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January 13, 1982

Richard S. SCHWEIKER, Secretary of Health and Human Services, and the Prudential Insurance Co. of America, Defendants

The opinion of the court was delivered by: DEBEVOISE

Plaintiff, Lawrenceville Nursing Home, Inc., brings this action pursuant to section 1878(f) of the Social Security Act, 42 U.S.C. § 1395oo, for review of a decision of the Provider Reimbursement Review Board denying reimbursement under the Medicare program, 42 U.S.C. § 1395, et seq. The Board decision from which plaintiff appeals upheld a determination by plaintiff's fiscal intermediary, the Prudential Insurance Co., to: (a) recapture accelerated depreciation, and (b) disallow certain legal fees for which plaintiff had sought reimbursement.

I. Background

 A. Statutory and Regulatory Framework

 The Medicare program is "a federally funded health insurance arrangement designed to reimburse health care providers for the basic costs of rendering certain limited services to patients over the age of sixty-five." Monmouth Medical Center v. Harris, 646 F.2d 74, 76 (3d Cir. 1981). Under the statute, providers who have rendered services to eligible Medicare beneficiaries are entitled to reimbursement for the lesser of the "customary charges" or "reasonable cost" of such services. 42 U.S.C. § 1395f(b). Payments are to be made from a federally administered fund at periodic intervals, not less than monthly, "with necessary adjustments on account of previously made overpayments or underpayments." 42 U.S.C. § 1395g. The initial responsibility for making reimbursement determinations may be delegated to a public agency or private organization designated a "fiscal intermediary" upon agreement with the Secretary of Health and Human Services. 42 U.S.C. § 1395h.

 If a provider is represented by a fiscal intermediary, the intermediary makes interim estimated payments to the provider for its Medicare-related services from its own funds. The intermediary is then reimbursed, in turn, by the Secretary of Health and Human Services. At the close of each fiscal year, the provider prepares costs reports of its reimbursable expenses. "The intermediary is then responsible for auditing the provider's annual cost reports to determine which costs were properly charged to Medicare and make any necessary adjustments." Moody Nursing Home, Inc. v. United States, 223 Ct. Cl. 581, 621 F.2d 399, 400 (Ct. Claims 1980); see also Pasadena Hospital Association, Ltd. v. United States, 223 Ct. Cl. 72, 618 F.2d 728, 729 (Ct. Claims 1980).

 "Reasonable Cost". This action involves a post-audit determination by plaintiff's fiscal intermediary that plaintiff's reimbursement claims for Medicare-related services exceeded the "reasonable cost" of such services.

 "Reasonable cost" is a concept upon which the Medicare statute elaborates at some length. Section 1861(v)(1)(A) of the Act, 42 U.S.C. § 1395x(v)(1)(A), provides, in relevant party, that:

The reasonable cost of any service shall be the cost actually incurred, excluding therefrom any part of incurred cost found to be unnecessary in the efficient delivery of needed health services, and shall be determined in accordance with regulations establishing the method or methods to be used, and the items to be included.

 The "cost" section further provides that "such regulations" shall:

take into account both direct and indirect costs of providers and services ... in order that ... the necessary costs of efficiently delivering covered services to individuals covered by the insurance programs established by this title will not be borne by individuals not so covered, and the costs with respect to individuals not so covered will not be borne by such insurance programs.

 Finally, the "cost" section provides that the regulations must:

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.

 Regulations promulgated by the Secretary, pursuant to authority granted in the statute, further define the concept of "reasonable cost." They provide that "(all) necessary and proper expenses of an institution in the production of services, including normal standby costs, are recognized." 42 C.F.R. § 405.402(a). The term "necessary and proper costs," according to the regulations, subsumes "costs which are appropriate and helpful in developing and maintaining the operation of patient care facilities and activities ... (and are) usually costs which are common and accepted occurrences in the field of the provider's activity." 42 C.F.R. § 405.451(b)(2). More detailed rules illuminating the general concepts set forth in the statute and the Code of Federal Regulations can be found in the Provider Reimbursement Manual (HIM-15). *fn1" See generally Annie M. Warner Hospital v. Harris, 639 F.2d 961, 964 (3d Cir. 1981).

 Capital Costs. By regulation, the Secretary has expressly authorized the reimbursement of providers for capital expenditures incurred for the purpose of providing services to Medicare program beneficiaries. Capital costs, either for the construction of buildings or the purchase of equipment, are reimbursed through the vehicle of depreciation allowances. 42 C.F.R. § 405.415(a). As a general principle, allowable depreciation expenses are calculated by prorating the cost or other basis (e.g., fair market value) of a capital asset, less its salvage value, over the estimated useful life of the asset.

 Prior to August 1, 1970, applicable regulations issued by the Secretary permitted providers to claim depreciation expenses on an accelerated basis. 42 C.F.R. § 405.415 (1967). Current regulations, however, severely curtail the taking of accelerated depreciation for capital assets acquired after August 1, 1970. 42 C.F.R. § 405.415(a)(3)(iii). The regulations now in effect do permit providers to continue taking accelerated depreciation, under either a "declining balance" method or "sum of the years digits" method, for capital assets which were acquired and depreciated using an accelerated method before August 1, 1970. 42 C.F.R. § 405.415(a)(3)(ii). They provide, however, that the excess of accelerated over straight-line depreciation on these items may, under certain circumstances, be "recaptured".

 The regulations which became effective on August 1, 1970 require recapture of accelerated depreciation whenever: (1) a provider terminates his participation in the Medicare program, or (2) "the health insurance (Medicare) proportion of (a provider's) allowable costs decreases so that cumulatively substantially more depreciation was paid than would have been paid using the straight-line method of depreciation." 42 C.F.R. § 405.415(d)(3). The Provider Reimbursement Manual (HIM-15) sets forth a more concrete test for determining when the proportion of Medicare patients served by a provider falls sufficiently to require recapture of accelerated depreciation, even though the provider has not terminated Medicare services altogether. Section 136.4.B of the Manual provides that recapture will be triggered when "the provider's ratio of health insurance (i.e., Medicare-reimbursable) days to total inpatient days ... has decreased 25 percent or more" between the "base period" (all fiscal years prior to the year audited) and the "computation period" (the year in which the fiscal intermediary conducts its audit) and also, between the same periods, the total number of health insurance (Medicare) days has decreased 25 percent or more. Recapture is effected only if the proportion of Medicare patients served during the base period was greater than 5 percent.

 B. Factual Background

 The facts underlying this controversy are not ...

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