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Slocum v. Hospital Rate Setting Commission

Decided: May 1, 1990; As Amended May 16, 1990.


On appeal from the New Jersey State Department of Health Hospital Rate Setting Commission.

King, Shebell and Keefe. The opinion of the court was delivered by Keefe, J.A.D.


[240 NJSuper Page 570] These three interrelated appeals resulting from actions taken by the Hospital Rate Setting Commission (HRSC) were consolidated for argument and decision. The first appeal involves a challenge by the Public Advocate to the January 20, 1988 and September 26, 1988 decisions of the HRSC which established the labor component of the economic factor on a state-wide basis for the 1988 rate year. The second appeal is a challenge by the New Jersey Hospital Association (NJHA) to the HRSC's December 21, 1988 decision dismissing the NJHA's request for additional across-the-board increases in the labor component for lack of jurisdiction. The third appeal is also a challenge by the NJHA to the HRSC's decision of September 15, 1989 limiting the time in which individual hospitals could file extraordinary rate appeals for 1988. With the exception of a modification of

the September 26, 1988 order, we affirm the orders under review.

In order to understand the context in which the HRSC hearings were conducted a review of the relevant statutory provisions of the Health Care Facilities Planning Act (HCFPA), N.J.S.A. 26:2H-1 to -26 and the regulations promulgated pursuant thereto, N.J.A.C. 8:31B-3.1-7.8, is helpful. In general the HCFPA provides that hospital rates are subject to regulation. The legislative policy to be advanced by the statute is "to provide for the protection and promotion of the health of the inhabitants of the State, promote the financial solvency of hospitals and similar health care facilities and contain the rising cost of health care services." N.J.S.A. 26:2H-1.

The HCFPA created three separate but interrelated entities to effect the system for setting hospital rates: the Health Care Administration Board (HCAB), the Commissioner of Health and the HRSC. The HCAB adopts regulations "to effectuate the provisions and purposes" of the HCFPA. N.J.S.A. 26:2H-5b. The Commissioner recommends regulations to the HCAB as well as the hospital's PCB and Schedule of Rates to the HRSC. The HRSC was created by statute to "approve or adjust the preliminary cost base" and the "schedule of rates" as proposed by the Commissioner. N.J.S.A. 26:2H-4.1b.

In response to its statutory mandate HCAB adopted a series of regulations, N.J.A.C. 8:31B-3.1-3.83, which "constitute the minimum necessary steps for implementing Chapter 83," the HCFPA. The regulations contain procedural requirements designed to "establish the process through which the Commissioner of Health shall propose hospital rates to the Rate-Setting Commission, the hospitals may respond, and the Commission shall make final determinations." N.J.A.C. 8:31B-3.1(b). The regulations also contain methodological approaches designed to "describe how the Commissioner shall arrive at the rates proposed." Id . The methodology by which the Commissioner and

HRSC establish the schedule of rates for each hospital shall be described briefly.

The rate setting system is designed to set a prospective rate of reimbursement in advance of actual treatment which is related to the hospital resources consumed in treating particular illnesses, described as Diagnosis Related Groupings (DRG). N.J.A.C. 8:31B-5.1; Riverside Gen. v. New Jersey Hosp. Rate Setting Comm'n., 98 N.J. 458, 487 A.2d 714 (1985). Each DRG reflects a wide variety of different kinds of costs associated with hospital care. The costs are derived from the actual expenses incurred by a hospital during a base year, in this case 1982, and reported to the Department of Health (DOH). N.J.A.C. 8:31B-3.16. A hospital's costs are allocated between two major categories, direct patient care costs and indirect patient care costs. Direct care costs include such things as salaries and fringe benefits for nurses and other employees engaged in the direct delivery of patient care while indirect patient care costs are the equivalent of institutional overhead expenses for managerial, educational, research and maintenance functions. These costs along with other "financial elements" are reported to the DOH for the purpose of arriving at the hospital's current cost base. N.J.A.C. 8:31B-3.17. A hospital's current cost base is used to develop its "preliminary cost base" (PCB) and a schedule of rates. N.J.A.C. 3:31B-3.16. The legislature defined the PCB as:

