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March 13, 1992

LGH, LTD., d/b/a LARKIN GENERAL HOSPITAL, et al., Plaintiffs,
LOUIS W. SULLIVAN, M.D., Secretary of Health and Human Services, Defendant. BIG SUN HEALTHCARE SYSTEMS, INC., d/b/a MUNROE REGIONAL MEDICAL CENTER, et al., Plaintiffs, v. LOUIS W. SULLIVAN, M.D., Secretary of Health and Human Services, Defendant. INDIAN RIVER COUNTY HOSPITAL DISTRICT, d/b/a INDIAN RIVER MEMORIAL HOSPITAL, Plaintiff, v. LOUIS W. SULLIVAN, M.D., Secretary of Health and Human Services, Defendant.

The opinion of the court was delivered by: JOHN H. PRATT

 These consolidated cases arise out of a dispute between seven Florida hospitals and the Secretary of Health and Human Services ("Secretary") over whether certain assessments paid by the hospitals into a state-operated malpractice insurance fund constitute costs reimbursable under Medicare's old system of reimbursement for inpatient hospital services. Before the court are plaintiffs' and defendant's motions for summary judgment and the oppositions, replies, and supplemental memoranda thereto. The matter has been fully briefed. For the reasons stated below, we grant plaintiffs' motion and deny defendant's motion.

 I. Background

 A. Overview of Medicare Provider Reimbursement

 Before getting into the legal issues involved, it is necessary to set forth in some detail the statutory provisions and past and current practices governing Medicare reimbursements.

 Medicare beneficiaries are entitled to receive hospital services at any hospital participating in the Medicare program as a "provider." 42 U.S.C. §§ 1395d, 1395x(b), 1395x(u). To the extent that hospital services furnished to a Medicare beneficiary are covered by the Medicare program, no charge is made to the beneficiary by the hospital, except for certain deductible and coinsurance amounts. 42 U.S.C. § 1395cc(a). Instead, the hospital is paid directly by Medicare.

 From the inception of the Medicare program in 1966 until hospital fiscal years beginning on or after October 1, 1983, the Medicare program paid each hospital its actual "reasonable cost" for covered services. See 42 U.S.C. § 1395f(b)(1). Reasonable cost is defined at 42 U.S.C. § 1395x(v)(1)(A) as "the cost actually incurred, excluding therefrom any part of incurred cost found to be unnecessary in the efficient delivery of needed health services." In addition, both direct and indirect costs are covered. Id. The statutory definition of reasonable cost authorizes the Secretary to adopt regulations specifying which costs are allowable, how costs are to be apportioned, and any cost limits that might apply. Id.

 In 1983, Congress instituted a fundamental change in the method of payment for inpatient hospital services effective for cost reporting periods beginning on or after October 1, 1983. Social Security Amendments of 1983, Pub. L. No. 98-21, 97 Stat. 65, 149. Under the new prospective payment system ("PPS"), a hospital's actual operating costs are irrelevant in computing the amount of payment for acute care inpatient services. Instead, each patient discharge is assigned a value (known as diagnosis related groups or DRGs) based on the amount of hospital resources that patient's diagnosis and treatment normally require. The DRG values corresponding to all of the hospital's Medicare patient discharges are multiplied by a pre-established prospective payment rate to yield a provider's total Medicare payment. See 42 U.S.C. § 1395ww. As defendant notes, because the PPS system is designed to provide an incentive for hospitals to operate efficiently, it may produce lower annual payments to hospitals for services to Medicare patients than did the previous cost-based reimbursement system. Memorandum of Points and Authorities in Support of Defendant's Motion for Summary Judgment ("Defendant's Motion") at 4.

 Under both cost-based reimbursement and PPS, hospital providers enter into agreements with the Secretary and nominate fiscal intermediaries *fn1" to implement the Medicare compensation process. 42 C.F.R., Part 421. Hospital providers file with their fiscal intermediaries an annual cost report setting forth their costs during the year. Under the former cost-based reimbursement system, the intermediary reviewed the cost report for each provider to ascertain whether the hospital's costs are allowable under regulations and instructions promulgated or published by the Department of Health and Human Services ("HHS").

