37 Soc.sec.rep.ser. 284, Medicare & Medicaid Guidep 40,203mt. Diablo Hospital, Plaintiff-appellant, v. Louis W. Sullivan, M.d., Secretary of Health and Humanservices, Defendant-appellee.memorial Hospitals Association, Plaintiff-appellant, v. Otis R. Bowen, M.d., Secretary of Health and Human Services,defendant-appellee, 963 F.2d 1175 (9th Cir. 1992)

Mt. Diablo and Memorial Hospitals appeal from the district courts' grants of appellee Secretary of Health and Human Services Louis Sullivan's ("Secretary") motions for summary judgment. We consider whether the district courts erred in concluding (1) that the Secretary's methods for determining routine cost limits for Medicare reimbursement are not arbitrary and capricious and (2) that the providers were not entitled to retroactive corrective adjustments to compensate them for the effects of those cost limits. For the reasons stated below, we affirm the judgment in Memorial Hospitals v. Sullivan, No. 90-15857, but reverse and remand the decision in Mt. Diablo Hospital v. Sullivan, No. 90-15772.

* BACKGROUND

Appellants provide health care services to eligible aged and disabled persons under the Medicare program, 42 U.S.C. § 1395 et. seq. For the cost years at issue in this case,¹  providers were reimbursed for daily routine service costs at a rate equivalent to the lesser of the "reasonable cost" of the services or the "customary charges" for the services. Appellants challenge the methods used by the Secretary to determine the "reasonable cost" of providing routine care.

In 1972, Congress amended the Medicare Act to give the Secretary broad discretion to define reasonable costs.²  The amendments were motivated by the desire to contain costs arising from "variations in the efficiency of operation [and] the provision of amenities in plush surroundings." H.R.Rep. No. 231, 92nd Cong., 2d Sess., reprinted in 1972 U.S.C.C.A.N. 4989, 5069 [hereinafter House Report]. Previously, providers had been reimbursed for their actual incurred costs. The new regulations excluded "any part of incurred cost found to be unnecessary in the efficient delivery of needed health services...." 42 U.S.C. § 1395x(v) (1) (A).

In 1974, the Secretary began the yearly publication of a schedule of routine cost limits pursuant to the 1972 amendments. The schedules were based on factors the Secretary found "appropriate and practical," including types of services furnished, geographic area, and institutional size. The schedules categorized hospitals by the per capita income of the location area and by number of beds. In 1979, the Secretary began using a wage index to calculate the reasonable cost of labor. The index was based on reports of quarterly hospital wages made to the Bureau of Labor Statistics of the Department of Labor ("BLS"). The average wage for a geographic area was computed by dividing the total hospital wages paid in one year by the total number of hospital workers in the area. The index was then formulated by dividing the average local wage by the national average. The resulting index value for each area would reflect the wage level for that area relative to the national average. See Health Care Financing Administration Medicare Program; Schedule of Limits on Hospital Per Diem Inpatient General Routine Operating Costs for Cost Reporting Periods Beginning on or after July 1, 1981, 46 Fed.Reg. 33637, 33638-89 (June 30, 1981) [hereinafter 1981 Schedule of Limits ].

The BLS data was criticized for several perceived flaws, including its age and its failure to standardize for factors such as the variation in occupational mix and proportion of part-time workers. The data's effective assumption that all employees worked full-time was detrimental to areas that employed large numbers of part-time workers. Areas in which hospitals employed large numbers of part-time employees were determined to have lower costs per employee, and consequently assigned lower index values, than areas in which hospitals had the same costs but a different mix of part-time and full-time workers. Commentators also noted a distorting effect from the inclusion of federal and state hospital wage data in the index. The Secretary defended the use of the BLS data, stating that the indices employed "the most reliable data available." Health Care Financing Administration Medicare Program; Schedule of Limits on Hospital Inpatient General Routine Operating Costs for Cost Reporting Periods Beginning on or after July 1, 1980, 45 Fed.Reg. 41868, 41871 (June 20, 1980).

In 1983, Congress ordered the Secretary to conduct a study to develop a wage index that accounted for the deficiencies in the BLS data. According to the Secretary, the group which eventually conducted the study concluded that the failure to account for part-time workers was the "most serious deficiency" in the BLS data. In 1986, the Secretary finally revised the index to distinguish between part-time and full-time employees.

