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March 22, 1994


The opinion of the court was delivered by: CHARLES L. BRIEANT


 This case is brought by plaintiff Rye Psychiatric Hospital Center, Inc. *fn1" (the "Hospital"), a provider of inpatient hospital services to Medicare-eligible patients under an agreement filed with the defendant Secretary of the United States Department of Health and Human Services (the "Secretary") pursuant to 42 U.S.C. § 1395cc. The action arises under Title XVIII of the Social Security Act ("Medicare"), 42 U.S.C. §§ 1395 et. seq. ; *fn2" Chapter 7 of the Administrative Procedure Act, 5 U.S.C. § 701 et. seq, and the Fifth Amendment to the United States Constitution. This court has jurisdiction of the action under 28 U.S.C. §§ 1331, 28 U.S.C. § 1361, and 42 U.S.C. § 1395oo(f)(1).

 The parties cross-move for summary judgment. Based on the papers submitted and oral argument held on February 4, 1994, the motions by the parties are resolved pursuant to 28 U.S.C. §§ 2201-2202 by the declaration as set forth below, and in all other respects are denied.

 Hospitals providing in-patient services to Medicare-eligible patients are entitled to have their reimbursements reviewed to ensure that such payments for necessary services are fair and reasonable.

 This case involves a challenge by a private psychiatric hospital seeking to overturn several Medicare reimbursement provisions and regulations promulgated thereunder by the Secretary. The plaintiff hospital is one of a minority of hospitals "exempt" *fn3" from the system based on diagnostic-related prospective payment rates now applicable to most in-patient hospital services for Medicare-eligible individuals.

 The Court holds that under the statute the hospitals may obtain adjustments of any unworkable restrictions under the statutory framework and obtain judicial review if such adjustments are arbitrarily denied. The Court further finds that hospitals confronting an unusually large proportion of governmentally-subsidized patients who do not produce as much income to the hospital as others, are entitled to have this hardship considered under statutory provisions applicable to each type of hospital.

 The plaintiff Hospital is entitled to a judgment declaring its rights under the statute and regulations.


 Before addressing the merits of the controversy before me, it is important to clarify various terms and reimbursement methods used in this complicated statute, see New York City Health and Hospitals Corp. v. Perales, 954 F.2d 854, 858 (2d Cir.), cert. denied 113 S. Ct. 461, 121 L. Ed. 2d 369 (1992) with its many interlocking and arguably obliquely interrelating provisions. All statutory references are to the Medicare provision governing payments to hospitals for in-patient services, 42 U.S.C. § 1395ww (1993), unless otherwise specified.

 Pre-1983: "reasonable actual costs "

 Until October 1983, the Medicare program reimbursed hospitals for in-patient services *fn4" under a retrospective, cost-based system which was called a "reasonable cost" regime. *fn5" See 42 U.S.C. § 1395 ("§ 1395") f(b); § 1395(x)(v); see generally Episcopal Hospital v. Shalala, 301 U.S. App. D.C. 332, 994 F.2d 879, 881-882 (D.C.Cir. 1993), cert. denied 114 S. Ct. 876, 127 L. Ed. 2d 73 (1994); Tucson Medical Center v. Sullivan, 292 U.S. App. D.C. 105, 947 F.2d 971, 973-975 (D.C. Cir. 1991). "Reasonable cost" of covered services was defined as "the cost actually incurred, excluding therefrom any part of incurred cost found to be unnecessary in the efficient delivery of needed health services." § 1395(x)(v) (emphasis added). Hospitals received reimbursement for allowable operating costs of services provided to patients on a per diem basis on days for which the patients had Medicare coverage. See § 1395q(d), x(v).

 These provisions, and particularly § 1395f(b), are referred to hereinafter as the "reasonable actual cost provisions."

 Adjusted cost based on prior years (TEFRA limitations): § 1395ww(b):6

 "Concerned that this system provided little incentive for hospitals to reduce or contain costs because reasonable cost reimbursement shifts the burden of cost increases from hospitals to the federal government," Episcopal Hospital, 994 F.2d at 881; Tucson Medical Center, 947 F.2d at 974, Congress imposed in 1982 a limit to slow the rate of increases of in-patient reimbursement but the basic retrospective cost-based framework of the pre-October 1983 system was left intact. These limitations were enacted as part of the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"), Pub. L. No. 97-248, 96 Stat. 324 (1982). The applicable provisions, codified as amended at 42 U.S.C. § 1395ww(b), "intended to restrain growth of hospital costs and to relieve the stress that increases in these costs put on the financial soundness of the Hospital Insurance Trust Fund." 47 Fed.Reg. 43282 (September 30, 1982). *fn7"

 Under TEFRA as set forth in § 1395ww(b), a new, separate, interim control *fn8" was put in effect, whereby hospitals which keep their costs below a certain "target amount" are provided with incentives in the form of bonuses, while hospitals exceeding their target amounts are penalized by reductions in the amount of their reimbursements. Subsection (b)(1).

