Sunrise Retirement Community, Friendship Haven, Presbyterian Village, Rose Vista Home, Longview Home, United Presbyterian Home, Riceville Community Rest Home, Hubbard Care Center, and Happy Siesta Care Center v. Iowa Department of Human Services

IN THE SUPREME COURT OF IOWA
No. 11–1145

Filed June 28, 2013

SUNRISE RETIREMENT COMMUNITY, FRIENDSHIP HAVEN,
PRESBYTERIAN VILLAGE, ROSE VISTA HOME, LONGVIEW HOME,
UNITED PRESBYTERIAN HOME, RICEVILLE COMMUNITY REST
HOME, HUBBARD CARE CENTER, and HAPPY SIESTA CARE
CENTER,

Appellants,

vs.

IOWA DEPARTMENT OF HUMAN SERVICES,

Appellee.

On review from the Iowa Court of Appeals.

Appeal from the Iowa District Court for Polk County, Arthur E.

Gamble, Judge.

The Iowa Department of Human Services requested further review

of a decision of the court of appeals reversing the agency’s disallowance
of certain expenses from cost reports submitted by nursing homes.

DECISION OF COURT OF APPEALS AFFIRMED; DISTRICT COURT

JUDGMENT REVERSED AND REMANDED WITH INSTRUCTIONS.

Patrick B. White of White Law Office, P.C., Des Moines, for

appellants.

Thomas J. Miller, Attorney General, and Timothy L. Vavricek,

Assistant Attorney General, for appellee.
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HECHT, Justice.

Several nursing homes submitted annual reports disclosing their

income and expenses to the Iowa Department of Human Services (DHS).

The reports were used by DHS to calculate the Medicaid per diem

reimbursement rates for the nursing homes. Some of the nursing homes’

expenses were disallowed by DHS, which adjusted those reports and

reduced reimbursement rates accordingly. We must decide in this

appeal whether DHS properly interpreted and applied its departmental

rules in setting the rates. As we conclude the agency’s action was based
on an incorrect interpretation of its rules, we reverse and remand.

I. Background Facts and Proceedings.

Sunrise Retirement Community, Friendship Haven, Presbyterian

Village, Rose Vista Home, Longview Home, United Presbyterian Home,

Riceville Community Rest Home, Hubbard Care Center, and Happy

Siesta Care Center are long-term care facilities licensed in Iowa and

approved by DHS as Medicaid providers. Each of these facilities accepts

patients with different payment sources—e.g., private payment,

Medicare, and Medicaid.

To participate in Medicaid, each facility must submit a “Financial

and Statistical Report” annually to DHS. The report details the facility’s

overall operating costs and sources of revenue. The information

submitted on the report is used by DHS to calculate a per diem

reimbursement rate for each participating facility.

The per diem rate is not designed to reimburse nursing facilities for

their precise costs incurred in caring for Medicaid patients. Instead,

DHS calculates rates after determining a facility’s allowable costs, which

are derived from a facility-specific reporting system. In this system, each

facility reports all costs incurred and revenue received from all sources in
 3

its annual financial and statistical report. An accounting firm employed

by DHS then reviews the reports to determine which costs are allowable

under the agency’s rules when calculating the appropriate Medicaid

per diem rate.

In submitting their cost reports for the fiscal year ending

December 31, 2008, the appellant care facilities included in their reports

costs incurred for services provided to residents whose primary source of

payment was Medicare Part A. DHS deemed some of these costs

disallowed.
When a resident is admitted with Medicare Part A as a payor, a

facility bears up front all costs of treatment and care for the resident.

This is true even when the resident receives treatment or care outside the

facility, such as when he or she is sent to a local provider for an x-ray or

lab work. In these cases, the outside provider bills the nursing facility

directly for its services, including the three types of services at issue in

this case—prescription drugs, x-rays, and lab work. The outside

provider may not bill the resident directly and may not bill Medicare.

Instead, Medicare provides a per diem payment to the nursing facility for

each resident intended to cover all care, treatment, and services for that

resident. Medicaid, by contrast, pays the Medicaid patients’ outside

providers of prescription drugs, x-rays, and lab work directly.