[That] proportion of a hospital's current cost which may reasonably be required to be reimbursed to a properly utilized hospital for the efficient and effective delivery of appropriate and necessary health care services of high quality required by such hospital's mixed patients. The preliminary cost base initially may include costs identified by the commissioner and approved or adjusted by the commission as being in excess of that proportion of a hospital's current costs identified above, which excess costs shall be eliminated in a timely and reasonable manner prior to certification of the revenue base. The preliminary cost base shall be established in accordance with regulations proposed by the commissioner and approved by the [Health Care Administration] board. [ N.J.S.A. 26:2H-2k].

The schedule of rates which a hospital is permitted to charge per DRG is designed to produce net revenue to the hospital

equal to the PCB for each hospital as opposed to the current cost base for the hospital. N.J.A.C. 8:31B-3.37. The PCB, therefore, is a function of the statutory purpose in accommodating the two competing policies undergirding the HCFPA, i.e., the financial solvency of hospitals and containment of the rising costs of health care services.

An example of how this competing policy is attempted to be achieved can be found in the treatment of a hospital's reported direct and indirect patient care costs. When the DOH receives a report of such costs from an individual hospital, those costs are compared with a standard developed by the DOH for the hospital's peer group. Each hospital is categorized as either a major teaching, minor teaching or non-teaching hospital. Thus, a reporting hospital's indirect and direct patient care costs are compared against the standard for the category in which it is grouped in order to determine whether those costs are reasonable. See generally N.J.A.C. 8:31B-3.22, -3.24. The screening methodology is designed to arrive at a system of "incentives" and "disincentives" so as to promote hospital efficiency by containing costs. If a hospital's costs are below the standard, it is considered to be operating more efficiently than other hospitals in the same categories and is rewarded with an incentive. In such case, the hospital is entitled to charge rates designed to provide it with income in excess of its actual costs in the amount of the incentive. N.J.A.C. 8:31B-3.24(b). On the other hand, if the hospital's cost exceed the standard, it is deemed not to be operating as efficiently as its peers and is penalized with a disincentive. N.J.A.C. 8:31B-3.24(c). In the latter case, the hospital's rate for that category will be set at a standard which will yield revenues less than the hospital's actual cost.

Therefore, the PCB for each hospital includes among other things a calculation for the "reasonable" direct and indirect patient care costs, as opposed to the actual costs incurred which are a function of the current cost base. In addition the PCB includes an economic factor adjustment on a yearly basis which is designed to be a "measure of the change in the prices of

goods and services used by New Jersey hospitals." N.J.A.C. 8:31B-3.26(a). Thus, the PCB is the "reasonable cost" of the financial elements of a hospital's current cost base, "adjusted for projected economic factors" as well as a capital facilities allowance. N.J.A.C. 8:31B-3.20. There are various economic factors identified in the regulations which are required to be updated on an annual basis. N.J.A.C. 8:31B-3.26(a). For the purpose of this opinion, we shall focus on the labor component of the economic factor, identified in the regulations as the "labor proxy." Id. This factor has been identified as being approximately 60% of an average hospital's cost.

As indicated, it is the HRSC which must ultimately approve the PCB and the schedule of rates. Riverside General, 98 N.J. at 462, 487 A.2d 714. Briefly stated, the process by which this is accomplished is as follows. For hospitals on a calendar year basis, the Commissioner is required to propose to the HRSC a PCB and a schedule of rates for each hospital by January 31 of the rate year. N.J.A.C. 8:31B-3.2. As to those hospitals, all rates "approved or modified" are deemed to be effective as of January 1 of the rate year and any adjustments or modifications resulting from the appeal process are to become effective prospectively and on an "interim basis". N.J.A.C. 8:31B-3.42.

