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In re William B. Kessler Memorial Hospital

Decided: January 11, 1979.


On certification to the Superior Court, Appellate Division, whose opinion is reported at 154 N.J. Super. 147 (1977).

For reversal and remandment -- Chief Justice Hughes and Justices Mountain, Sullivan, Clifford and Handler. For affirmance -- Justices Pashman and Schreiber. The opinion of the court was delivered by Sullivan, J. Handler, J., concurring. Justice Mountain joins in this opinion. Pashman, J., dissenting. Justice Schreiber joins in this opinion. Mountain and Handler, JJ., concurring in the result.


[78 NJ Page 566] This case involves a dispute between William B. Kessler Memorial Hospital (Kessler) and the State Department of Health (Department) over the calculation of the per diem rate for 1976 at which Blue Cross and Medicaid were to reimburse Kessler for covered patient hospital care. The administrative decision was made pursuant to the Health Care Facilities Planning Act, N.J.S.A. 26:2H-1 et seq. in a proceeding in which Kessler challenged the per diem rate set for Blue Cross and Medicaid patients.

The Act was passed in 1971 in response to widespread public concern over the spiraling costs of institutional health care. It declared the public policy of the State to be

[ N.J.S.A. 26:2H-1]

Prior to 1974, the hospital rate-setting process was largely a peer review program administered by the hospital industry itself with routine approval being given by the Commissioners of Health and Insurance. However, in 1974, it became apparent that the program was resulting in substantial annual increases in hospital costs in excess of guidelines promulgated under the federal Economic Stabilization Act of 1970. Accordingly, it was determined that a greater degree of State involvement in the rate-setting process was necessary, and hospitals were notified that beginning in 1975 the State would fully implement its rate-review authority under the Act.

In 1975, detailed rate review guidelines were issued by the Commissioners of Health and Insurance. Hospitals were required to submit itemized proposed budgets to the Department using forms and a cost reporting system specified in the Standard Hospital Accounting and Rate Evaluation (SHARE) Manual promulgated by the Department of Health.*fn1

The instant case involves the fixing of the 1976 per diem rate at which Blue Cross and Medicaid were to reimburse Kessler for covered patient hospital care. Under the 1976

guidelines, hospitals in the fall of 1975 submitted proposed 1976 budgets in the manner and form required by the SHARE manual. Included were the hospital's approved 1975 budget figures and projected actual 1975 costs. Dependent on the percentage of increase sought in estimated costs, the proposed budget was subjected to a detailed analysis.

Basically, the analysis involved a two-step process. First a budget base was determined by comparing the previous, or base, year's cost figures with those of similar hospitals (peer comparison). If any of the previous year's costs exceeded the cost of the median in the peer grouping by a certain percentile, the excess was deducted from the base year costs. This budget base was then adjusted to account for various differences projected for the coming year such as inflation, volume and other economic factors. The hospital's budgeted expenditures which exceeded this adjusted base were excluded from the calculation of the proposed per diem rate. The hospital was then notified of the proposed rate and of the proposed costs that had been challenged as presumptively unreasonable.

In the present case Kessler had submitted its proposed budget for the year 1976 to the Department of Health. So far as is here relevant, the budget was challenged by a departmental analyst as to two proposed cost items. With regard to the emergency room center, the analyst challenged $124,871 of the proposed costs as unreasonable. The newborn nursery center had $12,000 of its proposed costs similarly challenged.

When Kessler was unable to adjust the matter with the analyst, it filed an administrative appeal. Hearings thereon were conducted before a hearing officer in July 1976, and on September 22, 1976 the hearing officer recommended that the challenges to the two cost centers be sustained. In December 1976 the hearing officer's report was upheld and Kessler was notified that its final administrative rate (which did not include the challenged costs in its computation) had been approved at $134.60 per diem.

