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09/18/87 Memorial Hospital/Adair v. Otis R. Bowen

September 18, 1987




Silberman, Buckley, and D. H. Ginsburg, Circuit Judges.


Appeals from the United States District Court for the District of Columbia, D.C. Civil Nos. 82-3208 & 84-2518.



The Secretary of Health and Human Services issued two decisions denying a rural hospital in Oklahoma full reimbursement for pharmacy services rendered to Medicare patients in 1979 and 1980. The Secretary's decisions are based on findings of Medicare's Provider Reimbursement Review Board which found Memorial's pharmacy costs to be unreasonable. The hospital, Memorial Hospital/Adair County Medical Center, disagreed with the Board's conclusions and filed complaints challenging the two decisions. The district court consolidated the complaints and granted summary judgment for the Secretary. We now reverse, holding that the Board's findings disregarded the Secretary's Medicare reimbursement regulations. We remand these cases to the district court with instructions to set aside the Secretary's decisions. I. BACKGROUND

In 1983 Congress changed the method of reimbursing hospitals for costs incurred in caring for Medicare patients. See Washington Hosp. Center v. Bowen, 254 U.S. App. D.C. 94, 795 F.2d 139, 141-42 (D.C. Cir. 1986) (discussing Social Security Amendments of 1983). Under the new system the Department of Health and Human Services ("HHS" or "Department") reimburses Medicare health care providers, including hospitals like Memorial, according to standard national rates for particular therapies. Id. at 142.

This case arises under the Medicare reimbursement scheme previously in effect. In Part A of the Social Security Act, 42 U.S.C. §§ 1395c-1395i (1982) (the "Act"), Congress permitted the Secretary of HHS to consider cost audits before approving hospital applications for Medicare reimbursement. Section 1395f(b) of the Act states:

The amount paid to any provider of services . . . with respect to services for which payment may be made under this part shall, subject to the provisions of sections 1395e and 1395ww of this title, be --

(1) except as provided in paragraph (3) [not applicable here], the lesser of the reasonable cost of such services, as determined under section 1395x(v) of this title and as further limited by section 1395rr(b)(2)of this title, or the customary charges with respect to such services;

42 U.S.C. § 1395f(b) (1982) (emphasis added). The Secretary did not base his decisions on the "customary charges" subsection of that provision. Rather, he premised them on the "reasonable cost" provision of section 1395f(b)(1), which incorporates the definition of "reasonable cost" appearing in title 42 U.S.C. § 1395x(v) (1) . This in turn provides that "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 . . . ." 42 U.S.C. 1395x(v) (1) (1982).

The Secretary published, among others, the following regulation:

Reasonable cost includes all necessary and proper costs incurred in renduring the services [covered under the Act], subject to principles relating to specific items of revenue and cost. However, . . . payments to providers of services are based on the lesser of the reasonable cost of services . . . or the customary charges to the general public for such services, as provided for in § 405.455.

42 C.F.R. § 405.451 (a) (1985). The regulation further defines "reasonable cost" in a broad fashion:

The costs providers' services vary from one provider to another and the variations generally reflect differences in scope of services and intensity of care. The provision in title XVIII of the Act for payment of reasonable cost of services is intended to meet the actual costs, however widely they may vary from one institution to another. This is subject to a limitation where a particular institution's costs are found to be substantially out of line with other institutions in the same area which are similar in size, scope of services, utilization, and other relevant factors.

42 C.F.R. § 405.451 (c) (2) (1985) (emphasis added).

In addition to this regulation, section 2103 of the Secretary's Provider Reimbursement Manual (HCFA Pub. 15-1) ("Manual") informs Medicare health care providers of their responsibilities. The Secretary relies in part on that section of the Manual to support his decisions. Paragraph A of section 2103 states that "the prudent and cost-conscious buyer not only refuses to pay more than the going price for an item or service, he also seeks to economize by minimizing cost." Paragraph B adds that intermediaries may "employ various means for investigating and detecting" excessive spending. "Included may be such techniques as comparing the prices paid by providers to the prices paid for similar items or services by comparable purchasers, spot-checking, and querying providers about indirect, as well as direct, discounts." Manual, J.A. Exhibit D.

Memorial is a fifty-bed general hospital located in Stilwell, Oklahoma. It is not operated for profit. During the fiscal year ending on September 30, 1979, "its percent of occupancy was 63.76 and its Medicare utilization was 62.2 percent." Memorial Hospital (Stilwell, Okla.) v. Blue Cross Assoc./Blue Cross/Blue Shield of Oklahoma,

the surveyor told him to come to Oklahoma City (Doctors Hospital of Oklahoma) to observe an acceptable pharmacy operation. He observed a contract pharmacy, HPI [Hospital Pharmacies, Inc.], for the first time. He requested HPI to survey the provider ...

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