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December 8, 1983

MARGARET M. HECKLER, et al., Defendants; MEMORIAL OSTEOPATHIC HOSPITAL, et al., Plaintiffs v. MARGARET M. HECKLER, et al., Defendants; ALLEGHENY GENERAL HOSPITAL, et al., Plaintiff v. MARGARET M. HECKLER, et al., Defendants

The opinion of the court was delivered by: FULLAM


 On March 15, 1979, the Secretary of the Department of Health, Education and Welfare -- subsequently rechristened the Department of Health and Human Services (HHS) -- issued a proposed rule that altered one aspect of the method by which hospitals are reimbursed for their participation in Medicare, the federally funded health insurance program for the aged and disabled. 44 Fed. Reg. 15744. Under Title XVIII of the Social Security Act (the Medicare Act), 42 U.S.C.A. §§ 1395-1395pp (1974 & West Supp. 1983), HHS contracts with health-care providers to render medical services to eligible individuals. Providers are entitled to be reimbursed for all "reasonable costs" of providing such services. Id. § 1395f. The "Malpractice Rule," which was promulgated in final form on June 1, 1979, revised the formula for calculating the portion of hospitals' malpractice insurance costs attributable to Medicare patients and thus reimbursable by the Medicare program. 44 Fed. Reg. 31641, codified at 42 C.F.R. § 405.452 (b)(1)(ii). The new rule significantly reduces the reimbursement made to most hospitals, and has generated virtually unanimous opposition from the nation's hospitals.

 Plaintiffs here are non-profit health-care facilities, including acute-care hospitals, hospital-based skilled nursing facilities, and hospital-based home-health agencies. Plaintiffs challenge the rule on three separate grounds: (1) that the Secretary failed to comply with the notice and comment requirements of the Administrative Procedure Act (APA), 5 U.S.C. § 553, which governs informal rulemaking; (2) that the Malpractice Rule is arbitrary and capricious and thus violates § 706(2)(A) of the APA; and (3) that the rule is substantively invalid under the Medicare Act because it fails to reimburse hospitals for reasonable costs incurred in providing services to Medicare patients.


 Until the Malpractice Rule went into effect in July 1979, malpractice insurance costs -- which may take the form of premiums paid to an insurer or payments to a self-insurance fund -- were included in the "General and Administrative" category (G&A) of hospital expenses, along with other insurance costs, administrative salaries, and so forth. To apportion G&A costs between Medicare and non-Medicare patients, the G&A total was simply multiplied by the hospital's Medicare utilization rate (i.e., the percentage of patient bed-days used by Medicare patients).

 The March 15 Notice of Proposed Rulemaking (NPRM) stated that under the utilization approach the Medicare program paid a disproportionate amount of malpractice costs. 44 Fed. Reg. 15744, 15745 (1979). In support of this conclusion, the Secretary cited a consultant's study, which was interpreted as demonstrating that malpractice awards to Medicare patients were significantly lower than those to other patients, because Medicare patients -- being by definition over 65 or disabled -- have shorter life expectancies and lower projected future earnings than do other patient populations.

 As acknowledged in the preamble to the final rule, public comment was both extensive and unanimously negative, but the final rule was substantially similar to the proposal. As adopted, the Malpractice Rule reimburses a hospital for that percentage of its malpractice insurance costs equal to the dollar ratio of malpractice losses it has paid to Medicare beneficiaries to total malpractice losses paid to all patients during the current and four preceding fiscal years. Thus, if a hospital's insurer has paid $100,000 to Medicare claimants and $200,000 to non-Medicare claimants during that five-year period, the hospital would be reimbursed for one-third of its malpractice insurance costs for the current year. The one element that differed from the proposed rule to the final rule concerned hospitals that have paid no malpractice insurance claims during the past five years. Under the proposed rule, such hospitals were to obtain from an independent actuary an estimate of Medicare's share of current malpractice costs. 44 Fed. Reg. at 15745. The final rule eliminates the requirement of an actuarial estimate and replaces it with a "national ratio" of 5.1%. Thus, hospitals lacking claims-paid experience from the preceding five years will be reimbursed for 5.1% of their insurance costs for the year. The 5.1% figure was derived from data in the consultant's report.