Kessler appealed the administrative determination to the Appellate Division which reversed in an opinion reported at 154 N.J. Super. 147 (1977). The Appellate Division found that the challenged amounts, $124,871 in the emergency room center and $12,000 in the newborn nursery center, represented costs required by Department of Health licensing regulations, and that the agency's decision to exclude those costs was without evidential foundation and was arbitrary and capricious. This Court granted certification. 75 N.J. 616 (1978).

With regard to emergency room center costs, some background is needed. Prior to July 1975, Kessler had staffed this center with interns. In 1975, as a result of an incident in its emergency room, Kessler was cited for violation of a departmental regulation which requires 24-hour licensed physician coverage in an Emergency Department in a hospital. As a result of this incident, Kessler began to staff its emergency center with licensed physicians present in the center on an around-the-clock basis. This resulted in a substantial increase in emergency room costs which was included in the proposed 1976 budget.

The administrative decision which is the subject of this appeal disallowed the increase to the extent of $124,871 on the ground that while the departmental regulation required 24-hour physician coverage of the emergency room center, it did not mandate 24-hour staffing of the center with a physician present on an around-the-clock basis. Instead, the administrative decision indicated that the extent of emergency room physician coverage depended on need, that a physician could have other duties in the hospital and, depending on the volume, also cover the emergency room. The decision was to the effect that Kessler should establish a plan for physician coverage of its emergency room center adequate to meet its needs and that this would be a compliance with the departmental regulation.

We agree that the regulation does not require 24-hour staffing of the emergency room with a licensed physician present at all times. It does require physician coverage of the emergency room through the establishment of a plan to provide coverage, the extent of which would necessarily depend on the particular needs which the hospital had to meet. However, this interpretation does not fully resolve the problem.

At the administrative hearing, Kessler, in addition to contending that the regulation required it to staff its emergency room center with licensed physicians present on an around-the-clock basis, also argued that, even if the regulation were to be satisfied by establishing a plan of physician coverage other than staffing, Kessler could not meet that requirement because of physical location of the hospital, volume and kind of emergency room cases and lack of any house physician. It asserted that there were no physicians living, or having offices, near the hospital and that the members of its staff of physicians were mostly specialists not particularly adaptable to emergency room coverage.

In short, Kessler urged that its situation was such that the only way it could provide physician coverage of its emergency room adequate to meet its needs was to staff it in the manner provided for in its budget.

This latter issue, an important consideration, is not resolved by the administrative decision which was limited essentially to interpretation of the departmental regulation. The Appellate Division, apparently in the exercise of its original jurisdiction, decided this question in favor of the hospital. However, the very nature of the problem calls for the application of departmental expertise and experience in the first instance. The Department's evaluation of the factors relied on by Kessler would carry substantial weight on judicial review.

Therefore, we conclude that protection of the public interest and fairness to Kessler require that the matter be remanded

to the Department for consideration of this issue. To the extent necessary, the hospital should have the opportunity to expand the record to expose its position fully. It may well be that partial staffing of the emergency room and partial coverage by other hospital physicians would be adequate.

The Appellate Division opinion was critical of the way the Department had used peer group comparison as one of the mechanisms in the rate-setting process. The Appellate Division stated that the costs compared must be derived from hospitals which are truly comparable and that there was evidence of significant differences between Kessler and the peers to which it was compared. It also indicated that the Department should have made findings that Kessler's peers were comparable and how their differences, if any, were, or were not, significant to their cost experience.

We disagree. Peer comparison has always been recognized as useful in the analysis of hospital budgets. However, no two hospitals are exactly alike. Thus, to require the Department, in peer review, to make specific findings as to what differences existed between the hospitals in the peer group (statewide peer grouping could involve over one hundred hospitals), and the extent to which these differences may affect cost experience, would complicate the process to a point where it would drain peer comparison of its usefulness and efficiency as a rate review tool.

While the Department may not act arbitrarily in its peer groupings and comparisons thereunder, we must recognize its expertise and experience in this field and allow it considerable flexibility in the use of the peer comparison mechanism as a rate review tool. The record does not indicate that the Department has acted improperly or arbitrarily in the matter.

