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Alaska Dept. of Health & Social Svcs. v. Hope Cottages (11/19/93), 863 P 2d 246
Notice: This is subject to formal correction before
publication in the Pacific Reporter. Readers are
requested to bring typographical or other formal errors
to the attention of the Clerk of the Appellate Courts,
303 K Street, Anchorage, Alaska 99501, in order that
corrections may be made prior to permanent publication.
THE SUPREME COURT OF THE STATE OF ALASKA
STATE OF ALASKA, DEPARTMENT OF )
HEALTH & SOCIAL SERVICES, ) Supreme Court No. S-5031
MEDICAID RATE COMMISSION, )
) Trial Court No.
Appellant, ) 3AN-88-10564 Civil
v. ) O P I N I O N
HOPE COTTAGES, INC., )
Appellee. ) [No. 4027 - November 19,
Appeal from the Superior Court of the
State of Alaska, Third Judicial District,
Charles K. Cranston,
Appearances: Mary Ann Lundquist, Glenn
M. Gustafson, Assistant Attorneys General,
Anchorage, Charles E. Cole, Attorney General,
Juneau, for Appellant. Timothy G. Middleton,
Law Offices of Timothy G. Middleton,
Anchorage, for Appellees.
Before: Moore, Chief Justice,
Rabinowitz, Burke, Matthews and Compton,
In this case we address whether the state Medicaid
payment statute mandating a "fair rate for reasonable costs"
requires the State to compensate a health facility on a dollar-
for-dollar basis for its workers' compensation premiums. We hold
that it does not.
I. FACTUAL AND PROCEDURAL BACKGROUND
Hope Cottages, Inc. (Hope) is a non-profit corporation
that provides health care for the mentally retarded and develop
mentally disabled. Hope is a "health facility" within the
definition provided by AS 47.07.080(7) and is therefore eligible
to receive Medicaid for its patients. After Hope submitted its
budget forms to the Alaska Medicaid Rate Commission (Commission)
for fiscal year 1988, the Commission staff recommended a
reimbursement rate to Hope of $261.49 per patient day.
Subsequently, Hope requested that the Commission increase the
recommended rate to cover the projected increase in Hope's
workers' compensation insurance premiums. The Commission denied
the request and set the rate at $261.49 per patient day,
consistent with the staff recommendation.
Hope filed an administrative appeal with the
Commission. The hearing officer denied Hope's request for an
increase and affirmed the rate set by the Commission. The
Commission adopted the hearing officer's decision. Hope then
appealed to the superior court, arguing that the Commission
should have fully compensated Hope for increases in its workers'
compensation insurance cost. The superior court agreed, finding
the State's denial of the increased rate inconsistent with the
statutory mandate of a "fair rate for reasonable costs." The
A. Federal and State Medicaid Programs1
Under the Medicaid program the federal government
reimburses the states for a portion of payments they make to
health care facilities providing medical care to the poor.
Although participation in the Medicaid program is voluntary, a
state that chooses to participate must comply with federal
statutory and regulatory requirements. Wilder v. Virginia Hosp.
Ass'n, 496 U.S. 498, 502 (1990); Harris v. McRae, 448 U.S. 297,
301 (1980). One of the requirements of the Medicaid Act, the
Boren Amendment (Boren), governs the method by which the states
establish payment rates for health care providers under the
Boren requires that a state plan for medical assistance
for payment . . . of the hospital
services, nursing facility services, and
services in an intermediate care facility for
the mentally retarded provided under the plan
through the use of rates . . . which the
State finds, and makes assurances
satisfactory to the Secretary, are reasonable
and adequate to meet the costs which must be
incurred by efficiently and economically
operated facilities in order to provide care
and services in conformity with applicable
State and Federal laws, regulations, and
quality and safety standards . . . .
42 U.S.C. 1396a(a)(13)(A) (1992) (emphasis added). Prior to
Boren, federal law essentially required states to reimburse all
"reasonable costs" of services provided. The shift from the
reasonable cost approach to Boren
represented a significant change in the
federal standard. This change permitted
states to alter their plans with the purpose
of encouraging cost containment in the
medical and health-related fields and
allowing the states to cope with reductions
in the amount of funds to be paid by the
federal government to the states under the
Wisconsin Hosp. Ass'n v. Reivitz, 733 F.2d 1226, 1228 (7th Cir.
1984) (emphasis added). The intent of Congress was clear: to
encourage states to create efficient cost-cutting payment systems
while ensuring adequate health services.2
In response to Boren, Alaska amended its Medicaid
payment method in 1983. The State moved from a retrospective,
cost-incurred payment method to a prospective payment system.
See AS 47.07.070; ch. 95, 3, SLA 1983. In 1988 Alaska's
The commission shall determine pro
spectively the rate of payment to a health
facility under this chapter and AS 47.25.120-
-47.25.300 based on a fair rate for
reasonable costs incurred by the facility.
The commission shall by regulation list the
factors it considers in making its rate
determinations under this section.
In enacting a prospective payment method, the Alaska
Legislature intended to implement the goals of Boren.
