-50

Sah

hospitals’ claims of entitlement to reimbursement for the

opportunity cost of capital used in the treatment .of

Medicare patients. Under Part A of the Medicare Act, 42

U.S.C. §§1395c-1395i-2, which provides hospital insurance

benef'ts to qualified elderly and/or disabled recipients,

hospitals are reimbursed for the “reasonable cost” of

providing services to these recipients. The thrust of the

plaintiffs’ position in this case is that a return on equity isa

reasonable cost under the Act and should be reimbursed.

Title 42 U.S.C. §1395x(v)(1)(A) initially defines reasonable

cost, for provider reimbursement purposes, as:

(v)1)(A) The reasonable cost of any services shall

be the cost actually incurred, excluding therefrom any

part of incurred cost found to be unnecessary in the

efficient delivery of needed health services, and shall

». determined in accordance with regulations

establishing the method or methods to be used, and the

items to be included, in determining such costs for

various types or classes of institutions, agencies, and

services;....

The section further provides the following principle which

is to be used to determine whether costs are or are not re-

imbursable reasonable costs:

Such regulations shall (i) take into account both direct

and indirect costs of providers of services. ..in order

that, under the methods of determining costs, the

necessary costs of efficiently delivering covered

services to individuals covered by the insurance pro-

grams established by this subchapter will not be borne

by individuals not so covered, and the costs with

respect to individuals not so covered will not be borne

by such insurance programs....

The gist of the “necessary costs” requirement is that

hospitals will be reimbursed for costs, either direct or in-

direct, which are attributable to Medicare patients. The

Medicare Program is not to be responsible for costs

incurred on behalf of non-Medicare patients. If indirect

costs are attributable to both Medicare and non-Medicare

A-51

patients, the provider will be reimbursed for the

proportionate share of such indirect costs as are incurred

for the benefits of the Medicare patients. 42 C.F.R.

§405.451(b\(1) and (c\3).

The Secretary of Health and Human Services has the

responsibility for administering the Medicare Program. 42

U.S.C. §1395kk. The Secretary is authorized by Congress to

“prescribe such regulations as may be necessary to carry

out the administration of the insurance programs under

this title.” 42 U.S.C. §1395hh. These regulations are found

in the Code of Federal Regulations, Subchapter B, Part 405

of 42 C.F.R. Chapter IV.

The regulations further delineate the types of costs which

will be allowable under the Program. These regulations

flesh out the general principles laid down in 42 U.S.C.

§1395x(v)(1)(A). One regulation which is at issue in this

case, at least indirectly, is 42 C.F.R. §405.429, which

specifically authorizes a proportionate reimbursement for

return on equity in the case of proprietary (for profit)

hospitals.

§405.429 Return on equity capital of proprietary

providers.

(a) Principle. (1) A reasonable return on equity

capital invested and used in the provision of patient

care is allowable as an element of the reasonable cost of

covered services furnished to beneficiaries by pro-

prietary providers....

(2) For the purposes of this subpart, the term

“proprietary providers” is intended to distinguish

providers, whether sole proprietorships, partner-

ships, or corporations, that are organized and

operated with the expectation of earning profit for the

owners, from other providers that are organized and

operated on a nonprofit basis.

(b) Application—(1) Computation of equity

capital. Proprietary providers generally do not

receive public contributions and assistance of Federal

A-52

and other governmental programs in financing

capital expenditures. Proprietary institutions his-

torically have financed capital expenditures through

funds invested by owners in the expectation of earning

a return. A return on investment, therefore, is needed

to avoid withdrawal of capital and to attract

additional capital needed for expansion....

Presumably for the reasons expressed in subsection (b),

above, the Secretary has made no analogous provision fora

return on investment costs in the cases of nonproprietary

providers. The plaintiffs in this case are challenging the

Secretary’s disallowance of a proportionate share of their

return on equity costs, primarily on the basis of their per-

ception of the general spirit of 42 U.S.C. §1395x(v)(1)(A)

and on some legislative history.

The first Medicare Regulations, issued by the Secretary

in 1966, authorized a reimbursement of an additional 2% of

total allowable costs for nonproprietary facilities as

compensation for otherwise unspecified costs. One of the

costs included in the 2% was a return on equity capital. (See

Proposed HEW i.egulations, §§ 405.402(e) and 405.428(b)

(1966); statements of the Commissioner of Social Security,

Robert M. Ball in the Hearings on Reimbursement Guide-

lines for Medicare Before the Senate Committee on

Financing, 89th Congress, 2d Sess., at 55-56 (1966), R.

0501-2; and Mr. Ball’s comments in the 1966 Hearings at 72

{R. 0508].) Proprietary hospitals were only given a 1-to-1-

1/2% additional reimbursement. The regulation expressly

recognized that proprietary hospitals had already been

given a return on equity capital reimbursement under

§1395x(v)(1)(B) and 42 C.F.R. §405.429. 42 C.F.R. §405.428

(formerly 20 C.F.R. §405.428).

It is clear that the nonproprietary providers’ 2%

allowance did include a return on equity capital: it is

equally clear that Congress heard discussion of the return

on equity issue before these regulations were passed. The

problems at issue for the nonproprietary hospital plaintiffs

A-53

began in June, 1969, when the Secretary dropped both the

2% and the 1-1/2% allowances. 34 Fed.Reg. 9927 (June 27,

1969). As a result, the nonproprietary providers are left

with only the “reasonable cost” definition found in 42

U.S.C. §1395x(v)(1)(A). Proprietary providers may still be

reimbursed for return on equity capital costs pursuant to

42 C.F.R. §405.429, the regulatory counterpart of

§1395x(v)(1)(A).

The plaintiffs in this case now contend that a return on

equity is a “reasonable cost” and that it is anomalous to

grant a return on equity capital reimbursement to

proprietary but not to nonproprietary providers. The argu-

ments which shore up their contention that Congress

intended that all providers be reimbursed for return on

equity expenses are based primarily on postenactment

legislative history and on more generalized arguments that

this expense is a “reasonable cost” within the meaning of 42

U.S.C. §1395x(v)(1)(A).

(a) Authority of the Secretary

It is necessary to dispense with two minor arguments

made by the plaintiffs before reaching the merits of the

return on equity capital issue. The hospitals contend that

great deference should be given to the PRRB’s decision in

favor of the hospitals on the return on equity issue. The

decision in favor of the providers was reversed by the

Deputy Administrator.

Title 42 U.S.C. §139500(f) states that:

(f) A decision of the Board shall be final unless the

Secretary, on his own motion, and within 60 days after

the provider of services is notified of the [Provider Re-

imbursement Review] Board’s decision, reverses, af-

firms or modifies (adversely to such provider) the

Board’s decision. In any case where such a reversal or

modification occurs the provider of services may

obtain a review of such decision by a civil action

commenced within 60 days of the date he is notified of

the Secretary’s reversal or modification. Such action

A-54

shall be brought in the district court of the United

States for the judicial district in which the provider is

located or in the District Court for the District of

Columbia. ...

The Secretary delegated the power to review PRRB

decisions to the Administrator of the Health Care

Financing Administration, 42 Fed. Reg. 57351 (Nov. 2,

1977). That delegation specifically anticipated the

possibility of redelegation, stating that “(t]he authority in

Section 1878(f) [42 U.S.C. §139500(f)]...may only be

redelegated to the Deputy Administrator.” On September

5, 1979, the Administrator redelegated his authority to

review PRRB decisions to the Deputy Administrator.

