SUBJECT: Minnesota Department of Human Services

DECISION

The Minnesota Department of Human Services (MDHS) appealed the April 29, 2002 determination of the Centers for Medicare & Medicaid Services (CMS) disallowing $118,725 in federal financial participation (FFP) claimed under title XIX of the Social Security Act. The amount disallowed represents costs incurred in the three quarters ended September 30, 2001 for planning activities to bring Minnesota's Medicaid Management Information System (MMIS) into compliance with the requirements of the Health Insurance Portability and Accountability Act of 1996 (HIPAA). MDHS sought FFP in all of the costs of these activities. CMS determined that MDHS should have allocated some of the costs to state-funded programs that used the MMIS instead of allocating all of the costs to the Medicaid program. CMS therefore disallowed that part of the costs that it determined should have been allocated to the state-funded programs.

On appeal, MDHS argued principally that the costs in question were allowable because they were allocated to Medicaid in accordance with MDHS's Advance Planning Document (APD) for the HIPAA planning activities, which was approved by CMS. As discussed in detail below, we conclude that the applicable regulations provide that the type of costs in question here shall be allocated in accordance with the approved APD. Furthermore, we find that MDHS's approved APD clearly provided for allocating all of the costs to Medicaid, and that this allocation was not inconsistent with the applicable cost principles. Accordingly, we reverse the disallowance.

Legal Background

This case presents the issue whether MDHS properly allocated costs incurred for planning activities to bring its MMIS into compliance with HIPAA, Public Law No. 104-191. Under HIPAA, the Department of Health and Human Services (HHS) is required to adopt national standards for all health care information that is electronically exchanged. The standards must then be implemented by all health care entities in both the public and private sectors. See MDHS Ex. 7, letter to State Medicaid directors dated 9/8/00.

The Medicaid program was established by title XIX of the Social Security Act (Act), which provides for joint federal and state financing of medical assistance for certain needy persons. States which establish a Medicaid program are required to submit a state plan meeting all federal requirements. Act, section 1902. Among the expenses for which title XIX authorizes reimbursement are those associated with the "design, development, or installation of such mechanized claims processing and information retrieval systems as the Secretary determines are likely to provide more efficient, economical and effective administration" of the state plan. Act, section 1903(a)(3). The regulations define a "mechanized claims processing and information and retrieval system" (MMIS) as-

the system of software and hardware used to process Medicaid claims from providers of medical care and services furnished to recipients under the medical assistance program and to retrieve and produce service utilization and management information....

42 C.F.R. � 433.111(b). Section 1903(a)(3)(A)(i) of the Act provides for the payment to states of 90% of the costs "attributable to the design, development, or installation of such mechanized claims processing and information retrieval systems . . . ." This means that 90% of any such MMIS costs which are allocated to Medicaid are reimbursable with federal funds. The Medicaid regulations provide that 90% FFP is available "only if the APD is approved by [CMS] prior to the State's expenditure of funds for these purposes." 42 C.F.R. � 433.112(a). The term "APD," or "Advance Planning Document," is defined in HHS's general administration regulations for grants, including Medicaid, as "a written plan of action to request funding approval for a project which will require the use of [automatic data processing] equipment" (such as an MMIS). 45 C.F.R. � 95.605 (made applicable to Medicaid by 42 C.F.R. � 433.111(a)).

The regulations also address the claiming of FFP in costs of automatic data processing acquisitions. Section 95.631 of 45 C.F.R., captioned "Cost identification for purpose of FFP claims," provides in pertinent part:

The conditions of this subpart apply notwithstanding the existence of an approved cost allocation plan. State agencies shall assign and claim the costs incurred under an approved APD in accordance with the following criteria:

(a) Development costs. (1) Using its normal departmental accounting system, the State agency shall specifically identify what items of costs constitute development costs, assign these costs to specific project cost centers, and distribute these costs to funding sources based on the specific identification, assignment and distribution outlined in the approved APD; (2) the methods for distributing costs set forth in the APD should provide for assigning identifiable costs, to the extent practicable, directly to program/functions. The State agency shall amend the cost allocation plan required by Subpart E of this part to include the approved APD methodology for the identification, assignment and distribution of the development costs.