The legislature finds that, because
Medicaid is a joint state and federal program
and because federal Medicaid funds have been
and are likely to continue to be reduced
dramatically, a retrospective payment system
no longer serves as an appropriate method of
compensation, nor does it respond with appro
priate flexibility to continued federal
cutbacks. A prospective payment system is
necessary to prudently address payments to
health facilities under the Medicaid and
general relief medical assistance programs.
Ch. 95, 2, SLA 1983. Thus the state statutory standard of a
"fair rate for reasonable costs"reflects the Boren standard of
rates that must be "reasonable and adequate to meet the costs
which must be incurred by efficiently and economically operated
As directed by the state statute, the Commission set
out the rate-setting methodology in a set of regulations. See 7
AAC 43.683; 7 AAC 43.685; 7 AAC 43.686 (Register 99). In
combination, the version of the regulations applicable here
directed the Commission to determine payment by
(1) determining the facility's actual
operating costs as allowed by 7 AAC 43.686
for the fiscal year ending 12 months prior;
(2) subtracting interest on long-term
debt, depreciation, amortization, and
operating leases (costs related to capital
improvements) from the actual operating
(3) adjusting forward the amount
remaining by an inflation factor determined
in accordance with 7 AAC 43.683; and
(4) adding capital improvement costs at
the amount estimated in budget data submitted
by the facility.
In essence, then, a facility is reimbursed based on a modified
"cost plus"basis -- actual operating costs incurred two fiscal
years ago plus an inflation factor plus anticipated capital
improvement costs. See 7 AAC 43.683, .685, .686.
The rate set by the Commission using this methodology
is the central issue in dispute.
B. Medicaid Compensation Required by the State and
The State argues that the superior court erred when it
found that the state statutory standard of a "fair rate"required
the State to compensate Hope fully for increases in workers'
compensation insurance. The State contends that state and
federal law mandate only that the overall rate paid to a facility
be fair in relation to the costs incurred by the facility, not
that each component of a facility's costs be compensated at a
Hope argues that workers' compensation insurance is
required by the State and that rates are the same for all
carriers. Accordingly, Hope concludes that the expense should be
treated as a fixed cost and passed through on an actual cost
basis similar to capital improvement costs. Hope contends that
the definition of "[f]airness in this [statutory] context
requires that a fixed cost for an expense that is required be
Hope's interpretation of the payment standard miscon
strues the language and purpose of Boren and, as the State notes,
would return the payment standard to the pre-Boren standard of
full reimbursement of reasonable costs. Boren does not require
payment of actual costs, only payment of a reasonable rate for
"costs which must be incurred by efficiently and economically
operated facilities." Cases interpreting Boren are clear on this
point: "federal Medicaid law does not require actual reimburse
ment." AMISUB (PSL), Inc. v. State of Colorado Dep't of Social
Servs., 879 F.2d 789, 798 (10th Cir. 1989) cert. denied, 496 U.S.
935 (1990). See also, Colorado Health Care Ass'n v. Colorado
Dep't of Social Servs., 842 F.2d 1158, 1169 (10th Cir. 1988)
("The states are not required to reimburse providers for costs
they actually or even reasonably incur."); Friedman v. Perales,
841 F.2d 47, 48 (2d Cir. 1988) ("'The efficient cost standard of
the Medicaid provisions requires only that [facilities] be
reimbursed for the efficient cost of their operation, not that
every component of reimbursable cost be compensated at an
efficient rate.'") (quoting Friedman v. Perales, 668 F. Supp.
216, 225 (S.D.N.Y. 1987)); Mary Washington Hosp., Inc. v. Fisher,
635 F. Supp. 891, 899 (E.D. Va. 1985) ("the premise that a
hospital is entitled under the new law to be recompensed its
reasonable costs unless it is inefficient or uneconomical . . .
reflects a misunderstanding of [Boren]").
To support its conclusion that federal law mandates
full compensation for Hope's increase in workers' compensation
insurance, the superior court relied primarily on the following
language found in Multicare Medical Center v. State of
Washington, 768 F. Supp. 1349, 1398 (W.D. Wash. 1991):
The Boren Amendment does not
require a state to pay all costs incurred by
its hospitals or even all reasonable costs.
Congress, in adopting the Boren Amendment,
clearly intended to promote a more cost
efficient Medicaid scheme. Although States
must therefore be given broad discretion to
create their own reimbursement program, they
may not provide a reimbursement plan which
fails to pay all fixed as well as variable
costs that must be incurred by an efficiently
and economically operated health care
provider providing services to Medicaid
(Emphasis added by the superior court) (citation omitted). After
quoting this language the superior court stated: "The court's
interpretation of the federal standard is clear: a prospective
reimbursement plan may not fail to pay all fixed costs incurred
by an efficiently and economically operated health care
The reimbursement system at issue in Multicare
compensated facilities for the marginal or incremental costs of
treating medicaid patients, but not for "fixed"or capital costs.
The Multicare court found this aspect of the system to be
illegal. However, the court did not hold that particular
components of a facility's costs, marginal or fixed, had to be
paid for. The court stated: "For purposes of determining
whether the State's rates fall within the range of
reasonableness, it is the entire reimbursement payment taken as a
whole that is relevant, not the particular components that
comprise the rate." Id. at 1397. Unlike the Washington system
at issue in Multicare, Alaska's system does not exclude fixed
costs in calculating reimbursement rates. The holding of
Multicare therefore has little relevance to the present case.