The hospitals contend that these delegations were

against the will of Congress, since Congress had authorized

the Secretary to review the Board’s decisions. Therefore,

they state, the decision of the PRRB is final and the Court

has no jurisdiction over this matter. The cases cited by the

plaintiff are not on point.

The usual concern of courts in situations of delegation is

that important quasi-judicial final decisions not be made

by minor subordinates. This is not the case here. First, it is

ludicrous to suppose that the Secretary of Health and

Human Services could review all PRRB decisions

personally. Second, the Deputy Administrator is not a

minor official. Third, the very statute upon which the

plaintiffs rely, 42 U.S.C. §139500(f), provides for judicial

review of the Secretary’s decisions.

The Ninth Circuit Court of Appeals has held delegations

under HHS’s earlier, but analogous, organizational struc-

ture to be proper:

Under the Medicare Act, it is the Secretary who may

reverse or modify a decision of the PRRB. 42 U.S.C.

§139500(f). However, section 8.D of HEW’s “State-

ment of Organization, Functions and Delegations of

Authority,” 33 Fed.Reg. 5836 (1968), delegates the

functions of the Secretary under the Medicare Act to

A-55

the Commissioner of Social Security. The District

Court correctly found that this was a proper delega-

tion, and was properly exercised in this case.

Pacific Coast Medical Enterprises v. Harris, 633 F.2d 123

(9 Cir. 1980).

The delegations of authority to review PRRB decisions

by the Secretary to the Administrator, then to the Deputy

Administrator were valid. This Court may review the

decision, albeit made by the Deputy Administrator. The

reversal of the PRRB must be reviewed as the Secretary’s

own decision. Not only was the review of the PRRB’s

decision pursuant to a valid exercise of authority, but the

Secretary’s decision to deny reimbursement for return on

equity must be given a great degree of deference.

(b) Standard of Review

The standard of review of §139500(f) decisions is

specified to be that established by the Administrative Pro-

cedure Act (APA), 5 U.S.C. §§701-706. Section 706 of the

APA provides that “the reviewing court shall decide all

relevant questions of law, [and] interpret constitutional

and statutory provisions,” and that the court “hold

unlawful and set aside agency action, findings and

conclusions found to be...arbitrary, capricious, an abuse

of discretion, or otherwise not in accordance with law;...”5

U.S.C. §706.

This “arbitrary, capricious, abuse of discretion”

standard is not the equivalent of a de novo review. A recent

Ninth Circuit case dealt with the nature of judicial review

of a decision by the Secretary of Health, Education and

Welfare in the context of a Medicare reimbursement

dispute. The Secretary’s decision interpreted the

reasonable return on equity regulation, 42 C.F.R. §405.429.

Pacific Coast Medical Enterprises v. Harris, 633 F.2d 123

(9 Cir. 1980). The court, after setting out the standard of

- review contained in the APA (5 U.S.C. §706, above), stated:

A-56

The primary question before us is whether the

Secretary may interpret and apply the Medicare

regulations above as he has done in denying PCME’s

claims. [Footnote omitted.] Generally, when a

meaning of a provision within the expertise of an

agency is involved, the courts will afford deference to

that agency’s construction. In such cases, the agency's

expertise make [sic] it particularly suited to interpret

the language. This is especially true when an agency’s

own regulation is involved, and ordinarily its

construction will be affirmed if it is not clearly

erroneous or inconsistent with the regulation.

[Citations omitted. ]

The deference which a reviewing court is to afford to

an agency’s interpretation of its regulations is not

total, however....As where courts review an agency’s

construction of a statute which the agency ad-

ministers, “the deference owed to an expert tribunal

cannot be allowed to slip into a judicial inertia... .”

[Citations omitted.] Even though the Medicare re-

imbursement area is complex, and to a great degree

left to the Secretary to structure, [footnote omitted ] his

interpretations are nonetheless subject to our

examination.

Id. at 130-31.

The Court in this instance must give deference to the way

in which the Secretary interprets his own regulations.

However, there is no obligation for the Court to defer to the

agency in such matters as challenges to the constitu-

tionality of the Medicare regulatory or statutory scheme.

If, for example, a regulation or a construction thereof

conflicts with the authorizing congressional statutes or

policies underlying those statutes, deference to the Secre-

tary’s opinion comes to a halt. /d., at 131-32. Thesame APA

standard of review applies to judicial review of decisions of

the PRRB. Good Samaritan Hospital, Corvallis v.

Mathews, 609 F.2d 949, 951 (9 Cir. 1979).

The plaintiffs have suggested that the ordinary degree of

A-57

deference to the Secretary’s expertise be lessened in this

case because the Secretary reversed the PRRB on the issue

of return on equity capital. The government has pointed out

that the PRRB now has decided to follow the Secretary’s

position on the return on equity issue. At this point in the

proceedings it does not matter what the PRRB has done.

The Secretary has ultimate responsibility and decision-

making authority over the Medicare program. It is his deci-

sion (the Deputy Administrator’s) that the Court is called

upon to review. As noted in American Medical Interna-

tional, Inc. v. Secretary of Health, Education and Welfare,

466 F.Supp. 605 (D.DC. 1979), another Medicare re-

imbursement case:

Plaintiffs, however, suggest that this Court deviate

from the normal rule of deference in this case because

the decision of the Provider Reimbursement Review

Board differed in substantial part from the

Secretary’s final decision. As noted, review by this

Court shall be “pursuant to the applicable provisions

[of the Administrative Procedure Act].” 42 U.S.C.

§139500(f). [Footnote omitted.] It is well settled that,

under the APA, final responsibility for rendering the

decision lies in the agency itself, not in any subordinate

hearing officers. This is because it is the agency, not

any subordinate officers such as the Provider

Reimbursement Review Board, that is charged with

the responsibility for implementing and adminis-

tering the agency’s program.

Id., 466 F.Supp. at 611. In essence, once the Secretary, or in

this case the Deputy Administrator of the Health Care

financing Administration, makes his decision, it is

immaterial what the PRRB did. This Court is reviewing, in

accordance with APA guidelines, the decision of the

Secretary.

(c) Isa Return on Equity Capital a Reasonable Cost for

Nonproprietary Providers Under 42 U.S.C. §1395a(v)(1)(A)?

The stance of the Department of Health and Human Ser-

A-58

vices on this issue is that nonproprietary providers may not

recoup any Medicare funds for a return on equity. The

rationale of the Deputy Administrator is that there is no

regulation that authorizes the reimbursement, so if the

hospitals are to recover these amounts, it must be done as a

reasonable cost under §1395x(v)(1)(A). The Department’s

analysis of this statute and its conclusions is set out in the

Deputy Administrator’s opinion in the group appeal now

before the Court:

It would appear that if a return on equity capital were

paid to non-profit hospitals, Medicare would be paying

a disproportionate share of provider costs. This is be-

cause the return is a profit rather than a cost. Under

Section 1861(v)(1)(A) of the Act and the supporting

regulations, Medicare reimburses all of a provider’s

reasonable costs in caring for Medicare beneficiaries.

This includes a proportionate share of the cost of

capital investment related to patient care such as a

building or equipment.

In this case, the Board found that non-profit providers

need the funds from the return on equity capital for

capital investment purposes, and to cover the costs of

bad debts and charity allowances. However, under

these circumstances, Medicare would be paying an

amount in excess of its share of reasonable cost. This

excess would be used to satisfy the burden of non-

Medicare patients. This is contrary to the mandate in

Section 1861(v)(1)(A) of the Act and the Board’s find-

ing in this regard is clearly erroneous.

