On appeal from the Hospital Rate Setting Commission.
Michels, Brody and D'Annunzio. The opinion of the court was delivered by Michels, P.J.A.D.
In these appeals, St. Barnabas Medical Center (St. Barnabas), Community Medical Center (Community) and Bergen Pines County Hospital (Bergen Pines) challenge a final administrative action of the New Jersey Hospital Rate Setting Commission (Commission) taken on December 10, 1990 that approved a settlement plan proposed by the Department of Health to dispose of numerous outstanding hospital rate appeals. The voluntary settlement program contained a two-tier cap on the amount of settlement and cash flow dollars that each hospital could collect in 1991 based upon each hospital's 1991 revenue requirements and financial hardship. The three hospitals here involved challenge that final administrative action, contending that the adoption of the cap on 1991 rates, as adjusted by the Commission, constitutes a rule not adopted in compliance with the Administrative Procedures Act. Alternatively, the three hospitals argue that the Commission's action was arbitrary and unreasonable because there was no rational relationship between the amount of the cap and the purpose for which it was adopted and it unfairly penalized each of them for exercising their right of appeal. We now consolidate these appeals.
By way of background, the comprehensive system of hospital rate setting, under which these appeals arise, was established pursuant to authority granted the Department of Health by the 1978 amendment to the Health Care Facilities Planning Act (Act). N.J.S.A. 26:2H-1 to N.J.S.A. 26:2H-52, amended by L. 1978, c. 83 (effective July 20, 1978). The Act, as originally enacted in 1971, had authorized a program for the regulation of hospital rates charged to Blue Cross and State governmental
agencies (such as Medicaid), as a means of containing the spiraling costs of hospital care. L. 1971, c. 136, § 18. See In re 1976 Hosp. Reimbursement Rate for William B. Kessler Mem. Hosp., 78 N.J. 564, 566-67, 397 A.2d 656 (1979). In 1978, the Legislature amended the Act, establishing a new system of hospital rate setting. L. 1978, c. 83. See In re Schedule of Rates for Barnert Mem. Hosp., 92 N.J. 31, 35-36, 455 A.2d 469 (1983). Regulatory authority was extended to cover the rates of reimbursement for hospital services charged to all payers subject to the State's jurisdiction, N.J.S.A. 26:2H-18(b), and payment of the financial losses from hospital services to indigent patients was made an express element to be included in the rates for all payers. N.J.S.A. 26:2H-18(d).
Administration of the rate setting system was delegated to the Department of Health, N.J.S.A. 26:2H-1, which adopts rules with the approval of the Health Care Administrative Board (HCAB). N.J.S.A. 26:2H-5(b). A "preliminary cost base" and a corresponding schedule of rates are to be proposed by the Commissioner of Health in accordance with regulations. N.J.S.A. 26:2H-4.1(b), -18(b). Plenary power to approve the cost base and the schedule of rates is vested in the Commission, a public body of five members, comprised of the Commissioner of Health, the Commissioner of Insurance and three members of the public appointed by the Governor. N.J.S.A. 26:2H-4.1(a) and (b). The Commission is authorized to approve the preliminary cost base and schedule of rates, and make "adjustments" to them. N.J.S.A. 26:2H-4.1(b); N.J.S.A. 26:2H-18.1(b), (c) and (d).
In recognition of the complexity of implementation of a comprehensive rate setting system, the Legislature permitted a phasing of hospitals into the system over a period of time, with all hospitals in the State to have an appropriate "preliminary cost base" and schedule of rates by January 1, 1983. N.J.S.A. 26:2H-4.1(b). In further recognition of the major effect the introduction of the new system could have upon hospital administration, the Legislature expressly permitted the initial "preliminary
cost base" to include costs in excess of those which were truly necessary for efficient and effective operations so long as the excess costs were gradually eliminated. N.J.S.A. 26:2H-2(k). It envisioned that after the transition to the new system had been accomplished and experience had been gained, the Department of Health would move toward fixing a "certified revenue base" for each hospital, to last for a number of years with periodic adjustments for inflation or deflation; industry wide changes in the efficiency of delivering health care services; and for each hospital's actual changes in volume and case mix. N.J.S.A. 26:2H-2(l); N.J.S.A. 26:2H-18.1(b). To date, however, the transition to a "certified revenue base" has not occurred.
The present methodology for the hospital rate setting system found at N.J.A.C. 8:31B-3.1 to N.J.A.C. 8:31B-3.90 creates a prospective rate of reimbursement in advance of actual treatment, which is related to hospital resources consumed in treating categories of illnesses. Each category of illness, referred to as "Diagnosis Related Grouping," reflects a variety of hospital costs. These hospital costs are derived from the actual expenses of a hospital during a given base year. N.J.A.C. 8:31B-3.3, -3.4, -3.5 and -3.16. While there are many components and calculations in the rate setting process, generally a hospital's base year costs are first allocated into the major categories of direct patient care costs and indirect patient care costs. N.J.A.C. 8:31B-3.18 to N.J.A.C. 8:31B-3.24.
Discrete grouping of costs in both major categories of direct and indirect patient care costs are screened for reasonableness, according to different formulae, by comparison to the base year costs of other hospitals in the peer group. If a hospital's own unit cost is above the particular standard in the formulae, the excessive cost (or "disincentive") is deducted from further calculations. On the other hand, if a hospital's base unit cost is below the standard it may earn additional amounts above its own costs, up to the amount of the standard, as "incentives" or rewards for its cost efficient. N.J.A.C. 8:31B-3.23 and 3.24.
After screening the direct and indirect costs for the base year, the aggregate amounts are adjusted by a capital facilities allowance and for losses due to bad debts and charity care. N.J.A.C. 8:31B-3.27; N.J.A.C. 8:31B-3.41. These amounts are further increased by economic and technology factors. N.J.A.C. 8:31B-3.26. The resulting amounts, after these adjustments, represent the "preliminary cost base" for the hospital, which is accompanied by a schedule of rates for producing sufficient revenue to correspond to the preliminary cost base. N.J.A.C. 8:31B-3.7; N.J.A.C. 8:31-3.38.
The hospitals can appeal their rates to the Commission pursuant to the procedures set forth in N.J.A.C. 31B-3.51. In addition, at the end of the rate year, hospitals report their actual data on volume, case mix and revenue for use in "final reconciliation," a process of comparing actual data collected by the hospital to revenue allowed under the approved schedule of rates. N.J.A.C. 8:31B-3.73. See In re 1982 Final Reconciliation Adjustment for Jersey Shore Med. Center, 209 N.J. Super. 79, 84, 506 A.2d 1269 (App.Div.1986). At final reconciliation, actual net revenue is compared to approved net revenue to calculate either an overcollection or undercollection by the hospital. If there was an undercollection, that amount plus interest is added to the hospital's rate schedule for the next year. N.J.A.C. 8:31B-3.75.
Due to the mounting backlog of outstanding rate appeals and final reconciliations, in 1986 the Commission began to develop informal methodologies to grant cash flow infusions, known as "cash flow adjustments." These cash flow adjustments are informal supplements to hospital rates, serving as ...