 The intermediary, after analyzing a given cost report and making any necessary adjustments, issues a Notice of Program Reimbursement ("NPR"). The NPR sets forth the amount due the provider, notes any adjustments, and informs the provider of appeal rights. 42 C.F.R. § 405.1803. If the provider is dissatisfied with the intermediary's determination and the amount in controversy is $ 10,000 or more, the provider may appeal to the Provider Reimbursement Review Board ("PRRB" or the "Board"), a five-member body comprised of persons knowledgeable in the field of provider payments. 42 U.S.C. § 1395oo(a), (h). Within sixty days after a PRRB decision, the Secretary, acting through the Administrator of the Health Care Financing Administration ("HCFA"), may affirm, reverse, or modify the PRRB's decision. 42 U.S.C. § 1395oo(f)(1); 42 C.F.R. § 405.1875. Dissatisfied providers may seek judicial review pursuant to the applicable provisions of the Administrative Procedure Act ("APA"), 5 U.S.C. § 701, et seq. 42 U.S.C. § 1395oo(f)(1).

 B. The Florida Patient Compensation Fund

 In 1975, Florida's primary medical malpractice insurance carrier, Argonaut Insurance, pulled out of the Florida malpractice market, leaving health care institutions and physicians unprotected. Rec. I at 248. *fn2" In response, the Florida legislature enacted the Medical Malpractice Reform Act, Fla. Stat. § 768.54, which created the Florida Patient Compensation Fund ("FPCF" or the "Fund"). Participation in FPCF was mandatory for hospitals, unless the hospital could meet a specific statutory exemption by demonstrating financial responsibility for malpractice claims. Rec. II at 35. Plaintiffs were members of FPCF from 1976 until July 1, 1982. *fn3" Rec. I at 6; Rec. II at 35; Rec. III at 12.

 Generally, insurance premiums must be set at an actuarially sound rate (i.e., one sufficient to cover all liability for adverse medical occurrences that take place in the coverage year, as well as all administrative expenses). Rec. I at 784-85. Actuarially sound membership fees, however, were never assessed during the time plaintiff providers participated in FPCF. Id. at 272-73. As a result, FPCF was underfunded from its inception. Id.

 FPCF was empowered to obtain funds from its participants in two ways: first, by charging a mandatory membership fee for a given year; and, second, by making an assessment for any earlier year for which the amount of money held by the Fund proved to be deficient under the statutory formula. Id. at 790-91. Since the fee for membership was relatively nominal, *fn4" the initial fund for each year was not actuarially sound. Id. at 783. As a result, deficiencies for some years inevitably would have to be covered through later assessments. Id at 783-84.

 To the extent that the fees collected were inadequate to cover claims, the Fund statute provided an assessment mechanism:

 If the Fund determines that the amount of money in an account for a given fiscal year is . . . not sufficient to satisfy the claims made against the account, the Fund shall certify the amount of the projected . . . insufficiency to the Insurance Commissioner and request the Insurance Commissioner to levy an assessment . . . for that fiscal year. . . .

 Fla. Stat. § 768.54(3)(d). Under the statute, assessments were based only on actual claims. Id. Projected future claims, which are considered in most insurance contexts, could not be computed into assessments.

 In 1981, FPCF acknowledged that it had a substantial deficit. Accordingly, in January 1982, it certified the first retrospective assessment, based only upon known claims. Rec. II at 1693-1702. A number of legal challenges to the assessment mechanism and the Fund statute's constitutionality ensued, but these were ultimately unsuccessful. Id. at 493-97; see also Department of Insurance v. Southeast Volusia Hospital District, 438 So. 2d 815 (Fla. 1983), appeal dismissed sub nom. Southeast Volusia Hospital District v. Florida Patient's Compensation Fund, 466 U.S. 901, 80 L. Ed. 2d 149, 104 S. Ct. 1673 (1984). In the meantime, the Fund certified an additional assessment in 1982 and two more in 1983. Rec. II at 694.

 C. Plaintiffs' Reimbursement Claims

 The facts giving rise to this reimbursement dispute arose in 1983 when the lawsuits challenging the Fund statute culminated in defeat for the hospitals. Three of the Florida plaintiffs in this action, the Larkin General, Venice, and St. Joseph's hospitals ("LGH group") marked accrued expenses on their books and voluntarily entered into identical settlement agreements with FPCF in 1984. Rec. II at 693. Plaintiff Indian River Memorial Hospital ("Indian River") similarly accrued a large medical malpractice expense on its financial records and reached a similar settlement agreement with the Fund in 1984. Rec. III at 12, 14. The Munroe, Cedars, and South Miami hospitals ("Big Sun group") made ...

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