Based on the specific wording of Section 1861(v)(1B)

of the Act and 42 CFR 405.429, and the Congressional

comments, the Deputy Administrator finds that a

return on equity capital is not an element of reasonable

cost for non-profit providers. It is not an out-of-pocket

cost and was not the type of cost contemplated as

reasonable, either direct or indirect, when Section

1861(v)(1A) was enacted. Section 1861(v)(1)B) was

enacted because under Section 1861(v)(1)(A) alone a

return on equity capital could not be paid to

A-59

proprietary providers. Therefore, the Board’s reliance

on Section 1861(v)(1)(A) in this regard is erroneous.

The Secretary’s position in regard to 42 C.F.R. §405.429

(quoted above, concerning return on equity for proprietary

hospitals) is correct. The terms of this statute are explicit in

the distinction between proprietary and nonproprietary

providers insofar as the return on equity issue is concerned.

(In accord, Valley View Community Hospital v. United

States, No. 126-80C (Slip Op., U.S. Court of Claims, May 19,

1982), 931,978, CCH Medicare and Medicaid Guide.) The

rationale for the distinction expressed in the regulation is

that proprietary providers must raise capital through

funds invested by owners in the expectation of earning a

profit. Alternatively, nonproprietary hospitals have other

sources of funding, i.e., public contributions and govern-

mental programs. /d., 931,978 Medicare and Medicaid

Guide, at 9748. The plaintiffs have not brought forward any

regulations which affirmatively authorize a return on

equity for nonprofit hospitals. They are relegated to the

very general reasonable cost standard defined in

§1395x(v)(1)(A).

As noted above, the Secretary’s position is that the intent

of Congress, as set forth in §1395x(v)(1)(A), in light of its

legislative history, is that a return on equity is not a reason-

able cost. This is also the position of the courts which have

viewed this issue.

The legislative history of the return on equity issue has

been quoted exhaustively by both parties to this litigation.

It has also been summarized in Hospital Authority of Floyd

County, Georgia v. Schweiker, 522 F.Supp. 569 (N.D.Ga.

1981).

The plaintiffs’ argument that a return on equity is a

reasonable cost under §1395x(v)(1)(A) is not borne out by

the legislative history. The bulk of the plaintiffs’ authority

is testimony from the transcript of the 1966 Senate Finance

Committee hearings on the issue of reimbursement guide-

lines. These hearings were held nearly a year after the

A-60

Medicare Act was passed by Congress. “Such post-

enactment history is not the surest guide of the legislative

intent in initially passing the Act. Cf Rogers v. Frito-Lay,

Inc., 611 F.2d 1074 (5th Cir. 1974) [cert. den. Moon v.

Roadway Express, Inc., 449 U.S. 889, 101 S.Ct. 246, 66

L.Ed.2d 115 (1980)]. Nevertheless, the testimony of the

witnesses and the remarks of the Senators are quite

instructive.” Floyd County, supra, 522 F.Supp. at 569.

The plaintiffs have placed great stock in statements

made by Robert Ball, the Commissioner of Social Security,

who agreed with the policy of including a return on equity

factor in the 2% allowance, because giving a return on

equity solely to proprietary hospitals would foster the

“anomalous result” of “reimbursing a profitmal.ing organi-

zation more than a nonprofit organization for rendering

exactly the same service—solely by reason of allowing

return on investment in one case but not the other.”

Reimbursement Guidelines for Medicare: Hearing before the

Committee on Finance, United States Senate, 89th Cong.,

2d Sess. (Comm. Print, May 25, 1966), at 56 (hereinafter

“Hearings”). Mr. Ball and Mr. Willcox, the General

Counsel of Social Security agreed that a return on invest-

ment was “some bit of this 2% item.” /d., at 107. “The Senate

Committee, in short, was being told by the Commissioner

{Mr. Ball] that no return on equity capital was allowed

explicitly, but that a return on equity capital was discreetly

included in the 2% allowance.” Floyd County, supra, at 572.

The idea that even the proponents of a return on equity

capital classified it as a portion of the 2% allowance rather

than as aautomatic “reasonable cost” is significant. Shortly

after the hearings Congress amended the Act to provide

explicitly for a return on equity to proprietary facilities.

Title 42 U.S.C. §1395x(v)(1)(B), the statutory counterpart

of 42 C.F.R. §405.429, provides:

(B) Such regulations in the case of extended care

services furnished by proprietary facilities shall

include provision for specific recognition of a reason-

A-61

able return on equity capital, including necessary

working capital, invested in the facility and used in the

furnishing of such services, in lieu of other allowances

to the extent that they reflect similar items[i.e., the 2%

allowance]. ...

Section 1395x(v)(1)(B) and 42 C.F.R. §405.429 remained

after the 1969 decision to discontinue the 1-1/2% and 2%

allowances. The following lengthy portion of the Floyd

County analysis of the legislative history reveals that the

understanding of the Congress was that a return on equity

was not provided in the original Act and that it was not

within the ambit of a §1395x(v)(1A) reasonable cost:

Having traced the footprints on the trail of legislative

enactment, the Court concludes that it was not the

intent of Congress to provide an allowance for a return

on equity capital to all facilities. In reading the

transcript of the Senate hearing, it is apparent that the

Committee basically approved the Secretary’s

proposal to table the issue of providing such an

allowance. This is what the Health Insurance Benefits

Advisory Council recommended, and this recom-

mendation was passed on to the Committee. The deci-

sion to amend the Act in October, 1966 to provide for

the allowance for proprietary facilities evidences Con-

gressional intent to reverse the former policy of simply

obscuring the allowance as a “bit” of the 2% allowance.

The exchanges at the Hearing between various

Senators and Mr. Ball and other administrative

officials make it quite unequivocal that the Senate

Committee members believed that a return on equity

capital was not, and should not, be provided. For

example:

THE CHAIRMAN [Sen. Russell B. Long]. But did

you have the impression anywhere that the con-

gressional intent was that we should have allowed

imputed interest on capital?

Mr. Myers[Chief Actuary, Social Security Ad-

A-62

ministration]. No. In making the cost estimates, I

had no thought that that would be done.

THE CHAIRMAN. What we are talking about is

an item neither you nor we had any idea of allow-

ing. I never had an idea we were going to allow

imputed interest. Nobody, so far as I know, in

your Department—did your Department have

any idea that we were going to allow imputed

interest? .

Mr. BALL. No, Mr. Chairman. And I think one

of the main reasons that the staff resisted the

tendency of the Health Insurance Benefits

Advisory Council to move to this position was not

necessarily on the merits of the economic argu-

ment, but the fact that it had not been considered,

and that it therefore ought to be postponed. That

was the thought there.

MR. BALL. Senator, I think the language of the

law “reasonable cost” is open to a great variety of

interpretations. The discussion, the legislative

history, the committee report, pinned that down

considerably.... I was answering literally the

question of whether the term “reasonable cost”

could have included such things [e.g. return on

equity capital].

But I don’t think it would have been reasonable

to so interpret the term in the light of the discus-

sions and the legislative history.

) ee

SENATOR WILLIAMS. In computing the costs in-

curred, how can you get an estimate for interest

which is not owed, not paid? How can you get an

allowance for an interest charge not owed and not

paid, if you are going to stick to the formula of

actual costs incurred? .

MR. BALL. We did not accede to this argument

for allowing an interest return on equity capital.

