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New York City Health and Hospitals Corp. v. Blum

decided: May 25, 1983.


Appeal from a judgment of the United States District Court for the Southern District of New York (Brieant, Judge) dismissing a five-count complaint alleging the invalidity of portions of New York's plan for reimbursing hospitals under the Medicaid Act.

Van Graafeiland, Pierce and Winter, Circuit Judges.

Author: Winter

WINTER, Circuit Judge:

New York City Health and Hospitals Corporation (HHC) appeals from Judge Brieant's dismissal of its five count complaint alleging the invalidity of certain provisions of the New York State Plan for Medical Assistance, (State Plan), N.Y. Admin. Code, tit. 10, § 86 (approved Jan. 1, 1980). We affirm.


HHC is a public benefit corporation which operates fourteen municipal hospitals and numerous health care facilities in the City of New York. Because it is the primary provider of medical services to the city's poor, it also receives substantial reimbursements from the federal government under the Medicaid Act, 42 U.S.C. §§ 1396-1396n (1976 and Supp. IV 1980). Of the three million in-patient days of care provided annually by HHC, roughly 60 percent of that care goes to Medicaid-eligible patients. Of the Medicaid days of care provided by New York State, 40 percent is accounted for by HHC.

Under the Medicaid Act in effect at the time of HHC's complaint, the State was required to establish a plan to formulate and pay HHC's "reasonable costs" for Medicaid patients. According to the State Plan, N.Y. Admin. Code, tit. 10, § 86 (1980), which has been statutorily approved by the Secretary of Health and Human Services (Secretary), Medicaid reimbursements were calculated through a complex formula which yielded prospective rates at which Medicaid services would be reimbursed. Under this formula, the rate for a particular hospital for a coming year (rate year) is derived from the costs it incurred in the year two years prior to that coming year (base year). Thus, the reimbursement rate for the rate year 1980 would be derived from the hospital's costs in the base year 1978.

For the years relevant to this case, 1980 and 1981, the formula determined a hospital's reimbursement rate by dividing its base year "allowable" costs related to patient care by total patient days. The result, adjusted for matters not relevant here such as the rate of inflation, yielded the per diem reimbursement rate for the rate year.

Complexity arose, however, in calculating reasonable costs under Medicaid so as to exclude costs inflated by the inefficient provision of services. To determine which costs were to be so disallowed, the State utilized a three-step process. First, it determined so-called disallowance ceilings on "routine" and "ancillary" costs. Routine costs are "hotel like" expenses of caring for patients -- food, laundry, etc. A hospital's total routine costs were divided by its total number of patient days to reach a facility routine per diem cost. This per diem cost was then compared to similar costs accrued by similarly situated hospitals, the recipient hospital's so-called peer group. A peer group average per diem routine cost was calculated, and a ceiling of 105 percent of that peer group average established. To the extent a particular hospital's routine per diem costs exceeded 105 percent of its peer group average, the excess was disallowed. The per diem excess would then be multiplied by total patient days, that sum subtracted from total routine costs, thereby yielding allowable routine costs.

Similar calculations were made with respect to ancillary costs. These are the costs of specific care required by particular patients and include operating room, x-ray and pharmacological expenses. Whereas routine costs were divided by patient days to reach a per diem rate, the formula divided total ancillary costs by the number of discharges in a particular year to reach a per patient rate. Again, after calculating actual facility costs and average peer group costs, a disallowance ceiling on ancillary costs was set at 105 percent of the peer group average. Total disallowed costs were then calculated, subtracted from total ancillary costs, yielding allowable ancillary costs.

Prior to determining the routine per diem and ancillary per patient figures to which the disallowance ceilings were applied, both figures were altered by "imputing" days or, in the case of ancillary costs, discharges to the hospital. This step in the formula was designed to reduce the enormous costs generated by hospitals which maintain an excessive number of hospital beds. A normative benchmark occupancy level was determined on the basis of (1) the use to which a bed was subject and (2) the location and pedagogical function of the hospital. Thus, in a downstate non-teaching hospital for which rates were being calculated in 1980, the benchmark occupancy levels for medical/surgical beds, maternity beds, and pediatric beds were 85 percent, 75 percent, and 70 percent, respectively. To the extent a hospital in a particular category failed to reach the specific benchmark, additional use was imputed and the imputed days or discharges became part of the routine and ancillary cost calculations. To avoid this penalty, a hospital could decertify an appropriate number of beds.

If the formula contained no further steps, allowable routine and ancillary costs would be added and the sum divided by the sum of total patient days to reach the per diem prospective reimbursement rate for Medicaid patients in particular hospitals. The record indicates that Blue Cross reimbursed hospitals for insured patients by an analogous method.

Prospective per diem reimbursement, however, created incentives in hospitals to increase patient lengths of stay. First, since reimbursement by Blue Cross and Medicaid is provided on a flat per diem basis and some costs are "frontloaded" (e.g., admission expenses) while others tend to decline over length of stay (e.g., nursing care), prolonged lengths of stay of Blue Cross or Medicaid patients yield greater net revenues to hospitals than short stays. Second, the State Plan's attribution of imputed days or discharges as a consequence of unused beds itself created an incentive to increase the lengths of stay of all patients. Relevant studies tended to show, moreover, that these incentives were in fact affecting patient lengths of stay. See Dowling, et al., Prospective Reimbursement in Downstate New York and Its Impact on Hospitals -- A Summary, Report to the Social Security Administration, Department of HEW, Contract No. HEW-OS-74-248; Berry, Prospective Rate Reimbursement and Cost Containment: Formula Reimbursement in New York, 13 Inquiry 288 (1976).

To reduce these incentives, yet a third disallowance ceiling, the legality of which is the central issue in this litigation, was devised. Beginning in 1977, the State Plan utilized a "length of stay" (LOS) disallowance to eliminate costs attributable to excessively prolonged hospitalizations in the base year. Over time the methodology of determining the LOS disallowance was modified to increase its precision. The 1980 (rate year) LOS methodology worked as follows. First, each hospital in the state was placed in one of four peer groups -- upstate teaching, upstate nonteaching, downstate teaching, downstate nonteaching. Second, using Medicaid and non-Medicaid patient data, the 1978 (base year) discharge information was segregated into 493 age/diagnostic categories or cells. The upper one percent of the cases in each cell were eliminated to factor out aberrant cases, and an average LOS was determined for each cell. Third, each hospital's unique patient discharge information was multiplied by the peer group average for each cell. The products were added and that total was divided by the hospital's total number of patients to achieve an expected average LOS unique to the hospital's patient mix. Finally, each hospital's actual average LOS was compared to its expected average LOS and to the extent the ...

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