The opinion of the court was delivered by: Spatt, District Judge.
MEMORANDUM OF DECISION AND ORDER
This dispute arises out of reimbursement allegedly due to
Huntington Hospital, Long Island College Hospital, Nassau County
Medical Center, New York Methodist Hospital, Northern
Westchester Hospital Center, Phelps Memorial Hospital Center,
St. Vincent's Hospital of New York, Sound Shore Medical Center,
Southampton Hospital, Staten Island University Hospital, and
Good Samaritan Hospital (collectively the "Hospitals" or the
"plaintiffs"), under the Medicare Statute 42 U.S.C. § 1395, et.
seq. The narrow issue presented here is whether the Secretary of
Health and Human Services (the "Secretary" or a "defendant")
exceeded her statutory authority when she promulgated the
regulation that set September 30, 1982, through September 20,
1983, as the base year for the hospital specific portion of the
blended payment rate that was to be used in the four-year
transition from a cost-based Medicare hospital reimbursement
system to a prospective payment system.
A. Statutory and Regulatory Framework
Part A of the Medicare Program, 42 U.S.C. § 1359c et. seq.,
authorizes payment for in-patient hospital services to eligible
aged and disabled persons. Providers of these services are
reimbursed by fiscal intermediaries designated by the provider
and the Secretary. See 42 U.S.C. § 1359h-1359i.
Prior to October 1, 1983, the Medicare Program reimbursed
hospitals based on a "retrospective, reasonable cost system. At
the end of each fiscal year, hospitals reported the total costs
for which they sought reimbursement." Rye Psychiatric Hosp.
Ctr., Inc. v. Shalala, 52 F.3d 1163, 1165 (2d Cir. 1995). The
Medicare Program reimbursed the hospitals for the reasonable
cost of covered services, excluding charges that the Secretary
found were "unnecessary in the efficient delivery of needed
health services." 42 U.S.C. § 1395x(v)(1)(A). This method of
reimbursement provided little incentive for hospitals to reduce
or contain costs and shifted the burden of cost increases from
the hospitals to the federal government. See Rye Psychiatric,
52 F.3d at 1165; Episcopal Hosp. v. Shalala, 994 F.2d 879, 881
(D.C.Cir. 1993); Tucson Medical Ctr. v. Sullivan,
947 F.2d 971, 973-74 (D.C.Cir. 1991) (noting that under the reasonable
cost system, "[t]he more the [hospitals] spent, the more they
As a consequence, and in an attempt to control Medicare costs,
Congress enacted the Tax Equity and Fiscal Responsibility Act of
1982 ("TEFRA"). Pub.L. No. 97-248, §§ 101-128, 96 Stat. 324
(1982) (codified at scattered sections of 42 U.S.C.). TEFRA
changed the Medicare Program by imposing limits on the rate
Part-A reimbursements could be increased.
Under TEFRA, a provider's rate of reimbursement is based on its
"target amount," or the maximum amount a provider can be
reimbursed per year. See 42 U.S.C. § 1395ww(b)(3); Rye
Psychiatric, 52 F.3d at 1166. A provider's target amount for
its first "cost reporting period" for which subsection (b)(3)(A)
was in effect consists of the provider's "allowable costs" for
the preceding year. See 42 U.S.C. § 1395ww(b)(3)(A). The
provider's target amount for each subsequent year is calculated
by multiplying the preceding year's target amount by a
percentage prescribed by the legislature and based on "an index
of appropriately weighted indicators of changes in wages and
prices." 42 U.S.C. § 1395ww(b)(3)(B). If a hospital's operating
costs for the cost reporting period are less than its target
amount, it receives its operating costs plus a bonus. See id.
§ 1395ww(b)(1)(A). However, if the hospital's operating costs
exceed its target amount, it is reimbursed only to the extent of
its target amount. See id. § 1395ww(b)(1)(B).
The Court of Appeals described the effect TEFRA's target
amount has on hospitals' Medicare reimbursements:
How fully a TEFRA hospital is reimbursed from year to
year thus depends on (1) how representative its base
period is of its actual total costs in the relevant
year, and (2) how closely the Congressionally fixed
percentage increase mirrors any increase in the
hospital's costs. . . . Because the base period is
the starting point for the determination of all
subsequent ceilings, changing the base period affects
all future target amount calculations of the
hospital, not merely that of a particular year.
Rye Psychiatric, 52 F.3d at 1166.
On October 1, 1983, Congress replaced this retroactive
reimbursement of reasonable costs with the Prospective Payment
System ("PPS"). See Pub.L. No. 98-21, §§ 601-606, 97 Stat. 65,
149 (1983) (codified as amended primarily at
42 U.S.C. § 1395-1395ww). Congress' intent was "to reform the financial
incentives hospitals face, promoting efficiency in the provision
of services by rewarding cost-effective hospital practices."
H.R.Rep. No. 25, 98th Cong., 1st Sess. 132 (1983), reprinted
in U.S.C.C.A.N. 219, 351. The PPS established 470 "diagnosis
related groups" ("DRGs") and set a fixed rate of reimbursement
for each DRG. 42 U.S.C. § 1395ww(d)(4). "DRG cost schedules are
generated from anticipated national and regional average costs
for the treatment of particular illnesses." Rye Psychiatric,
52 F.3d at 1167 (citing 42 U.S.C. § 1395ww(d)(2)(D) (1983)). The
PPS promotes efficiency and treatment-cost reduction by allowing
the hospitals to retain the difference between the hospital's
actual operating cost and the DRG while forcing the hospitals to
absorb operating costs in excess of the DRG. See Rye
Psychiatric, 52 F.3d at 1167 n. 4 (citing H.R.Rep. No. 25, 98th
Cong., 1st Sess. 132 (1983), reprinted in 1983 U.S.C.C.A.N.
219, 351; S.Rep. No. 23, 98th Cong., 1st Sess. 47 (1983),
reprinted in 1983 U.S.C.C.A.N. 143, 187); New York University
Medical Ctr. v. Shalala, 1996 WL 636128 (S.D.N.Y. 1996).
Recognizing that implementation of the PPS would create a
financial hardship for many hospitals, Congress created a
four-year transition period between the reasonable cost system
and the PPS, see 42 U.S.C. § 1395ww(d), that was designed to
"minimize disruptions that might otherwise occur because of a
sudden change in reimbursement policy." S.Rep. No. 23, 98th
Cong., 1st Sess. 53 (1983), reprinted in 1983 U.S.C.C.A.N.
143, 193; H.R.Rep. No. 25 136, 98th Cong., 1st Sess., reprinted
in 1983 U.S.C.C.A.N. 143, 355. During the transition period,
the federal government reimbursed hospitals according to a
"blended" rate, which had two components. The first component,
the hospital-specific portion ("HSP"), was a percentage of "the
hospital's target amount for the cost reporting period (as
defined in subsection (b)(3)(A) of this subsection)."
42 U.S.C. § 1395ww(d)(1)(A)(i)(I), (ii)(I). The
ecretary promulgated a regulation that defined the HSP base year
for the transition period as the hospital's allowable costs "for
the twelve month or longer cost reporting period ending on or
after September 30, 1982, and before September 30, 1983."
42 C.F.R. § 412.71(a).
The second component of the blended rate was the "federal"
portion, which was a percentage of the DRG prospective payment
rate. See 42 U.S.C. § 1395ww(d)(1)(A)(i)(II), (ii)(II). Over
the course of the four-year transition period, which began on
October 1, 1983, the federal portion of the blended rate became
progressively larger while the HSP portion became progressively
smaller until the ...