Hearings, 49-51.

A-63

Mk. COHEN [Under Secretary]. I think the

point, Senator, is that Congress did, in setting up

the concept of reasonable cost, intend for us to

reflect what the economic cost of hospital care

was. And as Mr. Gordon says, if you were going to

pay for the interest on borrowing the money it

seems to us to be reasonable to try to reflect in the

cost what is actually the incurred cost of a hospital

when it has to operate. So while it was not dis-

cussed in those specific terms, I think it is

absolutely consistent with the intent of Congress

that what the program should pay should really

reflect what the economic cost is for a hospital in

providing these services.

SENATOR ANDERSON. I just could not disagree

with you more. We discussed this over and over

and over again, and rejected that in the com-

mittee. I just cal! your attention to the committee

report, page 33:

The cost of the hospital services varies

widely from one hospital to another, and the

variations reflect differences in quality and

cost. The same thing is true with respect to

the cost of services provided. The provision in

this bill for the payment of reasonable cost of

services is intended to meet the actual cost.

“Actual.” This is not economic or fanciful or any-

thing else. We put it in there so they could not

bring in the various things you are talking about

now. How do you get around this?

MR. COHEN. Well I think this is the actual cost. I

think when you are talking about economic

costs—

*_ * *

SENATOR ANDERSON. Just one more question

from page 37 of the report which I think should

have some importance to you. I really believe

when a committee goes to the extent of preparing

a report, and filing it, and telling the Congress. .

A-64

and the people that this is what they mean, it is

wrong to try to reinterpret it some other way.

In paying reasonable cost, it should be the

policy of the insurance program to so

reimburse a hospital or other provider that

an accounting may be made at the end of

each cost period for costs actually incurred.

Not beneficiarily incurred, or anything else—

“actually incurred.” And if you don’t pay interest

on a debt, that is not a cost that it actually

incurred.

id. at 69-70.

At the outset of the hearing, Senator Long, the

Chairman, outlined the various topics to be discussed:

Three. Can the reasonable cost include a return on

investment for proprietary institutions without a

similar payment to the nonprofit facilities. And

that is a fair question to be raised. It seems to me

that it was intended that there should be a return

on investment to proprietary institutions—and

that there is no similar requirement that they be

made to public or nonprofit groups.

id. at 43.

In addition, when the Act was amended in October,

Congressman John W. Byrnes of Wisconsin stated,

“(Under existing law] the amount that will be paid to

the individual nursing home or facility—shall be, and

I quote, ‘the reasonable cost’ of furnishing such care. In

other words, as the law now stands, fundamentally all

the Social Security Administration can pay are the

costs, with no allowance for profits or a return on the

invested capital.” 112 Cong. Rec. 28220(1966). Senator

Long made a similar statement to the Senate, “As the

proposed Medicare regulations stood [an investor]

would only have been reimbursed for the actual costs

of providing services with no specific return given on

his investment.” 112 Cong. Rec. 27608 (1966).

Floyd County, supra, at 572-74.

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—. “

a" :

2

A

This Court concludes, as did the district court for the

Northern District of Georgia, id., at 575, that a payment for

a return on equity capital is not within the scope of

§1395x(v)(1)(A). The plaintiffs have brought forward no

cases which stand as authority for the proposition that a

return on equity is a §1395x(v)(1)A) reasonable cost. —

Rather, they have relied on: (1) the PRRB’s decision, (2)

general policy statements which assert that a policy of

nonreimbursement for nonproprietar) providers would

violate the mandate of §1395x(v)(1)A) in that a heavier

share of costs would be borne by non-Medicare patients,

and (3) analogies to indirect costs which are reimbursed

(i.e., straight line depreciation, 42 C.F.R. §405.415, the

1966-1969 2% allowance, 20 C.F.R. §405.428, interest on

some loans, 42 C.F.R. §405.417(cX2), and return on net

assets to proprietary hospitals, 42 C.F.R. §405.429).

None of these arguments addresses the critical question:

did the Secretary misconstrue the statute in denying a

return on equity? Given the legislative history quoted

above, it is clear that not only did Congress not consider a

return on equity when it passed the Medicare Act, it

specifically viewed this item during the 1966 Hearings as

an expense which did not fall within the purview of

§1395x(v)(1)(A). When the 2% allowance, some “bit” of

which was a return on equity, was abandoned in 1969, the

expense, as to nonproprietary providers, returned to its

status as a nonreimbursable expense. In light of its

legislative history, 42 U.S.C. §1395x(v)(1MA) cannot be

stretched to cover this item of cost.

Another district court which has considered this issue of

whether a return on equity is a reasonable cost was

recently upheld by the Court of appeals for the District of

Columbia Circuit. American Medical International, Inc. v.

Secretary of Health, Education and Welfare, 466 F. Supp.

605 (D.D.C. 1979), aff'd, 677 F.2d 118 (D.C. App. 1981). In

American Medical International the court discussed

return on equity capital because the plaintiffs had

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analogized it to the stock maintenance costs for which they

sought reimbursement. The district court stated:

Plaintiffs argue that stock maintenance costs,

though related to investment, should be reimbursed

because Medicare allows proprietary providers a

return on equity capital. 42 U.S.C. §1395x(v)(1)(B).

[Footnote omitted.] By allowing this payment,

plaintiffs contend, the Medicare program expressly

recognized that costs related to investment may be

reimbursed. This argument assumes that the return

on equity capital in §1395x(v)(1)(B) is a reasonable cost

within the meaning of §1395x(v)(1)(A). However, this

return on equity provision was added subsequent to

the passage of the Medicare Act and it constitutes the

sole exception to the basic Medicare principle that

reimbursement be limited to those costs actually

incurred in providing patient care services. It is clear

from the purpose behind the return on equity

provision (§1395x(v)(1)(B)), its legislative history, and

the provision itself that the return on equity capital

provision cannot be used by plaintiffs to support the

position that reasonable costs under 42 U.S.C.

§1395x(v)(1)(A) was meant to include costs for

investment.

Id., 466 F. Supp. at 613. (In accord, Valley View, supra.)

Therefore, the Secretary did not misinterpret

§1395x(v)(1)(A), nor do the regulations conflict with the

statutory scheme. Although the plaintiffs’ policy

arguments might have been convincing during the initial

stages of legislative debate on the Medicare legislation,

they were not accepted by Congress. It is beyond the

province of the Court to do more than discern the will of

Congress on this issue. A return on equity was not within

the definition of reasonable cost originally. Since Congress

has done nothing to change the statute in the 13 years since

the demise of the 2% allowance, this Court cannot proclaim

a return on equity capital to be &@ §1395x(v)(1)(A)

reasonable cost.

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(d) Does the Statutory or Regulatory Scheme Violate the

Just Compensation Provision of the Fifth Amendment?

The plaintiffs content that if the statutory or regulatory

schemes deny a return on equity to nonproprietary

providers, they are constitutionally infirm. The hospitals

urge that such provisions would violate the Fifth

Amendment’s mandate that “private property. ..[not] be

taken for public use without just compensation.” The

plaintiffs have presented the Court with no cases which

support this position. They urge that being denied

compensation for the opportunity cost of the assets used in

furnishing care to Medicare patients is unjust compensation.

If the United States does not pay them for the opportunity

cost, the plaintiffs claim that the government is not

compensating them sufficiently for property it has taken.

