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June 20, 1986

MARGARET M. HECKLER, Secretary of the Department of Health and Human Services, et al., Defendants

The opinion of the court was delivered by: JACKSON

 Thomas Penfield Jackson, District Judge.

 These consolidated cases present an issue as to whether a hospital whose total costs are unexceptional is thereby entitled to reimbursement under the Medicare Act, 42 U.S.C. §§ 1395-1395xx (1982 & Supp. II 1984), for the extraordinary expenses of a single costly state-of-the-art service it elects to operate.

 Plaintiff Memorial Hospital/Adair County Health Center ("Memorial"), a small general hospital in rural Oklahoma, asks reimbursement for the Medicare portion of the costs incurred in fiscal years 1979 and 1980 by its full-service "contract pharmacy." The Department of Health and Human Services ("HHS" or "the Secretary") disallowed approximately $80,000 of the costs on grounds that they were "substantially out of line" with the pharmacy costs of similar hospitals in the same geographical area, and that Memorial had not been a "prudent buyer" of pharmacy services when it engaged its pharmacy contractor. The cases are presently before the Court on cross-motions for summary judgment on the administrative record. *fn1" For the reasons set forth below, the Court concludes that HHS' decision to deny reimbursement was rational and supported by substantial evidence, and will, therefore, grant defendants' and deny plaintiff's motions for summary judgment, and dismiss the complaints with prejudice.


 In enacting the Medicare Act in 1965 Congress created a program of health insurance for the aged and disabled. There are two basic components to the Medicare program-- hospital insurance, covering expenses of hospital and certain post-hospital services, and supplementary medical insurance, covering professional services by physicians. Only hospital insurance, "Part A" of the program, 42 U.S.C. §§ 1395c-1395i, is involved here.

 Under Part A, the federal government reimburses hospitals participating in the Medicare program, known as "providers of services," for the reasonable costs of the services they render to Medicare patients. See 42 U.S.C. §§ 1395x(u), 1395f(b). The reimbursement process is overseen by "fiscal intermediaries," usually private health insurance organizations, which act under contract with and as agents of HHS. See 42 U.S.C. § 1395h. The "reasonable costs" to which hospitals are entitled are defined in some detail in the Medicare statute, see 42 U.S.C. § 1395x (v)(1)(A), in regulations promulgated thereunder, see 42 C.F.R. §§ 405.401-482 (1984), and in administrative manuals issued by HHS. See Provider Reimbursement Manual §§ 2100, 2102-03; Intermediary Manual § 2130. The reimbursable amount is calculated by apportioning the hospital's total allowable costs between its Medicare and non-Medicare patients. See 42 C.F.R. § 405.403.

 The primary standard for determining the reasonableness of costs is that expenditures must not 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). Expenses do not, however, have to be identical to those of similar institutions; the regulations recognize that costs of services may vary, and that such "variations generally reflect differences in scope of services and intensity of care." Id.

 In addition, HHS manuals issued to providers and intermediaries declare that a hospital may be reimbursed only if it is a "prudent buyer" of those goods and services for which it requests reimbursement. See Provider Reimbursement Manual § 2103; Intermediary Manual § 2130. To be a "prudent buyer" a hospital is expected, "like any . . . cost-conscious buyer, [to] refuse to pay more than the going price for an item or service [and to] seek to economize by minimizing cost." Intermediary Manual § 2130.1. See also Provider Reimbursement Manual § 2103(A). A hospital which fails to shop wisely may have its extravagance penalized by reductions in its allowable costs, id., and, in making its determination, the intermediary has authority to audit. See Intermediary Manual § 2130.1.

 A provider dissatisfied with audit adjustments imposed by the fiscal intermediary may appeal the determination to the Provider Reimbursement Review Board ("PRRB"). 42 U.S.C. § 1395oo. The Secretary, or his delegate, has discretion to review any decision of the PRRB, 42 U.S.C. § 1395oo(f); 42 C.F.R. § 405.1875 (1984), and a refusal to review, in an exercise of that discretion, renders the PRRB decision final for exhaustion-of-remedies purposes. 42 U.S.C. § 1395oo(f).


 Memorial is a 50-bed, general acute care, non-profit hospital located in Stilwell, Oklahoma. The area served by Memorial is rural, and its population low income. Over half of Memorial's patients receive Medicare benefits; approximately a quarter are covered by Medicaid. The nearest neighboring hospital is 25 miles away.

 In 1977 Memorial opened a new facility, simultaneously contracting with Hospital Pharmacies, Inc. ("HPI") for the latter to provide pharmacy services to the hospital for five years. HPI is the nation's largest pharmacy contractor. Like its competitors, HPI offers more sophisticated - and arguably safer - services than traditional in-house pharmacies staffed with employee-pharmacists and administered by hospital management. *fn2"

 In 1980 Memorial's fiscal intermediary, Blue Cross of Oklahoma ("BCO"), conducted an audit of Memorial's fiscal year 1979 cost report, thereafter disallowing reimbursement of approximately $36,000 of Memorial's pharmacy costs under the "substantially out of line" and "prudent buyer" rules. Memorial appealed to the PRRB, and in September, 1982, the PRRB upheld the disallowances. The Secretary, by her delegate, then declined to review the Board's decision, making it the final administrative ...

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