In this case, most of the facilities included in their Medicaid cost

reports costs incurred on behalf of Medicare patients for x-rays, lab

work, and prescription drugs. DHS contends that including these

categories of costs in reports used to calculate the Medicaid per diem

reimbursement rate would result in “double-counting.” The facilities

maintain that DHS regulations allow, if not require, the inclusion of

these costs.
 4

In 2008, DHS determined these costs were not allowable and

therefore excluded them from the cost reports. This marked a departure

from prior practice. Until the 2008 adjustments, DHS had allowed the

facilities to include in the cost reports the costs paid to third parties for

lab services, x-rays, and prescription drugs provided to Medicare

patients.1 The facilities appealed the adjustments, and a contested case

hearing was held. A proposed decision was issued by an administrative

law judge who concluded the costs incurred by the facilities for x-rays,

lab work, and prescription drugs provided to Medicare patients were
properly reported by the nursing homes. The ALJ elaborated:

At the hearing, the Department opined that [Medicare] Part A
costs should be excluded because the costs are covered/paid
for by the Medicare per diem and if the costs were included
in the Medicaid per diem calculation, it would artificially
inflate the Medicaid rate. This argument by the Department
lacks merit however since the Medicare Part A revenue is
also reported by the facility as a part of the cost report and
already part of the equation. Moreover, the Department
conceded that it could perform an offset to account for the
costs/revenue associated with costs for a Part A resident. As
such, the Department has a methodology for dealing with
this perceived “enrichment” without disallowing the costs on
the Medicaid cost report.

DHS requested intra-agency review, and the director of human
services issued a final decision which accepted the ALJ’s fact findings

but concluded the costs should be disallowed on the cost reports. The

facilities sought judicial review, and the district court affirmed the

director’s decision. The facilities appealed. The court of appeals reversed

the district court, concluding the DHS rules did not support the agency’s

1Although DHS had never objected to the reporting of prescription drug
expenses incurred for Medicare patients prior to 2008, it had apparently excluded those
expenses from its Medicaid per diem calculations for prior years.
 5

determination that the costs in question were not allowable. DHS

sought, and we granted, further review.

II. Standard of Review.

Final agency action is reviewed for corrections of errors at law.

Eyecare v. Dep’t of Human Servs., 770 N.W.2d 832, 835 (Iowa 2009). We

apply the standards of chapter 17A of the Iowa Administrative Procedure

Act to agency action to determine if our conclusions are the same as the

district court’s conclusions. Id. We are bound by the agency’s findings

of facts if they are supported by substantial evidence. Id. We will not,
however, defer to DHS’s interpretation of its rules and regulations, as it

has not been clearly vested with the authority to interpret them. Id. at

836; see also Iowa Code § 17A.19(10)(c) (2009).

III. Discussion.

Iowa Code chapter 249A governs Iowa’s Medicaid program.

Section 249A.4(1) instructs the director of DHS to

make rules, establish policies, and prescribe procedures to
. . . [d]etermine the greatest amount, duration, and scope of
assistance which may be provided, and the broadest range of
eligible individuals to whom assistance may effectively be
provided, under this chapter within the limitations of
available funds.

Iowa Code § 249A.4(1). Section 249A.4(9) directs DHS to adopt rules for

determining the method and level of reimbursement for all medical and

health services specified in section 249A.2 after considering the following

goals:

a. The promotion of efficient and cost-effective delivery
of medical and health services.

b. Compliance with federal law and regulations.

c. The level of state and federal appropriations for
medical assistance.
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d. Reimbursement at a level as near as possible to
actual costs and charges after priority is given to the
considerations in paragraphs “a”, “b”, and “c”.

Id. § 249A.4(9).