As to the $12,000 at issue in Kessler's newborn nursery center costs, the Appellate Division held that full time registered nurse staffing of the center was required for compliance with a Departmental regulation which provides:

(a) Separate personnel shall be assigned to the obstetrical service which shall be under direct supervision of a registered professional nurse at all times. If the caseload does not justify the total time of one nurse on each tour of duty, exception may be made by action of the hospital licensing board after submission and approval of written techniques. * * *

(b) There shall be at all times, day and night, registered professional nurse supervision of the nursing care of mothers and infants, and such other nursing supervision and coverage as is required.

[ N.J.A.C. 8:43B-8.4 (a) (b)]

Under this regulation, full time registered nurse staffing was generally required for the nursery as well as for the obstetrical service. Exceptions to this regulation were permissible for hospitals having a small caseload and the Department would allow the hospital to use licensed practical nurses when there were fewer than two babies in the nursery and registered nurse supervision was not necessary. This substitution of licensed practical nurses in the nursery did not require Departmental approval. However, in the obstetrical unit, substitution could be made only after submission and approval of written techniques. N.J.A.C. 8:43B-8.4(a). Kessler had applied for such approval for its obstetrical service which was denied because of its practice of mixing obstetrical patients with gynecological and other female medical/surgical patients.

The Appellate Division, while it recognized the low volume of newborn babies (300 per year) concluded, contrary to the administrative decision, that full staffing of the newborn care center by registered nurses was required by departmental regulations even though there was substantial underutilization of the facility. In this regard we find it to have been in error. The State regulations do permit a hospital, depending on volume, to use licensed practical nurses instead of registered nurses in a newborn care center. The underutilization of the newborn nursery center contributed substantially to the challenge of $12,000.*fn2 The

amount challenged "was generated in total accord with the 1976 SHARE guidelines." The record amply supports the administrative decision.

The judgment of the Appellate Division is reversed and the matter remanded to the Department for further proceedings in accordance with this opinion.

HANDLER, J., concurring. I find myself in agreement with the opinion of this Court. Because of the novelty, complexity and importance of the issues involved in this litigation, I feel constrained to comment upon certain aspects of the controversy and the manifold problems which it presents.


The Health Care Facilities Planning Act of 1971, N.J.S.A. 26:2H-1 et seq., represents a new governmental approach in this State for dealing with the acute social concerns over the escalating costs of hospital health care and services. It fashions a legislative and administrative regulatory format governing health care facilities and services which are deeply impressed with the public interest and general welfare. Primary responsibility for administering the State's health care program is vested by the Act in the State Department of Health. The regulatory tools of the Commissioner of Health are directed to two major areas, economy and quality. Through the transfer of jurisdiction over hospital licensing from the former Department of Institutions and Agencies, the Department of Health oversees the quality of hospital care. N.J.S.A. 26:2H-12, -13, -19, -22. Cost-containment and efficiency are addressed through the certificate of need program which requires health care providers to demonstrate that any proposed creation or expansion of services is necessary, economical and consistent with the orderly development of adequate health care services, N.J.S.A. 26:2H-7 to 11; St. Vincent's Hospital v. Finley, 154 N.J. Super. 24 (App.

Div. 1977); St. Joseph's Hospital and Medical Center v. Finley, 153 N.J. Super. 214 (App. Div. 1977), certif. den. 75 N.J. 595 (1978); and through statutory provisions which authorized the Commissioner of Health, in cooperation with the Commissioner of Insurance, to certify and regulate certain costs of health care services. N.J.S.A. 26:2H-5, -18.*fn1

In September 1974 the State notified hospitals that beginning in 1975 the State would implement its rate-review authority under the Act. In re 1975 Hospital Rate Review Program Guidelines, Report of Hearer, July 3, 1975, at 8 (hereafter Goldmann Report). Annual Hospital Review Program Guidelines, classified as temporary regulations (Guidelines), N.J.A.C. 8:31-14, -21, which set forth criteria for "reasonableness" used to review proposed hospital budgets, were promulgated in February 1975. These were accompanied by ...

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