A state plan under title XIX must provide that the state will have an approved cost allocation plan (CAP) on file with HHS "in accordance with the requirements in subpart E of 45 CFR part 95." 42 C.F.R. � 433.34. The CAP is used to determine the amount of commonly incurred expenditures that are allocable to each program the state administers. The regulations define a CAP as "a narrative description of the procedures that the State agency will use in identifying, measuring, and allocating all State agency costs incurred in support of all programs administered by the State agency." 45 C.F.R. � 95.505. A state is required to submit a CAP to HHS's Division of Cost Allocation (DCA) for approval. 45 C.F.R. � 95.507(a). In reviewing a proposed CAP or CAP amendment, DCA is directed to consult with the "affected Operating Divisions." 45 C.F.R. � 95.511(a). For the Medicaid program, the Operating Division is CMS. A state may amend its CAP for various reasons, including the discovery of a material defect in the CAP or a change which makes the allocation basis or procedures in the approved CAP invalid. 45 C.F.R. � 95.509(a). A state may claim FFP "only in accordance with its approved cost allocation plan. However, if a State has submitted a plan or plan amendment for a State agency, it may, at its option claim FFP based on the proposed plan or plan amendment, unless otherwise advised by the DCA." 45 C.F.R. � 95.517. The state must then "retroactively adjust its claims in accordance with the plan or amendment as subsequently approved . . . ." Id.

General requirements for allocating costs incurred by state governments under federal grants are set out in Office of Management and Budget (OMB) Circular A-87. OMB Circular A-87 is made applicable to the Medicaid program by 45 C.F.R. � 92.4(a)(3) and 92.22(b) as well as by 45 C.F.R. � 74.27(a). ⁽¹⁾ OMB Circular A-87 states that, in order to be allowable, a cost must "[b]e necessary and reasonable for proper and efficient performance and administration of Federal awards" and "[b]e allocable to Federal awards . . . ." OMB Circular A-87, Attachment (Att.) A, � C.1. The Circular further states: "A cost is allocable to a particular cost objective if the goods or services involved are chargeable or assignable to such cost objective in accordance with relative benefits received." Id., � C.3.a. The Circular continues: "All activities which benefit from the governmental unit's indirect cost, including unallowable activities and services donated to the governmental unit by third parties, will receive an appropriate allocation of indirect costs." Id., � C.3.b. ⁽²⁾

On April 8, 1997, HHS issued its Implementation Guide for OMB Circular A-87, ASMB C-10. Part 2.11, 2-12 of ASMB C-10 provides:

Circular A-87 requires that where a cost of activity benefits multiple activities or programs, those costs must be allocated in accordance with the relative benefits received by each activity or program. This requirement is an underlying principle of cost allocation. Exceptions to this requirement are permissible only under certain circumstances. If an awarding agency determines that costs allocable to another program or cost objective are allowable under their program, then the unallocable costs may be bourne by their program. This shifting of unallocable costs is permitted only when the head of the awarding agency advises the cognizant agency that under its enabling legislation, such cost shifting is allowed and expected. In the absence of such authorization, costs must be allocated to all benefiting programs.

Part 2.11, 2-13 of ASMB C-10 provides:

Circular A-87 requires that common activities be allocated to all benefitting programs. The notion of "primary program" is contrary to the allocability provisions of A-87. As noted in . . . 2-12 above, where the head of an awarding agency determines that the agency's enabling legislation permits reimbursement of unallocable costs, such costs may be allowed by the cognizant official for cost allocation or indirect cost agreements, when notified by the awarding agency head. Absent such notification, the primary program concept may not be used.

http://www.hhs.gov/grantsnet/state/index.htm (emphasis in original).