All nursing facilities wishing to participate in and receive funds

from the Medicaid program must submit an annual “Financial and

Statistical Report” to facilitate DHS’s calculation of the Medicaid

per diem rate. See Iowa Admin. Code r. 441—81.6 (2009). The report

must detail both revenues and costs associated with patient care

according to the subrules of rule 81.6. Id. Subrule 81.6(10) requires
that facilities report all revenues, as recorded in their general books and

records, associated with their provision of any routine daily services and

any ancillary services to patients. Id. r. 441—81.6(10)(a)–(b). The costs

portion of the report must be divided into categories of direct patient care

costs and support care costs.2 Id. r. 441—81.6. Subrule 81.6(11)

further provides that certain costs “not normally incurred in providing

patient care shall be eliminated or limited” according to a long list of

limitations, none of which make reference to direct care or Medicare-

related costs.3 Id. r. 441—81.6(11).

DHS determines per diem reimbursement rates based on a multi-

step calculation. Id. r. 441—81.6(16). First, DHS establishes per diem

direct care and nondirect care component cost bases for the facilities

based on the costs reported. Id. DHS then adjusts those component

bases for various purposes in subsequent steps having no bearing on the

2The parties appear to agree that costs incurred for x-rays, prescription drugs,

and labs constitute direct care costs.
3The enumerated limitations include, but are not limited to, federal and state

income taxes, fees paid to directors, bad debts, personal travel and entertainment, loan
acquisition fees, management fees, depreciation, and legal fees. Iowa Admin. Code r.
441—81.6(11).
 7

types of costs to be incorporated in establishing the bases. See id. To

establish the component cost bases, subrule 81.6(16) provides that each

facility’s “per diem allowable cost shall be arrived at by dividing total

reported allowable costs by total inpatient days during the reporting

period.” Id. r. 441—81.6(16)(a). Rule 81.1 defines “allowable costs” as

“the price a prudent, cost-conscious buyer would pay a willing seller for

goods or services in an arm’s-length transaction, not to exceed the

limitations set out in rules.” Id. r. 441—81.1. As we have noted, subrule

81.6(11) identifies fifteen different “limitations” of expenses—expenses
that must be limited or disallowed in some way—but fails to mention

Medicare expenses. See id. r. 441—81.6(11). In fact, no provision

anywhere in rule 81.6 makes any reference to Medicare in association

with the annual cost reports required of the nursing facilities.4 See id. r.

441—81.6. Instead, rule 81.6 tersely and generally directs that “costs for

patient care services shall be reported.” Id.

Interpreting these rules in the final agency action below, the

director of DHS affirmed the agency’s cost report adjustments disallowing

x-ray, lab, and prescription drug expenses on two grounds. First, the

director concluded the list of allowable cost limitations in subrule

81.6(11) did not constitute “an all-inclusive list of expenses disallowed in

the facility’s cost report.” Thus, the director concluded he could also

4Subrule 81.6(20) authorizes facilities’ claims “for Medicaid payment for
Medicare-covered nursing facility services rendered to a Medicare beneficiary who is
also eligible for Medicaid.” See id. r. 441—81.6(20)(a). This provision aims to insure
that (1) claims are adequately reimbursed if the Medicaid-allowable amounts for the
claims exceed the actual Medicare payments made, and (2) claims for services fully
reimbursed by Medicare receive no additional Medicaid reimbursement. See id. r.
441—81.6(20). The record does not reveal and the parties do not address what, if any,
bearing this provision may have on the propriety of incorporating costs for services
provided to Medicare patients that are not fully covered by Medicare reimbursement in
determining a facility’s Medicaid component cost bases under subrule 81.6(16).
 8

disallow costs for x-rays, labs, and drugs provided to Medicare patients

because Medicaid pays third-party vendors directly for those kinds of

services when they are provided to Medicaid patients. Second, the

director concluded that costs associated with x-rays, labs, and

prescription drugs for Medicare patients do not meet rule 81.1’s

definition of allowable costs because “they are not costs a prudent, cost-

conscious buyer would pay a willing seller.” The district court affirmed

the director’s decision, agreeing that x-rays, labs, and drugs “are not

properly included in the cost that a prudent, cost-conscious buyer would
pay for nursing care services at [appellants’] facilities in an arm’s-length

transaction.”