These opportunity cost arguments go to the compensation

element and do not need to be answered since the “taking”

element of the just compensation clause has not been

violated. The plaintiffs have stated that the hospitals are in

positions akin to those of public utilities. (Relying on Smyth

v. Ames, 169 U.S. 466, 18 S. Ct. 418, 42 L.Ed. 819 (1898).)

The basic principle of Smyth, as stated by the plaintiffs, is

that when a business dedicates a portion of its property to

activities deemed to be affected with a public interest, the

Constitution guarantees that the property will not be used

for the public benefit without just compensation being paid

for the services rendered.

There has been no taking in this case. The utilities cases

relied upon by plaintiffs are analogous to the case at bar,

but there are important distinctions which prevent the

application of the just compensation clause to this issue.

Smyth was a case in which the state regulated railroad

charges. The parties in Smyth were railroads and

stockholders of railroads, which were for-profit

corporations. The plaintiffs in the instant case are

nonprofit hospitals: the payment distinctions on the return

on equity issue are made on the basis of the differences

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between profit-making and nonprofit organizations (see 42

C.F.R. §405.429 and the equal protection discussion below.)

The Court identified as unconstitutional takings of

property in which property is “wrested” from its owner for

the benefit of another or for the public. Jd., 169 U.S. at 524-

25, 42 L.Ed. at 841. The prohibition was against “a tariff of

rates which is so unreasonable as to practically destroy the

value of property of companies engaged in the carrving

business....” Jd., 169 U.S. at 525, 42 L.Ed. at 841. This

“wresting away” and “practically destroying the value of

the property” has evolved into a standard which demands

at a minimum some loss of use.

The plaintiffs in this case have not demonstrated this

type of loss. They have volunteered to participate in the

Medicare program. They can terminate their participation

now. They may sell their physical plant at any time.

A district court for the Eastern District of New York

recently dealt with the just compensation clause’s “taking”

requirement in a similar case involving Medicaid

reimbursement provisions. Hempstead General Hospital v.

Whalen, 474 F. Supp. 398 (E.D.N.Y. 1979), aff'd without

opinion, 622 F.2d 573 (2 Cir. 1980). The plaintiffs in that case

challenged federally approved state limitations on capital

cost reimbursements to potential purchasers of health care

facilities. They contended that thése capital reimbursement

limitations constituted a taking because they eliminated

many potential buyers of health care facilities. The

Medicaid regulations at issue limited capital reimburse-

ment of purchasers to the net depreciated value of the

property rather than to either the purchase price or the fair

market value. After reviewing the recent just compensation

cases, the Court held that there was no taking in spite of the

fact that there was a greatly lessened market for hospital

facilities and the regulations “impose upon plaintiffs a

constantly diminishing potential sale price.” /d., 474 F.

Supp. at 411.

The reasoning of the Hempstead court for the finding of

, A-69

~

no taking is that critical elements of governmental invasion

were missing:

As before, plaintiffs have full right to use the medical

center property. The challenged regulations impose

no direct legal restraint upon the property or upon its

use. There has been no physical entry by the state, no

ouster of the owner, no legal interference with

plaintiffs’ physical use, possession or enjoyment of the

medical center, nor any legal interference with the

owner’s power of disposition of the property.

Id., at 410-11.

The New York court held that the regulations did not

constitute a de facto taking, which requires a “physical

entry by the condemnor, a physical ouster of the owner, a

legal interference with the physical use, possession or

enjoyment of the property or a legal interference with the

owner’s property of disposition of the property.” Jd., at 410,

citing City of Buffalo v. J.W. Clement Company, 28 N.Y.2d

241, 253; [821 N.Y.S. 345, 356; 269 N.E.2d 895, 902] (1971).

Neither did the regulations come within the ambit of the

cases which deal with unconstitutional regulation of

utilities since the plaintiffs “have not lost any existing right

of property or contract.” Hempstead, supra, at 410. Within

the context of the utility overregulation cases, the court set

forth the following rule:

Many kinds of legislative and administrative action

affect property values, but, without some diminution

in the owner’s right of use, do not constitute a taking

within the purvue of the Fourteenth Amendment.

Chacon v. Granata, 515 F.2d 922, 925 (CA5 1975), cert.

yy 423 U.S. 930, 96 S. Ct. 279, 46 L.Ed.2d 258

(1975).

Id.

The instant case also lacks elements necessary for a

taking. The return on equity rules may not be what the

hospitals would design for themselves, but since these

plaintiffs retain full rights and control over their net

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investment, the statutory scheme is not constitutionally

deficient.

(d) Does the Statutory or Regulatory Scheme Violate the

Equal Protection Clause of the Fifth Amendment?

The plaintiffs claim that the Fifth Amendment is

violated if the Medicare statutes and regulations allow or

disallow a return on equity solely on the basis of whether a

provider is proprietary or nonproprietary. This equal

protection argument can only be proved under the Fifth

Amendment if the discrimination is “so unjustifiable as’to

be violative of due process.” Shapiro v. Thompson, 394 U.S.

618, 642, 89 S. Ct. 13822, 22 L.Ed.2d 600, 619 (1969);

Schneider v. Rusk, 377 U.S. 163, 168, 84 S. Ct. 1187, 12

L.Ed.2d 218, 222 (1964). Therefore, the due process clause

of the Fifth Amendment guarantees equal protection.

United States Department of Agriculture v. Moreno, 413

U.S. 528, 533 n.5, 93 S.Ct. 2821, 37 L.Ed.2d 782, 787 n.5

(1973).

The plaintiffs have attempted to support its claims that

this distinction is discriminatory with statements by

Robert Ball (the “anomalous result” testimony from the

Hearings, quoted above), a 1966 Memorandum of the

Comptroller General of the United States in favor of the 2%

allowance and unsupported assertions that the distinction

between proprietary and nonproprietary providers is

neither rational nor reasonable insofar as the return on

equity issue is concerned.

The standard to be applied in cases in which the constitu-

tionality of a social welfare program is challenged is the

same low level of scrutiny that is applied to legislation

regulating business. Weinberger v. Salfi, 422 U.S. 749, 771-

72, 95 S. Ct. 2457, 45 L.Ed.2d 522, 542-43 (1975). Salfi cited

with approval social welfare legislation cases (Richardson

v. Belcher, 404 U.S. 78, 92 S. Ct. 254, 30 L.Ed.2d 231 (1971);

Dandridge v. Williams, 397 U.S. 471, 90 S. Ct. 1153, 25

L.Ed.2d 491 (1970); and Flemming v. Nestor, 363 U.S. 603,

80 S. Ct. 1867, 4 L.Ed.2d 1435 (1960)) which “establish that

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a statutory classification violates due process only if it is

‘patently arbitrary. .., utterly lacking in rational justifica-

tion.’ 363 U.S. at 611. They establish that a classification

violates equal protection only if it lacks a reasonable basis:

there is no violation merely because the classification is

‘imperfect,’ or “‘not made with mathematical nicety or

because in practice it results in some inequality.” 397 U.S.

at 485-86.” Caylor-Nickel Hospital, Inc. v. Califano, Civil

No. F 77-83 (N.D.Ind. Sept. 10, 1979) 430,718, CCH

Medicare and Medicaid Guide. In Caylor-Nickel, Judge

Eschbach, with specific reference to the return on equity

provisions, held that the regulations which “provide for

profit institutions but not to nonprofit institutions” are

sufficiently rationally based to satisfy Salfi. Id., 430,718,

Medicare and Medicaid Guide at 9098. The reasons for this

finding of sufficient rationality to sustain the constitu-

tionality of the statutory and regulatory scheme are that:

It is certainly rational that profit institutions receive

this advantage when nonprofit institutions receive

numerous other advantages, such as various grants

and contributions, and tax-exempt status. The

purpose and rationality of this classification is made

clear in 42 U.S.C. §1395x(v)(1)(A) and in the legisla-

tive history.... The distinction drawn between profit

and nonprofit institutions violates nothing in the fifth

amendment. See Am. Med. Int'l, Inc. v. Sec. of H.E. W.,

466 F. Supp. 605, 615 (D.C. Dist. Columb. 1979).

Other cases which have accepted the rationality of the

distinction between proprietary and nonproprietary pro-

viders in the context of equal protection challenges are

Valley View, supra; Stevens Park Osteopathic Hospital,

Inc. v. United States, 633 F.2d 1373 (Ct.Cl. 1980); and Floyd

County, supra. Another explanation of the rationality of

this distinction, which relies upon the section of Judge

Eschbach’s opinion quoted above, states:

Both the Senate Finance Committee staff report and

G.A.O. report outline various reasons why profit and

nonprofit institutions should be treated differently.

