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New England Deaconess Hospital v. Kathleen Sebelius

April 29, 2013


The opinion of the court was delivered by: Judge Beryl A. Howell


This case concerns whether the plaintiff, New England Deaconess Hospital ("Deaconess"), a former healthcare provider and participant in the Medicare program, received appropriate reimbursement from Medicare for the depreciation of assets that it used to treat Medicare patients. Following the plaintiff's statutory merger with another healthcare provider, the plaintiff sought reimbursement from Medicare for what the plaintiff asserted was a loss that it incurred due to the depreciation of its Medicare assets that was almost $8.5 million dollars more than what Medicare had originally estimated. After a multi-tiered administrative proceeding, the defendant Secretary of the U.S. Department of Health and Human Services ("the Secretary") denied the plaintiff's reimbursement claim, which over the course of the claim proceedings grew to an estimated $15--20 million, concluding that the loss was not allowable because the statutory merger did not involve an arm's length transaction between unrelated parties for reasonable consideration, with each party acting in its own self-interest. The plaintiff challenges the Secretary's ruling*fn1 on the grounds that it was arbitrary, capricious, an abuse of discretion, otherwise not in accordance with law, and unsupported by substantial evidence.*fn2 Both parties have moved for summary judgment.*fn3


This is an administrative law case, and so the Court will begin by discussing the statutory and regulatory framework underlying the agency's decision. The Court will then summarize the factual circumstances of the plaintiff's statutory merger and the history of the agency adjudication at issue before addressing the merits of the plaintiff's claim.

A.Statutory and Regulatory Framework

1.Medicare Reimbursements Generally

Medicare is a federal program that pays for health care services furnished to eligible beneficiaries-generally individuals over 65 and individuals with disabilities. See Pl.'s Statement of Material Facts ("Pl.'s Facts") ¶ 1, ECF No. 17; see also 42 U.S.C. § 1395c. See generally CTRS. FOR MEDICARE & MEDICAID SERVS., MEDICARE & YOU (2012), available at The Centers for Medicare and Medicaid Services ("CMS"), formerly known as the Health Care Financing Administration,*fn4 is the component of the Department of Health and Human Services ("HHS") that administers the Medicare program. See, e.g., St. Elizabeth's Med. Ctr. v. Thompson, 396 F.3d 1228, 1230 (D.C. Cir. 2005). The CMS reimburses healthcare providers*fn5 for, among other things, "the reasonable cost" of the services they provide to Medicare beneficiaries. See 42 U.S.C. § 1395f(b)(1). The Medicare Act defines "reasonable cost" as "the cost actually incurred, excluding therefrom any part of the incurred cost found to be unnecessary in the efficient delivery of needed health services, and shall be determined in accordance with regulations" promulgated by HHS. Id. § 1395x(v)(1)(A).

Providers submit claims (also known as "cost reports") for reimbursement to a series of private "Medicare administrative contractors" (also known as "fiscal intermediaries"), who, among other functions, process claims and reimburse providers on behalf of Medicare. Id. § 1395kk-1. If a provider disagrees with a fiscal intermediary's reimbursement decision, the provider may appeal the decision to the Provider Reimbursement Review Board ("PRRB"), which is a five-member body appointed by the Secretary. See id. § 1395oo. At her discretion, the Secretary may reverse, affirm, or modify any PRRB decision. Id. § 1395oo(f); see also 42 C.F.R. § 405.1875. The Secretary's decision (or, if the Secretary takes no action, the PRRB's decision) constitutes a final agency action, and a provider has the right to challenge such a decision in federal district court within sixty days of issuance. See 42 U.S.C. § 1395oo(f).

2.Reimbursement for Asset Depreciation

The Medicare regulations state that the program will reimburse a provider for, inter alia, Medicare's share of "capital-related costs," which include the depreciation of any of the provider's buildings and equipment that are used to treat beneficiaries. See 42 C.F.R. §§ 413.130, 413.134(a). The rationale for such reimbursement is that depreciation reflects part of the "the cost actually incurred" by the provider in treating beneficiaries. See 42 U.S.C. 1395x(v)(1)(A); 42 C.F.R. § 413.5 (outlining principles of reimbursement for "allowable costs," including depreciation). To determine how much Medicare reimburses a provider for depreciation, the depreciating asset's historical cost-i.e., the cost to the provider of initially obtaining the asset, see 42 C.F.R.§ 413.134(b)(1)- is first pro-rated over the estimated useful life of the asset. See id. § 413.134(a).*fn6 Once the asset's overall estimated annual depreciation is calculated, Medicare reimburses the provider for the percentage of Medicare's share of that estimated annual depreciation, which is equal to the percentage of the asset used that year to treat beneficiaries. See id. § 413.134(a)(2)--(3); see also St. Luke's Hosp. v. Sebelius, 611 F.3d 900, 901 (D.C. Cir. 2010) ("[T]he annual reimbursable allowance is equal to the actual cost divided by the number of years of its useful life and then multiplied by the percentage of the asset's use devoted to Medicare services in the given year."). An asset's historical cost, less its cumulative estimated depreciation, is known as its "net book value." See 42 C.F.R. § 413.134(b)(9).