Factual Background

The following facts are shown by the record and were not disputed. MDHS processes Medicaid claims using its MMIS. About 10% of the claims processed by the MMIS during the quarters at issue were attributable to state-only programs. MDHS Ex. 14 (Affidavit of John Thueson), � 3.

In January 2001, MDHS submitted a proposed CAP amendment which provided for allocating the costs of planning activities to bring its MMIS into compliance with HIPAA requirements to all benefitting programs "on the basis of current quarter count of claims processed by MMIS." CMS Ex. 1. This proposed CAP amendment was never approved or disapproved. MDHS Reply Br. at 2 (citing MDHS Ex. 21 (Affidavit of Jon B. Darling)); Tape recording of 12/2/02 telephone conference, statement of CMS counsel.

On July 9, 2001, MDHS submitted an APD for the HIPAA planning activities. MDHS Ex. 8. The APD states that Minnesota's MMIS "processes the claims for the various health care programs administered by DHS." MDHS Ex. 8, at 3, unnumbered. The APD continues:

This document is being submitted to request ninety percent (90%) federal financial participation from the Centers for Medicare and Medicaid Services (CMMS) for the assessment of the impact HIPAA will have on Medicaid business practices, the MMIS system and supporting applications as well as security and privacy.

Id. at 3 (unnumbered). The APD also includes a "Planning Project Budget" stating that the "total estimated cost associated with the HIPAA Planning and Analysis phase is $1,880,000." Id. at 9 (unnumbered). The budget then shows 90% of that amount as the federal share and 10% of that amount as the state share. Id. at 9 and 12 (unnumbered).

CMS responded to MDHS's submission on August 9, 2001 as follows:

This is in response to your letter of July 9, 2001 requesting the review and approval of Minnesota's Planning Advance Planning Document (P-APD) for HIPAA activities.

We have determined that this request should be approved. Planning activities associated with HIPAA remediation are eligible for Federal Financial Participation (FFP) at the 90 percent rate. Accordingly, FFP of $1,692,000 is available for the planning activities required in order to bring Medicaid payment and information retrieval systems into compliance with the administrative simplification, security and data privacy requirements of HIPAA.

MDHS Ex. 9.

Subsequently, on September 6, 2001, MDHS submitted a proposed CAP amendment to DCA which provided for allocating all of the costs of HIPAA planning activities to Medicaid. MDHS Ex. 10.

Before DCA took any action on MDHS's September 2001 proposed CAP amendment, MDHS submitted a claim for the quarter ended September 30, 2001 for 90% FFP under title XIX of the Act in all of the costs of the HIPAA planning activities for the first three quarters of calendar year 2001. On April 29, 2002, CMS disallowed the portion of this claim representing costs that CMS determined should have been allocated to state-only health care programs. MDHS Ex. 1. The disallowance letter stated that "[t]he disallowed amount represents the portion of the HIPAA costs which should have been allocated to programs other than Medicaid under the State agency's approved cost allocation plan." Letter dated 4/29/02, at 1. The letter further stated that "the State did not follow its approved cost allocation plan, which stipulated that costs be allocated on the basis of claims processed, and claimed all the HIPAA costs at the 90% enhanced matching rate." Id. The letter also noted that charging the Medicaid program for costs which do not benefit it "is in violation of OMB Circular A-87." Id.

On August 13, 2002, DCA requested that MDHS revise its proposed CAP amendment to allocate its "HIPAA Planning" and "HIPAA Implementation" cost centers "to all programs that benefit from these projects based on the number of claims processed by MMIS." MDHS Ex. 11. DCA subsequently advised MDHS that it "will await the DAB decision on this issue before requiring you to further revise your CAP." Letter from Director, DCA, Central State Field Office, dated 12/18/02, at 1.