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Nonprofit institutions have various benefits which are

unavailable to proprietary institutions: tax benefits,

Hill-Burton grants, charitable donations, and

numerous other advantages created by the state and

federal governments.

Floyd County, supra, 522 F. Supp. at 575-76.

The plaintiffs have brought forward no cases which

refute these findings of rationality. The Court must agree

that the distinction between proprietary and non-

proprietary providers is rationally based.

All of the plaintiffs’ return on equity capital claims fail.

As to these issues, the Court must grant the defendant’s

motion for summary judgment.

(4) Bad Debts and Charity Costs

The hospitals ask the Court either to declare a regulation

with respect to bad debts, charity, and courtesy allowances

to be inconsistent with the “reasonable cost” requirement of

§1395x(v)(1)(A), or to rule that it violates the due process

clause of the Fifth Amendment. The hospitals claim that

because bad debts and charity not attributable to Medicare

patients are categorized by accountants as economic costs

of running a hospital, the Medicare program should

reimburse them for a proportionate share of these costs.

The Secretary has great leeway to formulate standards

for the determination of which are “reasonable costs” under

42 U.S.C. §1395x(v)(1)(A). In 1966, the Secretary

promulgated the following regulation, now challenged by

the plaintiffs:

§405.420 Bad debts, charity, and courtesy allowances.

(a) Principle. Bad debts, charity, and courtesy

allowances are deductions from revenue and are not to

be included in allowable cost; however, bad debts

attributable to the deductibles and coinsurance

amounts are reimbursable under the program.

(b) Definitions—(1) Bad debts. Bad debts are

A-73 .

amounts considered to be uncollectible from accounts

and notes receivable which were created or acquired

in providing services. “Accounts receivable” and

“notes receivable” are designations for claims arising

from the rendering of services, and are collectible in

money in the relatively near future.

(2) Charity allowances. Charity allowances are

reductions in charges made by the provider of services

because of the indigence or medical indigence of the

patient.

(3) Courtesy allowances. Courtesy allowances

indicate a reduction in charges in the form of an

allowance to physicians, clergy, members of religious

orders, and others as approved by the governing body

of the provider. Employee fringe benefits, such as

hospitalization and personnel health programs, are

not considered to be courtesy allowances.

(c) Normal accounting treatment: Reduction in

revenue. Bad debts, charity, and courtesy allowances

represent reductions in revenue. The failure to collect

charges for services rendered does not add to the cost

of providing the services. Such costs have already been

incurred in the production of the services.

(g) Charity allowances. Charity allowances have

no relationship to beneficiaries of the health insurance

program and are not allowable costs. The cost to the

provider of employee fringe-benefit programs is an

allowable element of reimbursement.

From the above it will be noted that plaintiffs are specif-

ically allowed to collect every penny of bad debts

attributable to the deductibles and coinsurance amounts

which Medicare patients fail to pay. In other words, pay-

ments are reduced in the first instance by applicable

deductibles and coinsurance amounts, 42 U.S.C. §1395e; 42

C.F.R. §405.110(b). Notwithstanding such fact, the amount

of these reductions is eventually paid to plaintiffs to the

extent that plaintiffs are not otherwise able to collect the

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same. 42 C.F.R. §405.420(a). Since the exact amount of the

bad debts incurred by Medicare patients in the foregoing

areas is reimbursed, it is logical to deny reimbursement,

either directly or as an item of overhead, of similar losses of

revenue attributable to non-Medicare patients, in keeping

with the congressional policy as expressed in 42 U.S.C.

§1395x(v)(1)(A).

With respect to charity allowances, this Court has

previously held, in a case which would apply to a great

many of the plaintiffs in this action, that the cost of services

furnished to indigents because of the free care obligation

imposed by the receipt of Hill-Burton Act funds are

indirect costs within the meaning of the Medicare

legislation and as such are proportionately reimbursable.

Johnson County Memorial Hospital, et al, v. Schweiker, 527

F.Supp. 1134 (S.D.Ind. 1981). Beyond that, however, it is

difficult to find a justification for the plaintiffs’ position.

The Congress has said that costs attributable to non-

Medicare patients are not to be borne by the Medicare

program. All of the items excluded by 42 C.F.R. §405.420

(a) are just such costs or, more accurately, lack of revenue.

The challenged regulation appears to be in complete

harmony with both the letter and the spirit of the statute,

and the decision of the Board with respect thereto is

correct.

To summarize, the motion for partial summary

judgment of plaintiff Indiana Hospital Association, Inc. is

denied. The motion of the defendants to dismiss Cause No.

IP 76-522-C for lack of subject matter jurisdiction will be

granted. The final decision of the Secretary is affirmed,

and summary judgment will be rendered in favor of the

defendants in the consolidated cases.

Dated this 12 day of August, 1982.

/s/ SS. HUGH DILLIN

S. Hugh Dillin, Judge.

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HEALTH CARE FINANCING ADMINISTRATION

Decision of the Administrator

In the Case of: Claim for:

INDIANA HOSPITAL ASSOCIATION

GROUP APPEAL No. 1

Provider Cost Reimbursement

Determination of Reasonable Costs

for Cost Reporting Period(s)

Provider Ending

Various

vs.

° Review of:

BLUE CROSS ASSOCIATION

MUTUAL HOSPITAL

PRRB Decision No. 79-D95

INSURANCE, INC,

Dated: December 17, 1979

Intermediary

This group appeal is before the Administrator, Health

Care Financing Administration, for review on own motion

of the decision entered on December 17, 1979, by the Pro-

vider Reimbursement Review Board. The review is under-

taken pursuant to Section 1878(f\1) of the Social Security

Act, as amended [42 USC 139500]. Comments were re-

ceived from a division of the Bureau of Program Policy re-

questing that the Board’s decision on Issue No. 2 be

reversed. On January 22, 1980, the parties were notified of

the intention to review the Board’s decision on that issue

and of their right to submit comments during the course of

this review. Comments were received from the Providers

requesting that the Board’s decision be affirmed on Issue

No. 2. No comments have been received from the Inter-

mediary and the time in which to submit them has passed.

Accordingly, the case is now before the Administrator for

final administrative decision.

ISSUES AS STATED BY THE BOARD

“Whether the intermediary properly disallowed re-

imbursement for the following items:

“1. Reimbursement for the cost of uncompensated ser-

vices, including charity allowances and bad debts; and

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“2. Reimbursement for a return on net assets (return on

equity)?”