Addressing first the director’s subrule 81.6(11) justification, we

take no position as to whether the expenses enumerated as excludable

under the rule constitute an exhaustive list. Regardless, we cannot

conclude that a determination of whether the list is exhaustive is

dispositive of the cost question here. Instead, we note that the language

of the subrule expressly limits the types of costs that shall be “eliminated

or limited” in confining its reach to “[c]ertain expenses that are not

normally incurred in providing patient care . . . .” Id. r. 441—81.6(11).

We think it straightforward to conclude, and the parties agreed both

below and on appeal, that the lab, x-ray, and drug expenses at issue here

are normally incurred in providing patient care. Indeed, DHS’s

accountant testified in the agency proceeding below that facilities do and

must regularly provide these services, regardless of payor type, to meet

DHS’s minimum requirements for provision of essential services to their

patients. Thus, regardless whether subrule 81.6(11) may contemplate

the elimination of costs not normally incurred in providing patient care
 9

and not expressly enumerated, we cannot conclude the subrule has any

bearing on the question of the regularly incurred costs here.

If the director’s conclusion may be read to suggest implicitly that

subrule 81.6(11) requires elimination of all expenses not normally

incurred in providing “Medicaid patient care,” as opposed to the broader

category of “patient care” expressly set forth in the subrule, we find no

support for that contention in the language of the subrule, the language

of rule 81.6 more generally, or in the standard practices of DHS.

Subrule 81.6(11) mentions Medicaid only in the context of allowing legal
fees related to defending threatened Medicaid decertification and, as

noted, makes no mention of Medicare.5 See id. r. 441—81.6(11).

Further, given the specific references in rule 81.6 to Medicaid and

Medicare where necessary to distinguish them as payment systems, we

are not persuaded that the silence of subrule 81.6(11) envisages an

unwritten Medicaid limitation. Instead, we think the structure of rule

81.6 compels the broader reading—namely, that facilities report all

revenues regardless of payor type, as conceded by the parties and

contemplated by subrule 81.6(10), and likewise facilities report all costs

regardless of payor type as contemplated by the introductory paragraph

of rule 81.6 before certain limitations are applied in accordance with

subrule 81.6(11). Finally, we note that DHS concedes it does not exclude

from cost reports expenses incurred for other services provided to

Medicare patients, including, for example, various therapy services. We

thus cannot conclude, as the director did, that rule 81.6 supports

5The subrule also never distinguishes between types of payors in establishing its
various limitations. See, e.g., id. r. 441—81.6(11)(f) (allowing expenses for
entertainment provided for “participation of all residents who are physically and
mentally able to participate” and eliminating only expenses for entertainment for which
patient is required to pay); id. r. 441—81.6(11)(h) (allowing reasonable costs for services
provided by immediate relatives and remaining silent regarding payor type).
 10

excluding the costs of the challenged services provided to Medicare

patients.

Turning to the director’s second ground for affirming the

elimination of the costs in question here, we find no support for the

elimination in the definition of “allowable costs” in rule 81.1. Because

the definition refers only to the “price a prudent, cost-conscious buyer

would pay a willing seller for goods or services in an arm’s-length

transaction” and specifies that the price cannot “exceed the limitations

set out in rules,” we cannot conclude the definition has anything to say
about elimination of the entire category of Medicare patient-related costs

or, more importantly, a specific subset of that category of costs including

x-ray, lab, and prescription drug costs. Id. r. 441—81.1 (emphasis

added). The director supported his conclusion with the rationale—and

DHS has raised the argument again on appeal—that because the x-ray,

lab, and drug costs are costs for Medicare patients, “they are not costs a

prudent, cost-conscious buyer would pay a willing seller” for services to

Medicaid patients. This rationale, in our view, relies either on adding

modifying language to the definition expressly set out in the rule, or on a

general assumption that the definition applies only to costs of services

provided to Medicaid patients. Given the structure of rule 81.6 and the

Department’s concession that “allowable costs” in some instances

encompass non-Medicaid costs, we are not persuaded the definition can

be read to imply a general limitation of its applicability to costs provided

to Medicaid patients. As for the possibility of implicit modifying

language, we note two additional problems with the position advanced by

DHS.