Parties' Arguments

On appeal, MDHS took the position that, regardless of any CAP, its claim for FFP in all costs incurred for HIPAA planning activities was allowable because its approved APD provided for allocating all of these costs to Medicaid. MDHS relied on the regulations at 45 C.F.R. � 95.631 and 42 C.F.R. � 433.112(a), which MDHS stated allow "a state to assign development costs in a manner different from that set out in its cost allocation plan, as long as the costs are distributed in accordance with the approved APD." MDHS Reply Br. at 7. According to MDHS, it was appropriate to allocate all of the costs of the HIPAA planning activities to Medicaid because "[t]he HIPAA enhancements Minnesota is required to make to MMIS will primarily benefit Minnesota's Medicaid Program," which "pays for approximately 90 percent of the health services provided under the State's health care programs." MDHS Br. at 7. MDHS also asserted that even if it had no state-funded health care programs, the planning and development costs incurred to bring its MMIS into compliance with HIPAA would remain the same. Id., citing MDHS Ex. 14 (Affidavit of John Thueson). ⁽³⁾

CMS acknowledged that 45 C.F.R. � 95.631 "would permit CMS to provide funding for MMIS costs that were not normally allowable under OMB Circular A-87 . . . if this were provided for in a duly approved APD." CMS Supplemental Br. at 2. CMS asserted, however, that the APD neither states nor implies that all HIPAA planning costs would be "direct charged," or fully allocated, to Medicaid. CMS Br. at 6. CMS further asserted that, in approving the APD, "CMS never intended to allow MDHS to direct charge all of the HIPAA planning and implementation expenses to Medicaid." Id. According to CMS, under HHS's implementation of OMB Circular A-87, CMS has "discretion to permit a state to allocate 100% of MMIS-related expenses to Medicaid even where state funded programs also benefit, but only if the head of the awarding agency issues a directive stating that this is allowed and expected." CMS Supplemental Br. at 1 (emphasis in original). Thus, CMS argued, "Minnesota should have realized that when CMS did not make explicit mention of cost allocation in its APD approval letter it was not thereby implicitly allowing MDHS to forego allocating expenses among benefitting programs as required by OMB Circular A-87." Id. at 2. CMS also argued that, under 45 C.F.R. � 95.631, MDHS was required to show that its "normal departmental accounting system" provided for allocating 100% of the costs of HIPAA planning activities to Medicaid, and that MDHS had failed to make such a showing. Tape recording of 12/2/02 telephone conference.

1. MDHS's Advance Planning Document clearly provides for allocating 100% of the costs of its HIPAA planning activities to Medicaid, and was approved by CMS as submitted.

MDHS asserted that its "APD clearly stated that all HIPAA-related planning and analysis costs would be charged to Medicaid and receive federal reimbursement at the enhanced 90 percent rate." MDHS Br. at 6. We agree. The APD states in part that it "is being submitted to request ninety percent (90%) federal financial participation from the Centers for Medicare and Medicaid Services (CMMS) for the assessment of the impact HIPAA will have on Medicaid . . . ." While this statement literally refers just to the rate of FFP in costs eligible for Medicaid funding, the fact that Medicaid is the only source of funding mentioned signals MDHS's intent to allocate 100% of the costs of HIPAA planning activities to Medicaid. More significantly, the budget included in the APD makes clear that 100% of the costs of HIPAA planning activities is to be allocated to Medicaid and none to state-funded programs. As noted above, the "Planning Project Budget" states that the "total estimated cost associated with the HIPAA Planning and Analysis phase is $1,880,000." MDHS Ex. 8, at 9 (unnumbered). The budget then shows 90% of that amount as the federal share and 10% of that amount as the state share. Id. at 9 and 12 (unnumbered). The amount of planning costs eligible for 90% FFP would have been less than $1,880,000 if some of the planning costs were being allocated to state-funded programs. Moreover, the APD states that MDHS used the MMIS to process the claims for "various health care programs administered by DHS." Thus, it is clear on the face of the APD that MDHS operated state-funded health care programs to which no costs were being allocated.