For the cost years at issue in this case, which were governed by the pre-1986 indices, appellants' costs exceeded the routine cost limits. Each appealed to the Provider Reimbursement Review Board ("PRRB") as required under the Medicare Act, 42 U.S.C. § 1395oo(a). Memorial sought reimbursement for costs in excess of Medicare's routine cost limits. Mt. Diablo requested an order allowing it to go directly to federal court to challenge the cost limits. The PRRB determined that it had no power to determine the validity of the wage index and authorized the parties to seek judicial review in the district court under 42 U.S.C. § 1395oo(f) (1).

Memorial and Mt. Diablo filed suit in the district courts in May 1988 and July 1989, respectively. Memorial sought a retroactive corrective adjustment to its reimbursement based on the "errors" in the wage index or, alternatively, an exemption from the routine cost limits on the grounds that the inaccurate wage index was "an extraordinary circumstance beyond its control."³  Mt. Diablo sought both a declaration that the methodology used in calculating the area wage index was invalid and a retroactive corrective adjustment. The district courts granted the Secretary's motions for summary judgment in each case. Both hospitals timely appealed.

II

STANDARD OF REVIEW

We review the district court's grant of the Secretary's motion for summary judgement de novo. Vallejo Gen. Hosp. v. Bowen, 851 F.2d 229, 230-31 (9th Cir. 1988).

The Secretary's Medicare reimbursement policy is reviewed under the Administrative Procedure Act (APA). 42 U.S.C. § 1395oo(f) (1). Under the APA, we must determine if the Secretary's action was "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law." 5 U.S.C. § 706(2) (A). In making this determination, we "must consider whether the decision was based on a consideration of the relevant factors and whether there has been a clear error of judgment." Citizens to Preserve Overton Park, Inc. v. Volpe, 401 U.S. 402, 416, 91 S. Ct. 814, 824, 28 L. Ed. 2d 136 (1971).

III

ANALYSIS

Mt. Diablo argues that the pre-1986 method for calculating routine cost limits was arbitrary and capricious for two reasons. First, it contends that the Secretary ignored a relevant factor--the discrepancies in the wage index caused by regional variations in the use of part-time and full-time employees. Second, it argues that the Secretary failed to respond adequately to public comments on this issue.

1. Failure to consider a relevant factor.

Mt. Diablo points to three comments on the proposed use of the BLS data as evidence that the Secretary knew about and failed to consider the distortion caused by part-time workers.⁴  In 1979, the Hospital Association of New York State (HANYS) commented: "A wage level comparison based upon [the BLS data relating to service workers] can be distorted by the regional variations in mix of part-time employment, hours worked per week, overtime pay, etc." Comments of the Hospital Association of New York State on the Proposed Schedule of Limits on Hospital Inpatient General Routine Operating Costs for Cost Reporting Periods Beginning On Or After July 1, 1979, April 30, 1979, at 2 [hereinafter Comments of HANYS ].⁵ 

In 1980, the Secretary received two additional comments on the wage index. The Hospital Association of Rhode Island advocated use of data from the American Hospital Association (AHA) because of the distortion caused by BLS' failure to account for part-time workers. An accounting firm also noted the impact of the omission, stating that "those areas with a large volume of part-time hospital workers will rate lower than areas with more full-time employment, even though their actual wage scales may be higher."

We review agency actions under the APA to determine if the agency has adequately considered all "relevant factors." See Citizens to Preserve Overton Park, 401 U.S. at 416, 91 S. Ct. at 823-24. An agency rule may be found to be arbitrary and capricious when

the agency has relied on factors which Congress has not intended it to consider, entirely failed to consider an important aspect of the problem, offered an explanation for its decision that runs counter to the evidence before the agency, or is so implausible that it could not be ascribed to a difference in view or the product of agency expertise.

Motor Vehicle Mfrs. Ass'n v. State Farm Mut. Ins. Co., 463 U.S. 29, 43, 103 S. Ct. 2856, 2867, 77 L. Ed. 2d 443 (1983).

