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From Health Law Daily, July 09, 2014

Definition of ‘new hospital’ found ambiguous and arbitrary

By Kathryn S. Beard, JD

Federal regulations entitling “new hospitals” to 85 percent of their reasonable capital-related costs for their first two years of existence and exempting them from the inpatient prospective payment system’s (IPPS) capital costs formulae during that time are ambiguous, according to the Court of Appeals for the District of Columbia Circuit. When, as here, “ambiguity begets ambiguity,” courts “have little choice but to declare” that CMS’s interpretation of the ambiguous regulations is “arbitrary and capricious” and therefore not warranted any deference (Select Specialty Hospital – Bloomington, Inc. v Burwell, July 8, 2014, Brown, J).

Regulatory background. The Medicare program provides capital reimbursements to hospitals for the construction of their facilities. Prior to 1987, these reimbursements were provided on a reasonable cost basis (see 42 C.F.R. sec. 413.5(a)); when IPPS was developed, it included a capital reimbursement system providing static reimbursements regardless of the hospital’s actual costs (42 U.S.C. sec. 1395ww(g)(1)). The HHS Secretary is authorized to provide appropriate exceptions to the capital prospective payment system, and used this authority to exempt “new hospitals” from IPPS for the first two years of their existence, rather entitling them to 85 percent of their reasonable capital-related costs (56 FR at 43362-43453). The Secretary defined “new hospitals” as a “hospital that has operated (under previous or present ownership) for less than 2 years” (42 C.F.R. sec. 412.300(b)); however, the regulations also include a list of four examples that “are not new hospitals.” The list includes (1) hospitals that build new or replacement facilities at the same or another location even if coincidental with a change of ownership, a change in management, or a lease arrangement; (2) hospitals that close and subsequently reopen; (3) hospitals that have been in operation for more than two years but have participated in the Medicare program for less than two years; and (4) hospitals that change status from being excluded from the prospective payment systems to being subject to the capital prospective payment systems (42 C.F.R. sec. 412.300(b)(1)-(4)).

According to the Secretary, the “new hospital” exemption was only intended for “new entrants into the hospital field that do not have a historic asset base” (57 FR at 39790), in order to give such new hospitals “special protection” because IPPS may be inadequate to cover the capital costs of newly-built hospitals (67 FR 49982 at 50101). Furthermore, the exception is only available to hospitals that have not received Medicare payments under the reasonable cost-based program.

Select Specialty Hospitals. The Select Specialty Hospitals organization is a national network of long-term care hospitals (LTCHs). A group of independent entity LTCHs (collectively, Hospitals) associated with Select Specialty Hospitals operate in the same building or campus as an established “host” hospital under a lease arrangement, known as “hospitals-within-hospitals.” The Hospitals identified themselves as “new hospitals” to claim reasonable cost basis reimbursements for their capital expenditures. All of the Hospitals leased buildings that had been operated by a hospital for more than two years prior to the lease arrangements. Therefore, a CMS intermediary disagreed with the Hospitals’ self-identification and reduced the amount of capital recovery to them. The Hospitals appealed the intermediary’s decision to the Provider Reimbursement Review Board (PRRB).

PRRB decision. The PRRB determined that the meaning of “hospital” under section 412.300(b) was ambiguous as to whether the term refers to an institutional entity, a brick-and-mortar asset, or both. However, based on the parties’ stipulation regarding the prior use of the leased buildings, the PRRB decided that the “new hospital” designation did not apply to the Hospitals. It found that the prior operation of the Hospitals’ leased physical assets meant that such assets had already been the subject of a reimbursement on the reasonable cost basis. Two members of the PRRB dissented, stating that the newly-formed nature of the business entities, as well as the capital expenditures necessary for rehabilitating and reconstructing the facilities, had been disregarded by the majority.

On appeal, the Medicare Administrator upheld the PRRB decision. When the Hospitals challenged the PRRB’s decision in federal district court, the court acknowledged the plausibility of both interpretations of the regulation, but deferred to the Agency’s interpretation of its own regulation and granted summary judgment against the Hospitals. The Hospitals then appealed to the circuit court.

“Arbitrary and capricious.” Courts of Appeals generally give agencies’ interpretations of their own regulations “substantial deference,” however, if the interpretation is “plainly erroneous or inconsistent with the regulation,” there is no need for deference. The D.C. Circuit Court thought that the PRRB’s focus on the definition of “hospital” rather than “new” was puzzling and “curious,” and caused the board to resolve a question that was tangential to the essential one, without answering the essential question—how to discern the newness of a hospital. It found that the PRRB’s decision did not serve either of the two principles of the regulation, namely, eliminating the possibility of double reimbursement and giving new hospitals without a historic asset base the opportunity to establish new operations. Rather, CMS’s failure to state its reasoning or to adopt an intelligible standard for its decision is so glaring that the court found this was a situation to “declare with confidence that the agency action was arbitrary and capricious.”

In support of this declaration, the court of appeals pointed to the PRRB’s “sweeping presumption” that the prior operation of physical assets by other hospitals meant the assets had already been the subject of a reasonable cost basis reimbursement. The court said that even if prior hospital organizations had obtained such reimbursement, new renovation-specific costs would not have been previously reimbursed. As another matter, the court found that the Secretary’s position on appeal is that “new hospitals” must be a new physical construction, looking to the establishment of the “bricks and mortar.” This decision led the court to ask what the difference is between a new hospital building and an old one that has been completely gutted and renovated, and whether only the former is entitled to reimbursement. The circuit court found that, despite the PRRB decision, district court opinion, CMS’s appellate briefs, and oral argument before the circuit court, it still could not “discern precisely” what decisional standard the PRRB used. In attempting to apply the decisional standards, the court found that the PRRB decision requires hospitals to be built from the ground up, but also leaves open the possibility of reimbursing the renovation of an older building that had never served as a hospital. In the court’s words, “such an amorphous rule is, by definition, arbitrary and capricious.” Therefore, the court reversed the district court’s grant of summary judgment and remands the case with instruction to return it to the Secretary for further proceedings.

Secretary’s authority. The court made sure to clarify that the Secretary has the authority to define “new hospital,” and the PRRB has the authority to adopt a decisional standard based on the Secretary’s definition. Because the court was unable to discern the PRRB’s decisional standard, much less whether it was applied correctly, the court could not maintain the PRRB’s decision, especially because it was “unintelligible.”

The case number is 12-5355.

Attorneys: Andrew C. Bernasconi (Reed Smith LLP) for  Select Specialty Hospital. Joshua Paul Waldman, U.S. Department of Justice, for Sylvia Mathews Burwell.

Companies: Select Specialty Hospital; U.S. Department of Health and Human Services

MainStory: TopStory CaseDecisions CMSNews IPPSNews ClaimsAppealsNews LTCHNews PartANews DistrictofColumbiaNews

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