The process, therefore, begins with the notification by the Commissioner of a proposed schedule of rates. N.J.A.C. 8:31B-3.51. The Commissioner also has the power to issue a proposed schedule of rates "in which particular aspects of the rates are made conditional." As to those aspects, "the rates shall be considered interim." N.J.A.C. 8:31B-3.9. Within 45 days of the receipt of the proposed schedule of rates, each hospital must notify the Commissioner and the HRSC of its decision to either accept or not accept the "preliminary cost base." N.J.A.C. 8:31B-3.51(b)1, 2. Acceptance by the hospital is "contingent upon approval by the Commission of a Schedule of Rates." Id. When the hospital notifies of its decision not to accept, it

must then submit a "list of exceptions" supported by documentation for review by the DOH. The exceptions are then submitted to an analysis by the DOH and further recommendations may issue "regarding the settlement, disposition, or lack of resolution concerning all exceptions raised. . . ." N.J.A.C. 8:31B-3.63(a).

Appeal "issues that are common to more than one institution" can be consolidated by the HRSC. N.J.A.C. 8:31B-3.63(b). The HRSC may, in its discretion, refer such matters to an administrative law judge for hearing. However, the regulation does not mandate such a referral. Id. Deadlines are provided by the regulation in which the HRSC is to make its "final decision", depending upon whether the matter was referred to an administrative law judge or retained by the HRSC. N.J.A.C. 8:31B-3.63(b), (d).

Any "modification" ordered by the HRSC to the schedule of rates proposed by the Commissioner must be "consistent with the purpose and intent of [the HCFPA] including but not limited to . . . [the] expressed public policy of [the HCFPA] for cost containment, and financial solvency for institutions that are properly utilized and which deliver effectively and efficiently, appropriate and necessary health care services of high quality required by their mix of patients; . . . ." N.J.A.C. 8:31B-3.64(a)1. In this connection the HRSC "may also consider the reasonableness of any matter within the scope of the legislation not specifically addressed in this subchapter." N.J.A.C. 8:31B-3.64(d). Further, "modifications which may be approved as a result of appeals . . . shall be implemented through an appropriate interim adjustment to the Schedule of Rates for a given hospital, [or] group of hospitals, . . . ." N.J.A.C. 8:31B-3.65(a). Modifications to the Schedule of Rates are "interim" pending "Reconciliation." Id. at (b).

Reconciliation is the process by which the hospital's actual net revenue collection is aligned with the HRSC approved schedule of rates. During this process, the DOH computes any

difference between the actual net revenue and allowable net revenue with interest and accordingly adjusts the hospital's schedule of rates for the next year. Under this process, if a hospital's actual costs are in excess of its allowable revenue as to a particular component of an approved DRG, the cost cannot be recaptured unless there has been an appropriate adjustment or modification in the rate schedule. See In re 1982 Final Recon. Adj. for Jersey Shore Med. Center, 209 N.J. Super. 79, 84, 506 A.2d 1269 (App.Div.1986). e 13 As will be seen later, it is this process that stimulated the NJHA's petition to the HRSC.

The regulations provide that "the Schedule of Rates itself must be periodically adjusted to reflect changes in inflation" for "direct (variable) financial elements." N.J.A.C. 8:31B-3.71(a). Such adjustments "are not dependent upon receipt of reports for a reporting period, and therefore, will be applied to the Schedule of Rates when and as appropriate." Id. at (b). "Periodic adjustments are made for any adjustments explicitly ordered by the Commission [HRSC] pursuant to N.J.A.C. 8:31B-3.64, Modification of Proposed Schedule of Rates." 8:31B-3.72(a).

One of the periodic adjustments which the HRSC is permitted to implement is the economic factor. Id. at (a)1. The HRSC is required to calculate the economic factor "for each year as soon as the necessary data are available." Id. Specifically, with respect to the labor component of the economic factor the regulation provides:

However, the labor component of the economic factor is to be prospective and final. If calculation of the final economic factor for the rate year shows a misprojection of the labor component, the rate year labor component shall not be changed. Instead an equal and offsetting adjustment is to be made to the projected economic factor when the projected economic factor for the upcoming rate year is calculated.

The annual recalculation of the economic factor pursuant to N.J.A.C. 8:31B-3.26, shall be based on each hospital's reported expenses of the current cost base by classification for the applicable rate period. [ Id. (emphasis added)].