 Plaintiffs first challenged the Malpractice Rule during their annual Medicare reimbursement proceedings in 1980. During such proceedings, fiscal intermediaries, *fn1" who serve under contract as agents of HHS, review Medicare reimbursements that have been made periodically through the year and adjust for over- or under-payment. Thereafter, plaintiffs requested a hearing with the Provider Reimbursement Review Board (PRRB), an entity established by the Medicare Act, 42 U.S.C. § 1395 oo, to hear appeals from intermediaries' reimbursement determinations. Hospital Association of Pennsylvania Group Appeal, PRRB Case No. 81-332-G. The appeal disputed the legality of the Malpractice Rule as applied for the year ending June 30, 1980. On its own motion, the Board found that it lacked authority to decide the validity of the Malpractice Rule, because it is bound under 42 C.F.R. § 405.186 by existing Medicare regulations. The Board accordingly directed expedited judicial review, pursuant to 42 U.S.C. § 1395 oo (f)(1). This action was promptly filed in the Eastern, Middle and Western Districts of Pennsylvania; all three cases were transferred to and consolidated in this court.


 Plaintiffs first contend that the rulemaking process followed by the Secretary in adopting the Malpractice Rule failed to conform with the Administrative Procedure Act's notice and comment requirements, which apply to informal rulemaking. 5 U.S.C.§ 553. Specifically, plaintiffs allege that the notice of proposed rulemaking failed to provide sufficient information to allow for meaningful comment, and that the basis and purpose statement of the final rule was inadequate.

 The general test of the adequacy of a Notice of Proposed Rulemaking (NPRM) is whether it "fairly apprise[d] interested parties of all significant subjects and issues involved," allowing the public to "effectively participate in the rulemaking process." American Iron and Steel Institute v. EPA, 568 F.2d 284, 291 (3d Cir. 1977) (citations omitted). Plaintiffs complain that their participation was seriously hampered because the notice failed to describe the methodology or findings of the study that was the sole empirical basis for the Malpractice Rule. In fact, the NPRM referred only to "a study conducted by an HEW consultant," though the final rule identified the report's author as Westat, Inc. As the D.C. Circuit has recently noted, it is especially important for "an agency to identify and make available technical studies and data that it has employed in reaching the decision to propose particular rules." Connecticut Light and Power Co. v. Nuclear Regulatory Commission, 218 U.S. App. D.C. 134, 673 F.2d 525, 531 (D.C. Cir.), cert. denied, 459 U.S. 835, 103 S. Ct. 79, 74 L. Ed. 2d 76 (1982).

 While the NPRM here challenged is hardly an exemplar by this standard, that defect is not fatal because at least some of the plaintiffs received the consultant's report in time to review it before submitting their comments. See, e.g., comments of the American Hospital Association, Administrative Record Vol. 5, Tab A; the Hospital Corporation of America, Vol. 5, Tab H; the Federation of American Hospitals, Vol. 6, Tab F. Because these organizations represent 6400, 120, and 1,000 hospitals respectively, id., it is not inappropriate to conclude that most interested parties had actual notice, which should be allowed to cure technical defects in notice. Common Carrier Conference-Irregular Route v. U.S., 175 U.S. App. D.C. 244, 534 F.2d 981 (D.C. Cir. 1976), cert. denied, 429 U.S. 921, 97 S. Ct. 317, 50 L. Ed. 2d 288. Particularly telling with regard to this case are the comments of the Hospital Association of Pennsylvania, which offered its views "after a thorough review of the HEW/Westat Study." Vol. 6, Tab H, at 2. Since the Association represents 330 institutions throughout Pennsylvania, plaintiffs here have little cause to complain they lacked effective notice.

 Plaintiffs also argue that notice was inadequate because it failed to address the one element contained in the final rule that was not present in the proposal, namely, the "national ratio". This is a contention which can be disposed of easily. As the Third Circuit has stated, "the submission of a proposed rule for comment does not of necessity bind an agency to undertake a new round of notice and comment before it adopts a rule which is different -- even substantially different -- from the proposed rule." American Iron and Steel, supra, 568 F.2d at 293. The test of adequacy remains whether interested parties were fairly apprised of the issues before the agency. Id. Because the NPRM explicitly stated ...

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