We may conclude that an agency has ignored relevant factors where its action amounts to an " 'artificial narrowing of options' [which] is antithetical to reasoned decisionmaking...." International Ladies' Garment Workers Union v. Donovan, 722 F.2d 795, 817 (D.C. Cir. 1983) (quoting Pillai v. Civil Aeronautics Bd., 485 F.2d 1018, 1027 (D.C. Cir. 1973)) (internal citation omitted). Agency actions cannot be sustained where the agency has failed to consider significant alternatives. See ILGWU, 722 F.2d at 815-16 (agency failed to consider "substantial testimony" and "specific proposals" for alternative actions). Similarly, an action will not be upheld where the agency has intentionally omitted evidence from consideration or where there is nothing in the record to support the agency's decision. See Pillai, 485 F.2d at 1027; California Hosp. Ass'n v. Schweiker, 59 F. Supp. 110 (C.D. Cal. 1982) (in drafting documents supporting a proposal, agency intentionally omitted facts which undermined its position), aff'd, 705 F.2d 466 (9th Cir. 1983).

Applying these criteria, we cannot conclude that the Secretary acted arbitrarily or capriciously by not factoring the use of part-time workers into the wage index. A relatively insignificant percentage of the comments received during the period leading up to the adoption of the 1981 routine cost limits were directed at the part-time worker issue. Most comments were directed at other concerns, particularly a fundamental change in the reimbursement rate and the proposed methods of classifying care providers. Additionally, the record suggests that, far from intentionally omitting the issue from consideration, the agency recognized the growing concern about the part-time worker issue and planned to address it in a comprehensive manner. Indeed, the agency proposed in 1981 to develop an appropriate database by modifying the Medicare cost report, but the proposal was delayed in part because of opposition from the hospital industry.

Moreover, the agency's action was well within the reasonable bounds of its Congressional mandate. The agency was given broad powers to promulgate regulations providing for the determination of the costs of services, including the establishment of limits on costs to be recognized as reasonable. See 42 U.S.C. § 1395x(v) (1) (A). A court must accord an agency's statutory interpretation "substantial deference," since "presumably [the agency] has brought its expertise to bear in formulating the regulation...." American Hosp. Mgmt. Corp. v. Harris, 638 F.2d 1208, 1212 (9th Cir. 1981). Review in such a case "is limited to determining whether the regulation is reasonably related to the purpose of the relevant enabling legislation...." Id.

Here, Congress recognized that "the initial ceilings will of necessity be imprecise in defining the actual cost of efficiently delivering needed health care.... The data that are available for this purpose will often be less than perfectly reliable...." House Report, supra, at 5070. To forbid the agency from adopting routine cost limits until perfect data concerning a relatively minor issue is developed would contravene the agency's mandate. This is particularly true in the case of part-time workers, since Congress had recognized the need for ongoing refinements and the agency had proposed to remedy the problem.

Mt. Diablo also argues that the Secretary should have used AHA data, which was weighted to account for the part-time worker issue, in formulating the wage index. It claims this data was available to the Secretary as early as 1979, and that it was used in calculating other portions of the wage index.

The Secretary did not indicate why (or whether) the BLS data was preferable to the AHA data with regard to the part-time worker issue. But "we will uphold a decision of less than ideal clarity if the agency's path may reasonably be discerned." Bowman Transp., Inc. v. Arkansas-Best Freight Sys., Inc., 419 U.S. 281, 286, 95 S. Ct. 438, 442, 42 L. Ed. 2d 447 (1974). That path is evident here. The record indicates that the decision to use the BLS data was based upon a number of factors, including variations in overtime, and variations in hospital occupational categories. The agency stated in the June 20, 1980, Federal Register that it did "not bas [e] the wage index on AHA data because these data are less complete than those supplied by the BLS, since they do not include all of the occupational categories comprised by the BLS data base." Medicare Program; Schedule of Limits on Hospital Inpatient General Routine Operating Costs of Cost Reporting Periods Beginning on or after July 1, 1980, 45 Fed.Reg. 41868, 41872 (1980). The agency simply chose one imperfect database over another while seeking to develop data superior to either. This choice was rational. The Secretary concluded that the BLS data were "the most reliable data available" at the time. See Schedule of Limits, supra at 33639. Given the narrow scope of review, we cannot regard the Secretary's decision to use that data as arbitrary and capricious.⁶ 

2. Failure to respond adequately to public comments.

Mt. Diablo argues that the routine cost limits are invalid because the Secretary "did not respond specifically" in the Federal Register to comments about the part-time worker issue. The Secretary explained his use of the BLS data only by saying that they were "the most reliable data available." See Schedule of Limits, supra at 33639. Mt. Diablo contends that the Secretary was obligated to explain the reasoning behind that conclusion.