N.J.A.C. 8:31B-3.72 provides the methodology by which the HRSC determines whether a modification to the schedule of rates is appropriate and how it is to be calculated. It incorporates by reference the provisions of N.J.A.C. 8:31B-3.26 which in turn is the methodology by which the Commissioner determines the economic factors for the proposed Schedule of Rates for a given year, specifically the labor proxy as contained in the Bureau of Labor Statistics series Average Hourly Earnings for Non-Supervisory Hospital Worker's (U.S.).

During the reconciliation process the Commissioner is directed to adjust the "[labor] components . . . using the value for each proxy which was applied in calculating the hospital's PCB in that rate year." N.J.A.C. 8:31B-3.73(a)1(iii), 19 N.J.R. 1145(a); 20 N.J.R. 77(a) effective 1/4/88.

The "proxy" referred to in the preceding regulation concerning reconciliation is the labor proxy defined in N.J.A.C. 8:31B-3.26, mentioned earlier, which at the time relevant to this appeal, provided as follows:

The proxy used for labor costs will change in 1983 and subsequent years to the Bureau of Labor Statistics series 'Average Hourly Wages Hospital Worker's (U.S.).'

The HRSC has construed the regulations to require it to adopt a final economic factor containing a labor component based upon the Bureau of Labor Statistic Series Standard for hospital workers current at that given time. It considers such determination to be both prospective in application and final in effect, as required by the regulations. As a result of that interpretation, any hospital that incurred labor costs in excess of the proxy used in the final calculation of the labor component for a given year could recover those excess costs through the reconciliation process only to the extent that the labor costs incurred by the hospital were equivalent to the final BLS series inflationary factor for the given rate year. Conversely, a hospital which incurred labor costs determined by market factors in excess of the average BLS series inflationary factor

for the year in question was unable to recoup those expenses in future years through adjustments in the Schedule of Rates.

It is this methodology utilized by the DOH for the recovery of labor costs that brought about the NJHA's petition to the HRSC from which this appeal stems.

The proceedings leading up to the HRSC's challenged decision of January 20, 1988 consumed some 457 pages of testimony.*fn2 We need not recount herein the details of the testimony before the HRSC. Suffice it to say that the NJHA, on behalf of its member hospitals, was advised that the Commissioner would recommend a Schedule of Rates for New Jersey Hospitals in 1988 that would reflect the BLS inflation rate of 4.7%, based on the second quarter statistics from 1987, as the labor proxy to be used for the 1988 rate year.*fn3 The NJHA expressed its concern that New Jersey Hospitals, in general, had incurred labor costs for direct patient care (mostly for nurses' salaries) over the past several years far in excess of the rate of inflation for such wages as reflected by the BLS for the same period of time. Because the BLS standard was used as the labor proxy for proposed and final rates, the hospitals were unable to recoup payments made for wages in excess of the final BLS factor for the rate year in the reconciliation process. The NJHA contended that this state-wide experience was proof that

the hospitals' predicament was a reflection of true market factors stemming from a lack of nurses as opposed to inefficient hospital management. The NJHA attributed the shortage of nurses, for the most part, to the hospitals' inability to compete in the labor market. The NJHA argued that the Legislature in passing the HCFPA intended hospitals to recoup such losses in order to maintain solvency. It also contended that the BLS was only an average of the labor costs incurred on a national basis and failed to reflect problems peculiar to the northeast region and New Jersey in particular. Because all hospitals were similarly affected, the NJHA sought state-wide relief.

The NJHA requested an 18.7% increase in the adjustment for labor in the 1988 year above the proposed 4.7% BLS rate. Its position was supported by a report commissioned by the NJHA and performed by a firm known as Mathematica.

The DOH commissioned a study by Laventhol and Horvath and requested additional financial information from the NJHA member hospitals. The Commissioner was not in a position in December, 1987 to make a recommendation concerning the labor component of the 1988 rates in response to NJHA's stated concern, but her representative advised the HRSC that the Commissioner would be able to do so by the end of January, 1988. The HRSC entered ...

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