Annual estimated depreciation (also known as an "allowance for depreciation," see id. § 413.134(a)), however, is just that-an estimate. Thus, any reimbursement based on that estimate is also necessarily an estimate. For this reason, the Medicare Act requires that "retroactive corrective adjustments" be made where "the aggregate reimbursement produced by the methods of determining costs proves to be either inadequate or excessive." See 42 U.S.C. § 1395x(v)(1)(A). An estimate "proves to be either inadequate or excessive" when a more accurate measure of depreciation can be ascertained. As a general matter, a change in ownership can provide a more accurate measure of depreciation, insofar as the change in ownership reflects the true "fair market value" of the asset. An asset's fair market value is "the price that the asset would bring by bona fide bargaining between well-informed buyers and sellers at the date of acquisition." See 42 C.F.R. 413.134(b)(2). In other words, fair market value is the price an asset would sell for in an arm's length, open-market transaction. Hence, when an asset is sold in such a market transaction, and the fair market value turns out to be more or less than the net-book value, a retroactive corrective adjustment is required. If the sales price is less than the estimated remaining value of the asset, then the annual estimated depreciation payments would have underestimated the amount of depreciation, and the provider would be entitled to additional reimbursement to account for Medicare's share of the decline in the asset's value. If, however, the sales price is more than the estimated remaining value of the asset, then Medicare would have overestimated the asset's depreciation, and it would recapture the excess depreciation paid to the provider. See, e.g., Forsyth Mem'l Hosp., Inc. v. Sebelius, 639 F.3d 534, 536 (D.C. Cir. 2011); Pl.'s Mem. in Supp. Mot. for Summ. J. ("Pl.'s Mem.") at 3 n.4, ECF No. 17. Such adjustments ensure that only "the cost actually incurred" by a provider is reimbursed-no more, no less. See 42 U.S.C. 1395x(v)(1)(A).

3.Depreciation Recalculations Involving Mergers

Until 1997, the Medicare Act and its implementing regulations permitted retroactive corrective adjustments for any gain or loss in depreciation costs realized as a result of a change in ownership of an asset. See 42 C.F.R. § 413.134(f) (1996). During the 1990s, however, changes in economic conditions, together with changes in the health care industry, caused sales and mergers of assets to result in an increasing number of depreciation losses, rather than gains, which in turn resulted in an increasing financial burden on the Medicare program. See Pl.'s Facts ¶ 35. See generally OFFICE OF INSPECTOR GEN., U.S. DEP'T OF HEALTH & HUMAN SERVS., MEDICARE LOSSES ON HOSPITAL SALES (1997), available at (estimating that Medicare would lose $512 million in depreciation adjustments for hospitals sold between 1990 and 1996). Due primarily to this increasing financial burden, Congress amended the Medicare Act to eliminate the possibility of being reimbursed for gains or losses arising out of a change in ownership. See Balanced Budget Act of 1997, Pub. L. No. 105-33, § 4404, 111 Stat. 251, 400.

This amendment was only prospective, however, see 111 Stat. at 400, and thus it does not apply to any changes in ownership that took place prior to December 1, 1997. See 42 C.F.R. § 413.134(f)(1). Since the change in ownership at issue in the instant case took place before December 1, 1997, the pre-1997 regulations regarding depreciation reimbursement for changes in ownership apply.Those pre-1997 regulations established that, if a Medicare provider merged with another entity under state law, the surviving entity would be eligible for reimbursement on any loss (or gain) realized as a result of depreciation of the merged provider's Medicare assets. See 42 C.F.R. § 413.134(f), (l)(2) (1996). As the CMS explained when promulgating this regulation in 1979, in the context of a statutory merger "the merged corporation ceases to exist as a corporate entity" and thus "there has indeed been a transfer of ownership and a revaluation is proper." See Effect of Capital Stock Transactions, 44 Fed. Reg. 6912, 6913 (Feb. 5, 1979). "Under the ...

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