A rule may be invalidated under the APA because an agency fails to explain the rule adequately. United States v. Garner, 767 F.2d 104, 117 (5th Cir. 1985); see also International Bhd. of Teamsters v. United States, 735 F.2d 1525, 1532 (D.C. Cir. 1984) (in absence of "other indication" of why the agency acted as it did, "bald assertion" that reporting items are "unnecessary" cannot be upheld). Nevertheless,

[t]here is no obligation to make references in the agency explanation to all the specific issues raised in comments. The agency's explanation must simply enable a reviewing court to see what major issues of policy were ventilated by the informal proceedings and why the agency reacted to them the way it did.

South Carolina ex rel. Tindal v. Block, 717 F.2d 874, 886 (4th Cir. 1983) (internal citations and quotations omitted), cert. denied, 465 U.S. 1080, 104 S. Ct. 1444, 79 L. Ed. 2d 764 (1984). In making the "keystone" inquiry whether the Secretary "engaged in reasoned decisionmaking," ILGWU, 722 F.2d at 815, the reviewing court is to consider the larger administrative record. 5 U.S.C. § 706.

As the preceding discussion explains, the record indicates that the Secretary acted reasonably in formulating the wage index. Moreover, given the fact that the part-time worker issue was of minor significance at the time the wage index was adopted, the Secretary had no obligation to provide a specific response to the comments about it. The Secretary's general response to the concern over the validity of the BLS data was appropriate.

The Medicare statute, 42 U.S.C. § 1395, requires the Secretary to make "retroactive corrective adjustments" for hospitals whose reimbursement under the cost rules "proves to be either inadequate or excessive." 42 U.S.C. § 1395x(v) (1) (A) (ii). Mt. Diablo and Memorial hospitals seek a retroactive corrective adjustment because they claim that the old cost rules undercompensated them by failing adequately to take into account their labor costs. The district courts denied relief on different grounds.

The statute at issue, 42 U.S.C. § 1395x(v) (1) (A), provides that " [t]he reasonable cost of any services ... shall be determined in accordance with regulations establishing the method or methods to be used ... in determining such costs.... Such regulations shall ... (ii) provide for the making of suitable retroactive corrective adjustments where, for a provider of services for any fiscal period, the aggregate reimbursement produced by the methods of determining costs proves to be either inadequate or excessive." On its face, the plain language of the statute appears to require the Secretary to make a retroactive adjustment when its cost method produces an inequitable result in a particular case.

In Regents of the Univ. of California v. Heckler, 771 F.2d 1182, 1189 (9th Cir. 1985), the Secretary contended that this provision requires "no more than a year-end balancing of the books." Id. at 1189. We rejected that argument for four reasons. First, such a limited reading was inconsistent with the plain language of the statute, which requires adjustments whenever a hospital's compensation is "inadequate or excessive," not merely when it has been calculated incorrectly. Id. at 1189-90. Second, a different section--42 U.S.C. § 1395g--already provides for a year-end adjustment to rectify accounting errors made in calculating the cost reimbursements. To read section 1395x(v) (1) (A) (ii) as requiring nothing more would make it redundant. Regents, 771 F.2d at 1189.

Third, the 1972 Medicare amendments, which established the cost methods at issue in Regents and here, "merely added another method of cost calculation to those already recognized as legitimate by the statute." Id. Prior methods had already been determined to be subject to the provisions for retroactive adjustment. To conclude that this new method was immune from retroactive adjustments on the basis of inadequate reimbursement would lead to the perverse result of "render [ing] the corrective adjustment clause nugatory in the case of one particular method of calculating costs." Id. at 1190. Finally, Regents reviewed the legislative history of the section, which seemed unambiguously to establish that the Secretary's cost limits were presumptive, not conclusive. Id. Thus, Regents concluded that hospitals were entitled to seek a retroactive corrective adjustment on the grounds that the cost limits, even though correctly applied, worked an injustice in their particular circumstance. Id. at 1191.