First, the definition of “allowable cost” makes no distinction

between Medicaid and Medicare services and no distinction between
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buyers and sellers of Medicaid and Medicare services. We find it

instructive that various other definitions in rule 81.1 make no such

distinction. For example, the definitions of “case mix” and “case-mix

index,” integral to the per diem calculation in subrule 81.6(16), are silent

regarding payor types. See id. r. 441—81.1. Moreover, as explained, rule

81.6 largely lumps all services together for reporting and per diem

calculation purposes. We cannot discern any reason in the language or

structure of rules 81.1 or 81.6 to import the director’s “buyer of Medicaid

services” limitation into the definition.
Second, in adopting the ALJ’s conclusions of law, the director

conceded both that (1) subrule 81.10(5)(c) expressly provides that the

Medicaid program will provide direct payment to facilities for the

provision of some services required by Medicare; and (2) subrule 81.10(2)

expressly requires that a facility must, when applicable, first exhaust all

Medicare benefits to remain eligible for any Medicaid payment. We

cannot conclude, based on these rules, that the Medicaid program is to

be treated as a buyer of strictly Medicare or strictly Medicaid services—

rather, we think the rules explicitly envision that the program may

reimburse facilities for provision of both Medicare and Medicaid services

and that any specific instance of a service for which a facility receives

reimbursement may simultaneously constitute a “Medicare” and

“Medicaid” service. These propositions, taken together with the

concession that facilities must provide lab, x-ray, and drug services

regardless of payment type, compel our conclusion that the definition of

“allowable costs” is silent regarding the inclusion or exclusion of a class

of Medicare costs, and cannot be read to incorporate the Medicaid

limitation the director advanced.
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We think it prudent to note that whether an expense is reported

may not be dispositive of whether DHS incorporates that expense in its

component base-rate calculation. The ALJ noted the availability of an

“offset” that could occur between facility cost reporting and DHS rate-

setting.6 As we conclude here, however, the director’s interpretation of

the rules as written cannot support the agency’s decision to exclude the

Medicare costs at issue from the facilities’ cost reporting.

We recognize the cost-containment concerns driving the agency

action here. We also acknowledge the significant challenges underlying
the director’s statutorily prescribed duty to “[d]etermine the greatest

amount, duration, and scope of assistance which may be provided, and

the broadest range of eligible individuals to whom assistance may

effectively be provided” in administering the Medicaid program. Iowa

Code § 249A.4(1). The difference between the meaning the director has

assigned to the rules and the meaning we are able to discern clearly

engages these policy concerns and raises questions as to what costs

should be considered in calculating Medicaid reimbursement rates.

Nevertheless, our task in this case is to determine the meaning of the

rules at issue and decide whether the director has erred in interpreting

them. Given the agency’s abrupt about-face in its practice regarding

exclusion of certain costs from reports, and the substantial disparity

between what the rules plainly say and what the director now suggests

they mean, we think DHS’s new interpretation of rule 81.6’s cost

reporting and per diem calculation procedures is akin to the creation of a

new rule. The appropriate course of action here cannot involve assigning

6Thenursing homes concede that to the extent Medicare prescription drug, x-
ray, and lab costs are properly reportable, the reports should also include the
corresponding Medicare revenue for those services.
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new meanings to rules not fairly evident from the language of the rules

themselves. Instead, in our view, the appropriate course requires new

rulemaking according to the procedures set forth in Iowa Code chapter

17A, which allows all relevant stakeholders adequate notice and

meaningful opportunity to address and help resolve the important policy

questions at stake.

IV. Conclusion.

The director’s conclusion affirming the agency’s exclusion of the

facilities’ lab, x-ray, and prescription drug costs from the nursing homes’
reports was erroneous. We affirm the decision of the court of appeals,

reverse the district court judgment, and remand to the district court.

The district court shall enter judgment remanding this matter to DHS for

further proceedings consistent with this opinion.

DECISION OF COURT OF APPEALS AFFIRMED; DISTRICT

COURT JUDGMENT REVERSED AND REMANDED WITH

INSTRUCTIONS.