Further, the language quoted by the superior court from that
decision does not mean, as the passage we reproduce above makes
clear, that a dollar-for-dollar reimbursement of specific costs
The State's interpretation of the statute complies with
the policies underlying Boren. Boren was intended to provide the
states with flexibility to create payment programs that encourage
cost containment and efficiency. To require the State to pay all
actual costs would return the payment system to pre-Boren
standards. In a recent case, the Seventh Circuit rejected an
interpretation of Boren that would require reimbursement of all
reasonably necessary costs, stating that this
characterization of the applicable
reimbursement standard, in our view, rests on
the false premise that a state is required to
reimburse any efficient and economic facility
for its reasonable, actual costs. This
merely transmutes the post-Boren prospective
rate-setting approach into the pre-Boren
retrospective "reasonable cost"standard.
Lett v. Magnant, 965 F.2d 251, 256 (7th Cir. 1992).
C. The Rate Set by the Commission
Federal courts that have been faced with the
determination of the validity of a rate set by state Medicaid law
utilize the "zone of reasonableness"standard.4 As the Multicare
decision described it:
The range of reasonableness doctrine
recognizes that rate making is an inexact
science and that rate making agencies must be
allowed "a substantial spread between what is
unreasonable because too low and what is
unreasonable because too high."
Multicare, 768 F. Supp. at 1397 (quoting Folden v. Washington
State Dep't of Social and Health Servs., 744 F. Supp. 1507, 1529-
30 (W.D. Wash. 1990) (quoting Federal Power Comm'n v. Conway
Corp., 426 U.S. 271, 278 (1976))). Boren does not require the
State to pay any specific rate or percentile, it only requires
that the rates be "reasonable and adequate." The United States
Supreme Court indicated in Wilder that a range of rates existed
within which the states could determine payment. Wilder, 496
U.S. at 519-20 ("While there may be a range of reasonable rates,
there certainly are some rates outside that range that no State
could ever find to be reasonable and adequate under the Act.").5
As noted, Hope's sole contention is that non-
reimbursement of a single component, workers' compensation
insurance, is unreasonable. Hope does not directly discuss the
reasonableness of the overall rate. It appears from the record
that the Commission followed the regulations in setting the rate
and did not violate state or federal law in refusing to reimburse
Hope's entire workers' compensation insurance expense. Without
evidence challenging the validity of the overall rate, no basis
exists to hold that the rate is outside the range of
The superior court's holding that the state Medicaid
payment statute requires the State to compensate Hope fully for
its workers' compensation insurance premiums is REVERSED. The
rate set for Hope by the Commission has not been shown to be
beyond the range of reasonableness. Therefore this case is
REMANDED to the superior court with instructions to AFFIRM the
decision of the Commission.
1 For further background on the interaction between the
State and Federal Medicaid programs, see State, Dep't of Health
and Social Servs. v. Alaska State Hosp. and Nursing Home Assoc.,
856 P.2d 755 (Alaska 1993).
2 The legislative history of Boren states:
[T]he Committee recognizes the
inflationary nature of the current cost
reimbursement system and intends to give
States greater latitude in developing and
implementing alternative reimbursement
methodologies that promote the efficient and
economical delivery of such services.
H.R. Rep. No. 158, 97th Cong., 1st Sess. 293-94 (1981).
3 Where the superior court acts as an intermediate appellate
court, this court owes no deference to its decision, but,
"[i]nstead, . . . independently scrutinize[s] directly the merits
of the administrative determination." Tesoro Alaska Petroleum
Co. v. Kenai Pipe Line Co., 746 P.2d 896, 903 (Alaska 1987). In
this case we are examining the Commission's interpretation of a
statute and the interpretation and validity of regulations, a
question of law. The substitution of judgment standard is
appropriate for reviewing questions of law "where the knowledge
and experience of the agency is of little guidance to the court
or where the case concerns statutory interpretation." Earth
Resources Co. of Alaska v. State, Dep't of Revenue, 665 P.2d 960,
965 (Alaska 1983) (emphasis added). As this case concerns a
matter of statutory interpretation, we utilize the substitution
of judgment standard.
4 See, e.g., Wilder v. Virginia Hosp. Ass'n, 496 U.S. 498,
520 (1990); Colorado Health Care Ass'n v. Colorado Dept. of
Social Servs., 842 F.2d 1158, 1167 (10th Cir. 1988); Wisconsin
Hosp. Ass'n v. Reivitz, 733 F.2d 1226, 1233 (7th Cir. 1984);
Multicare, 768 F. Supp. at 1396-97.
5 The Multicare court not only adopted the zone of
reasonableness standard, but went on to state that the allowable
range "for Medicaid rate payments is especially broad because of
Congress's intent in enacting the Boren Amendment of conferring
greater flexibility on the state agencies."768 F. Supp. at 1397
(citing Folden, 744 F. Supp. at 1530).