Under Regents, the hospitals are entitled to make their case for a retroactive corrective adjustment. The only question in this case is whether Regents remains good law after the Supreme Court's decision in Bowen v. Georgetown University Hospital, 488 U.S. 204, 109 S. Ct. 468, 102 L. Ed. 2d 493 (1988), which also applied section 1395x(v) (1) (A) (ii).

In Georgetown, the Secretary's 1981 cost rule had been struck down by a court, and the Secretary sought to reimpose the rule retroactively and collect the "overpayments" it had made to all hospitals during the time the rule had been held invalid. The Supreme Court rejected the Secretary's argument, holding:

This provision [1395x(v) (1) (A) (ii) ] on its face permits some form of retroactive action. We cannot accept the Secretary's argument, however, that it provides authority for the retroactive promulgation of cost-limit rules. To the contrary, we agree with the Court of Appeals that clause (ii) directs the Secretary to establish a procedure for making case-by-case adjustments to reimbursement payments where the regulations prescribing computation methods do not reach the correct result in individual cases. The structure and language of the statute require the conclusion that the retroactivity provision applies only to case-by-case adjudication, not to rulemaking.

Id. at 209. In so doing, Georgetown cited Regents with apparent approval, distinguishing it from those cases which had permitted the Secretary to engage in retroactive rulemaking. Id. at 209-10 n. 1.⁷ 

Thus, the rule established by the Supreme Court in Georgetown is that case-by-case adjustments in the interests of justice are allowed under clause (ii), but rules of general applicability are not. The only question, therefore, is whether what Mt. Diablo and Memorial are seeking constitutes across-the-board rulemaking or a case-by-case adjustment. It seems clear that they intended to seek the latter. In fact, the district courts in both cases recognized that the hospitals were seeking individualized adjustments to the aggregate amount of their reimbursement under clause (ii), not revisions in the cost methods used by the Secretary.⁸ 

The Secretary suggests that, notwithstanding the hospitals' characterization of their own claims, they really seek rulemaking changes. We do not agree. Unlike the Secretary's proposed changes in Georgetown, which would affect all hospitals under the rules, the adjustments sought by Mt. Diablo and Memorial would apply only to them. The situation of the hospitals is similar to the situation in Regents: the hospital there was entitled to seek reimbursement under clause (ii) over and above the cost limits imposed by the Secretary, even though its claims were based on exceptions the Secretary had already determined not to apply. See Regents, 771 F.2d at 1185-86. Both the facts of this case and Ninth Circuit precedent suggest that what the hospitals are seeking here is a case-by-case adjustment, not retroactive rulemaking.⁹ 

We therefore conclude that the hospitals are entitled to make a showing that their compensation was inadequate and that they are entitled to a retroactive adjustment awarding them their "reasonable" costs in excess of the limits prescribed by the Secretary. We remand the Mt. Diablo case to the district court to permit Mt. Diablo to make the required showing.

We do not need to remand the Memorial case, however. The district court in that case did not decide that Georgetown overruled Regents, but rather concluded that Memorial had not made a factual showing sufficient to entitle it to relief under clause (ii) because it could not demonstrate that its costs were reasonable. Memorial did not challenge that finding before this court, except to argue that the fact that the Secretary subsequently changed the cost limits automatically rendered its costs reasonable. We reject this argument for the reasons already discussed. The fact that under Regents hospitals may be entitled to retroactive corrective adjustments does not absolve them of the responsibility of proving that they are entitled to such adjustments in any particular case.

IV

CONCLUSION

We conclude that the Secretary's method for calculating routine cost limits for Medicare reimbursement was not rendered arbitrary and capricious by the Secretary's failure to account for the use of part-time workers. We also conclude that hospitals are entitled to seek a retroactive adjustment to the wage index to account for the use of part-time workers. The decision of the district court in docket No. 90-15857, Memorial Hospitals Ass'n v. Sullivan, is AFFIRMED. The decision of the district court in docket No. 90-15772, Mt. Diablo Hospital v. Sullivan, is REVERSED and REMANDED.