 The Secretary has determined in the regulation promulgated under section (b) *fn9" that for each 12-month cost reporting period (a "cost reporting period"), a hospital's target amount is computed first by determining the "allowable operating costs" for inpatient hospital services "incurred in the 12-month cost reporting period immediately preceding the first cost reporting period subject to ceilings established under this section." 42 § C.F.R. 413.40 (b)(1) (emphasis added). This preceding 12-month period is called in the regulation the "base year," *fn10" id. at § 413.40(b)(1), despite the absence of that term from the statutory subsection (b)(3)(A). *fn11" Step two in the computation process adds to that base year figure an annual statutory percentage increase. *fn12" These two components yield the target amount for the first year to which TEFRA applied.

 In years after the first year TEFRA was in effect for the particular hospital, the previous year's target amount (base plus increase) becomes the foundation upon which the annual statutory increase is added to become the next target amount, and so forth. See subsection (b)(3)(A)(ii); *fn13" 42 C.F.R. § 413.40 (c)(4). The target amount for each cost-reporting period is adjustable under subsection (b)(4), explicated in greater detail in 42 C.F.R. § 413.40 (g)-(h), as further described below.

 The ability of a hospital to meet the target amount for each cost-reporting period is the basis for determining whether incentive payments or penalties will apply for the particular period. *fn14"

 The Secretary describes the target amount as the "ceiling on rate of hospital cost increases," 42 C.F.R. § 413.40 (title), and uses "target amount" and "ceiling" interchangeably, id. at § 413.40 (c)(4), although "ceiling" does not appear in the statute.

 In sum, the Secretary interprets the statute to provide that each year's target amount computation relies on the target amount of the prior year, ultimately leading back to the base year. In essence, the "base year" is fixed, *fn15" and consequently imposes cost restraints far greater than the pre-1983 system. While the original base year calculation begins with retrospective actual costs determined to be reasonable, further limits are placed on those costs by the small annual increases permitted under the statute. For the Hospital here, the base year was and at present appears to remain 1982, *fn16" regardless of costs actually incurred in later years.

 Exceptions and adjustment under TEFRA

 Specific exceptions and adjustments to the limits imposed under TEFRA are contained in § 1395ww(b)(4)(A) (the "adjustment provision"), which provides that:

The Secretary shall provide for an exemption from, or an exception and adjustment to, the [adjusted cost based on prior years] method . . . where events beyond the hospital's control or extraordinary circumstances, including changes in the case mix of such hospital,. . . create a distortion in the increase in costs for a cost reporting period (including any distortion in the costs for the base period against which such increase is measured).
The Secretary may provide for such other exemptions from, and exceptions and adjustments to, such method as the Secretary deems appropriate, including the assignment of a new base period which is more representative, as determined by the Secretary, of the reasonable and necessary cost . . .

 (emphasis added).

 Prospective diagnostic-based payments (the "prospective payment system") for section (d) hospitals: § 1395(d)

 The "adjusted cost based on prior years" system under TEFRA was originally expected to last approximately three years. *fn17" In actuality, TEFRA only lasted for one year for most hospitals, see Tucson Medical Center v. Sullivan, 292 U.S. App. D.C. 105, 947 F.2d 971, 975 (D.C.Cir. 1991), although it continues to apply to certain types of hospitals and facilities, including the Hospital here. Because the Hospital challenges its reimbursement in comparison with that available to hospitals falling within what has come to be known as the "prospective payment system" (from which the Hospital is excluded), it is necessary to give a brief description of that prospectively-based method, which applies now to the vast majority of American hospitals.

 In 1983, Congress replaced the system mandated by TEFRA with a more radical reform of inpatient cost reimbursement, Episcopal Hospital v. Shalala, 301 U.S. App. D.C. 332, 994 F.2d 879, 881 (D.C. Cir. 1993), cert. denied 114 S. Ct. 876, 127 L. Ed. 2d 73 (1994); see 42 U.S.C. § 1395ww(d). The new prospectively-based system "'completely changed the method of reimbursing a hospital's Medicare costs,'" Doctors Hosp. Inc. of Plantation v. Bowen, 811 F.2d 1448, 1449 (11th Cir. 1987) (citation omitted). Congress believed that the new system would relieve two major problems caused by Medicare's prior reasonable-cost based system: inefficiency on the part of hospitals and lack of federal control over expenditures for hospital care. H.R. Rep. No. 25, 98th Cong., 1st Sess. 132, reprinted in 1983 U.S. Code Cong. & Admin. News 219, 351.

 This system bases reimbursement primarily *fn18" on predetermined, prospective national and regional rates on a per diagnosis (per-case) basis instead of the previous per-diem cost. See Episcopal Hospital, 994 F.2d at 881. Medicare patients are classified and reimbursement to hospitals is provided on the basis of some 470 classifications (known as "diagnostic related groups" or "DRGs") rather than on the actual costs of individual cases. Id.; § 1395ww(d).

 These hospitals are referred to hereinafter as "section (d)" hospitals or hospitals "paid under the ...

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