PROVIDER REIMBURSEMENT REVIEW BOARD

DECISION

Issue No, 1

“The Intermediary properly disallowed reimbursement

for the cost of uncompensated services, including charity

allowances and bad debts,”

PROVIDER REIMBURSEMENT REVIEW BOARD

DECISION

Issue No, 2

“The Intermediary should have allowed reimbursement

for a return on net assets, The adjustments are, accord-

ingly, reversed,”

SUMMARY OF THE DIVISION OF

INSTITUTIONAL SERVICES

REIMBURSEMENT'’S COMMENTS

The Division recommended that the Board's decision on

Issue No, 2 should be reversed because it is contrary to 42

CFR 405.1867 and 405,429, Under 42 CFR 405, 1867, the

Board is explicitly bound by the Medicare regulations,

Under 42 CFR 405.429%a)(1), a return on equity capital is

allowable only to proprietary providers, 42 CFR

405.429(b)\(1) explains that the return is necessary to avoid

withdrawal of capital and attract additional capital, since

proprietary providers do not receive contributions or

governmental assistance. The Bureau stated that the

regulations allowing the return to proprietary providers

only, are consistent with Section 1861(v)(1)(B) of the Act

and Congressional intent. The Board improperly sub-

stituted its judgement for that of ‘the Secretary in inter-

preting the law.

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SUMMARY OF PROVIDERS’ COMMENTS

The Providers commented that the decision of the Board

on Issue No, 2 should be affirmed, Concerning the merits of

the case, the Providers wrote that the Board's decision is in

keeping with Section 1861 (v)(1A) and (®) of the Social

Security Act, as amended, the U.S, Constitution, and is

supported by the testimony, lega: arguments, and the

record before the Board,

The Providers made nine objections concerning the

review of Board decisiuns as being illegal and unconstitu-

tional, They objected to the Secretary's consideration of ad

hoe unsolicited comments from persons not parties to the

appeal as contrary to the law on “own motion” review, and

the due process rights under the Fifth Amendment of the

U.S. Constitution, They objected that the delegation by the

Secretary to the Administrator, of the authority to review

Board decisions, is contrary to the Social Security Actanda

violation of the due process rights of the Providers, In addi-

tion, having staff assistance for preparing findings of fact

and conclusions of law may usurp the authority of the Ad-

ministrator by separately reviewing Board decisions.

The Providers objected to review because final rules

establishing the proper standards of review are necessary

in order to satisfy due process requirements, and that the

present interim procedures are not satisfactory sub-

stitutes. The review of a Board decision using such

standards are in excess of statutory authority. The

Providers pointed out that a decision of the Board may be

reversed only where it is clearly erroneous or not supported

by the record. Also, the Providers were not timely and

properly notified by the Secretary because the notification

did not come directly from the Secretary. The Providers

further objected that the “own motion” review process

violates due process in that there is no hearing, opportunity

for oral argument, or an opportunity to respond to

argument,

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EVIDENCE CONSIDERED

All the evidence that was before the Provider Re-

imbursement Review Board has been considered, includ-

ing the sworn testimony of the witnesses, the position

papers and exhibits by the parties, All communications

and comments received from the Providers and the

Division of the Bureau of Program Policy, after entry of the

Board's decision have been made a part of the record, The

complete statement of facts set forth by the Board in its

decision is incorporated by reference and supplemented as

follows:

The Providers in this group appeal are 68 not-for-profit

or non-profit Indiana hospitals (Providers’ Position Paper

(PPP, p. 8, and Attachment 1)). These hospitals are all

either church affiliated or are owned and controlled by

voluntary foundations, or cities and/or counties, and range

in size from 48 to 1,026 beds (Intermediary’s Position Paper

(IPP, p. 4)). The Providers are represented by the Indiana

Hospital Association whose President, Elton Tekolste, and

Chairman of the Board, Sister Martin, testified at the

hearing. The Providers claimed payment for a return on

equity capital in providing services to Medicare patients,

and for an allocable portion of the reasonable cost of bad

debts and charity care provided (PPP, p. 3).

The President of the Indiana Hospital Association

testified that a hospital needs to receive some type of

operating margin (profit) for capital purposes, for con-

tingencies, and to offset the costs of bad debts and charity

care (Transcript of Oral Hearing (Tr. 27-29)). He further

testified that foundations and charitable gifts have become

less of a factor in capital formation in recent years. Thus, it

has become necessary for hospitals to issue bonds and incur

long term debts (Tr. 30). Sister Martin testified that an

operating margin is necessary to induce investors to

purchase hospital bonds and to enable hospitals to pay off

the bonds (Tr. 38).

The American Hospital Association, in its Statement on

the Financial Requirements of Health Care Institutions

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and Services, states on page 5; “Investors in for-profit

health care institutions are entitled to a reasonable return

on their investments.” On page 12 this document states:

“The formula should provide for a reasonable return on the

investment in for-profit health care institutions,” (PPP,

Exh, P-36, pgs. 5 & 12), This was referred to during the

hearing by a Board member who was appointed as a repre-

sentative of providers and has been a delegate-at-large to

the House of Delegates of the American Hospital Associa-

tion,

The managing partner of the firm of Certified Public

Accountants for the Indiana Hospital Association testified

that in his opinion, the AHA document and the Medicare

program have terminology differences. He testified that in

the AHA they do limit the return on investment to

proprietary institutions. The return is to pay dividends to

shareholders and Federal Income Taxes. This witness

testified, however, that the AHA recognizes price-level

depreciation, whereas Medicare recognizes only historical

cost depreciation, Under price-level depreciation,

providers’ capital requirements are met (Tr. 129-130).

LAW, REGULATIONS, AND OTHER

GOVERNING CRITERIA

Section 1814(b) of the Social Security Act as amended [42

USC 1895f] sets forth, regarding the amounts to be paid

with Medicare funds to providers of services, as follows:

“(b) The amount paid to any provider of services with

es ag to services for which payment may be made

under this part shall, subject to the provisions of

section 1813, [1395e] be—

“(1) the lesser of (A) the reasonable cost of such ser-

vices, as determined under section 1861(v), [1896x] or

(B) me customary charges with respect to such

services; ...”

Section 1861(v1MA) of the Social ‘Security ‘Act, as

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is.

amended [42 USC 1395x], defines reasonable cost and sets

forth the guidelines for regulations:

“(v(1A) The reasonable cost of any services shall

be the cost actually incurred, excluding therefrom any

part of incurred cost found to be unnecessary in the

efficient delivery of needed health services, and shal]

be determined in accordance with regulations estab-

lishing the method or methods to be used, and the

items to be included, in determining such costs for

various types or classes of institutions, agencies, and

services; ...Such regulations may provide for deter-

mination of the costs of services on a per diem, per unit,

per capita, or other basis, may provide for using dif-

ferent methods in different circumstances, may

provide for the use of estimates of costs of particular

items or services, may provide for the establishment of

limits on the direct or indirect overall incurred costs or

incurred costs of specific items or services or groups of

items or services to be recognized as reasonable based

on estimates of the costs necessary in the efficient

delivery of needed health services to individuals

covered by the insurance programs established under

this title, ...Such regulations shall (i) take into

account both direct and indirect costs of providers of

services (excluding therefrom any such costs, includ-

ing standby costs, which are determined in

accordance with regulations to be unnecessary in the

efficient delivery of services covered by the insurance

programs established under this title). ..(ii) provide

for the making of suitable retroactive corrective ad-

justments where, for a provider of services for any

fiscal period, the aggregate reimbursement produced

by the methods of determining costs proves to be either

inadequate or excessive.”

Section 1861(v)(1(B) of the Social Security Act, as

amended [42 USC 1395x], provides for recognition of a

return on equity capital to proprietary facilities furnishing

extended care services:

“(B) Such regulations in the case of extended care

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services furnished by proprietary facilities shall

include provision for specific recognition of a reason-

able return on equity capital, including necessary

working capital, invested in the facility and used in the

furnishing of such services, in lieu of other allowances

to the extent that they reflect similar items. The rate of

return recognized pursuant to the preceding sentence

for determining the reasonable cost of any services

furnished in any fiscal period shall not exceed one and

one-half times the average of the rates of interest, for

each of the months any part of which is included in

such fiscal period, on obligations issued for purchase

by the Federal Hospital Insurance Trust Fund.”

Section 1871 of the Social Security Act, as amended [42

USC 1395hh] explains the Secretary’s authority in

establishing regulations for the program:

“The Secretary shall prescribe such regulations as

may be necessary to carry out the administration of

the insurance programs under this title. When used in

this title, the term ‘regulations’ means, unless the

context otherwise requires, regulations prescribed by

the Secretary.”

Section 1878(d) of the Social Security Act, as amended

[42 USC 139500(d)], states concerning decisions of the

Provider Reimbursement Review Board the following:

“(d) A decision by the Board shall be based upon

the record made at such hearing, which shall include

the evidence considered by the intermediary and such

other evidence as may be obtained or received by the

Board, and shall be supported by substantial evidence

when the record is viewed as a whole... .”

Section 1878(e) of the Social Security Act, as amended

[42 USC 139500(e)], sets forth:

“(e) The Board shall have full power and authority

to make rules and establish procedures, not incon-

sistent with the provisions of this title or regulations of

the Secretary, which are necessary or appropriate to

carry out the provisions of this section... .”

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42 CFR 405.415(e) provides an incentive for funding of

depreciation:

“(e) Funding of depreciation. Although funding of

depreciation is not required, it is strongly recom-

mended that providers use this mechanism as a means

of conserving funds for replacement of depreciable

assets, and coordinate their planning of capital ex-

penditures with areawide planning activities of com-

munity and State agencies. As an incentive for fund-

ing, investment income on funded depreciation will

not be treated as a reduction of allowable interest

expense.”

42 CFR 405.419 sets forth the following principle and de-

finitions regarding interest expense:

“(a) Principle. Necessary and proper interest on

both current and capital indebtedness is an allowable

cost. However, interest cost incurred as a result of

judicial review by a Federal court (as described in

§405.454(1)) is not an allowable cost.

“(b) Definitions—(1) Interest. Interest is the cost

incurred for the use of borrowed funds. Interest on

current indebtedness is the cost incurred for funds

borrowed for a relatively short term. This is usually

for such purposes as working capital for normal

operating expenses. Interest on capital indebtedness is

the cost incurred for funds borrowed for capital

purposes, such as acquisition of facilities and equip-

ment, and capital improvements. Generally, loans for

capital purposes are long-term loans.

“(2) Necessary. Necessary requires that the

interest:

“(iii) Be reduced by investment income except

where such income is from gifts and grants, whether

restricted or unrestricted, and which are held

separate and not commingled with other funds.

Income from funded depreciation or provider's

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qualified pension fund is not used to reduce interest

expense....”

42 CFR 405.423(a) and (cX1) concerns the principle

relating to grants, gifts and income from endowments:

“(a) Principle. Unrestricted grants, gifts, and

income from endowments should not be deducted from

operating costs in computing reimbursable cost.

Grants, gifts, or endowment income designated by a

donor for paying specific operating costs should be de-

ducted from the particular operating cost or group of

costs.”

“(c) Application. (1) Unrestricted funds, cash or

otherwise, are generally the property of the provider

to be used in any manner its management deems

appropriate and should not be deducted from

operating costs. It would be inequitable to require

providers to use the unrestricted funds to reduce the

payments for care. The use of these funds is generally a

means of recovering costs which are not otherwise

recoverable.”

42 CFR 405.429(a\1), (a2), and (b\1) set forth the

following on allowance for return on equity capital of

proprietary providers:

“(a) Principle. (1) A reasonable return on

equity capital invested and used in the provision of

patient care is allowable as an element of the reason-

able cost of covered services furnished to beneficiaries

by proprietary providers. The amount allowable on an

annual basis is determined by applying to the

provider's equity capital a percentage equal to one and

one-half times the average of the rates of interest on

special issues of public debt obligations issued to the

Federal Hospital Insurance Trust Fund for each of the

months during the provider's reporting period or

portion thereof covered under the program.

“(2) For the purposes of this subpart, the term

‘proprietary providers’ is intended to distinguish pro-

viders, whether sole proprietorships, partnerships, or

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corporations, that are organized and operated with the

expectation of earning profit for the owners, from

other providers that are organized and operated on a

nonprofit basis.

“(b) Application. (1) Computation of equity

capital, Proprietary providers generally do not re-

ceive public contributions and assistance of Federal

and other governmental programs in financing

capital expenditures. Proprietary institutions his-

torically have financed capital expenditures through

funds invested by owners in the expectation of earning

a return. A return on investment, therefore, is needed

to avoid withdrawal of capital and to attract addi-

tional capital needed for expansion....”

42 CFR 405.1867 explains the sources of the Board’s

authority:

“In exercising its authority to conduct the hearings

described herein, the Board must comply with all the

provisions of title XVIII of the Act and regulations

issued thereunder, as well as rulings issued under the

authority of the Commissioner of Social Security (see

20 CFR 422.408). The Board shall afford great weight

to interpretive rules, general statements of policy, and

rules of agency organization, procedure, or practice

established by the Medicare Bureau.”

Section 553 of the Administrative Procedure Act, 5

U.S.C. 553 provides concerning rule making:

“(b) General notice of proposed rule making shall

be published in the Federal Register, unless persons

subject thereto are named and either personally

served or otherwise have actual notice thereof in

accordance with law....

“Except when notice or hearing is required by

statute, this subsection does not apply—

‘(A) to interpretative rules, general

statements of policy, or rules of agency or-

ganization, procedure, or practice; ...”

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Section 556(d) of the Administrative Procedure Act, 5

USC 556, provides:

“(d) ...In...determining claims for money or

benefits...an agency may, when a party will not be

prejudiced thereby, adopt procedures for the sub-

mission of all or part of the evidence in written form.”

Section 557(b) and (c) of the Administrative Procedure

Act, 5 USC 557, provides:

“(b) ...On appeal from or review of the initial

decision, the agency has all the powers which it would

have in making the initial decision except as it may

limit the issues on notice or by rule....”

“(c) Before a...decision on agency review...the

parties are entitled to a reasonable opportunity to

submit for the consideration of the employees

participating in the decisions—

“(1) proposed findings and conclusions;

or

“(2) exceptions to the decisions. ..and

“(3) supporting reasons for the excep-

tions or proposed findings or conclusions.

Section 1878(f\1) of the Social Security Act, as amended

[42 USC 139500], provides:

“(f1) A decision of the Board shall be final unless

the Secretary, on his own motion, and within 60 days

after the provider of services is notified of the Board’s

psse ke reverses, affirms,

This text is long and has been trimmed here. Open the source document for the complete record.