Moreover, we find that CMS approved the APD as submitted. CMS's August 9, 2001 letter stated flatly that "this request should be approved." MDHS Ex. 9. CMS nevertheless argued that the statement in its letter that "FFP of $1,692,000 is available for the planning activities" did not refer to "an amount that Minnesota was guaranteed to actually receive, but the theoretical maximum that it could receive under the APD as approved--provided that the project cost as much as projected and Medicaid was the only benefitting program." CMS Response Br. at 6, n.1. While the Act limits FFP to the amount of actual expenditures, no limitation regarding benefitting programs is apparent on the face of the letter, or even implied. Moreover, as discussed later in this decision, the allocation of 100% of the HIPAA planning costs to Medicaid is not inconsistent with the cost principles in OMB Circular A-87, so there is no basis for CMS's contention that MDHS should have known that CMS did not intend to approve that allocation when it approved the APD. Accordingly, we conclude that CMS approved the allocation of 100% of the costs of HIPAA planning activities to Medicaid as provided in the APD submitted to it by MDHS.

2. Under 45 C.F.R. 95.631, MDHS was permitted to allocate automatic data processing development costs in accordance with its approved Advance Planning Document.

As CMS acknowledged, section 95.631 of 45 C.F.R. permits CMS to provide funding for automatic data processing development costs that are not normally allowable under OMB Circular A-87 if the costs are claimed in accordance with the state's approved APD. It is undisputed that the costs of the HIPAA planning activities in question here constituted development costs within the meaning of section 95.631. Since MDHS's approved APD provided for allocating all of the costs of HIPAA planning activities to Medicaid, MDHS was entitled to claim 90% FFP in the full amount of these costs.

We find no merit in CMS's argument that section 95.631 does not apply because MDHS did not show that its normal departmental accounting system provided for allocating all of the costs to Medicaid. The regulation directs a state agency to "use" its normal departmental accounting system to distribute development costs "to funding sources based on the specific identification, assignment and distribution outlined in the approved APD." This plainly requires that development costs such as the costs of the HIPAA planning activities be allocated to funding sources in accordance with the approved APD. Where, as here, the approved APD calls for no allocation among funding sources, but instead charges all of the costs to a single program, there is no reason for the state to use its accounting system method for distributing costs chargeable to more than one funding source. While the regulation requires that the state use its accounting system for other purposes, such as identifying and distributing costs to the project (i.e., the HIPAA planning activities), the disallowance here is not based on a finding that the amount charged as HIPAA planning activities was erroneous but rather on a finding that this amount was not allocable in its entirety to Medicaid.

3. The allocation of 100% of the cost of MDHS's HIPAA planning activities to Medicaid is not inconsistent with the cost principles in OMB Circular A-87.

CMS also asserted that it did not approve the allocation of all of the costs of MDHS's HIPAA planning activities to Medicaid because such an approval would have violated OMB Circular A-87. CMS acknowledged that OMB Circular A-87 gives federal agencies "the discretion to permit a State to allocate 100% of MMIS-related expenses to Medicaid even where state funded programs also benefit . . . ." CMS Supplemental Br. at 1. CMS took the position, however, that Part 2.11, 2-12 of HHS's Implementation Guide for OMB Circular A-87, ASMB C-10, permits this allocation "only if the head of the awarding agency issues a directive stating that this is allowed and expected." Id. (emphasis in original). According to CMS, the allocation of all of the costs of MDHS's HIPAA planning activities to Medicaid is impermissible because "[t]here has been no such directive in this case." Id.

There is such a directive in this case, however. We concluded above that the regulation at 45 C.F.R. � 95.631 provides that a state may allocate costs pursuant to an approved APD. This regulation gives CMS the same latitude as does ASMB C-10 to approve deviations from the benefitting program allocation approach that is generally applicable. That is, the regulation permits CMS, through the APD approval process, to determine in a particular situation that it is appropriate to allocate all automatic data processing development costs to a single benefitting program where more than one program benefits from the costs. The regulation specifically recognizes the possibility that CMS may approve a different allocation methodology than DCA would normally approve when it states that "[t]he conditions of this subpart apply notwithstanding the existence of an approved cost allocation plan" and directs the state agency to "amend" the CAP "to include the approved APD methodology . . . ." Thus, once CMS approved MDHS's APD, which provided for allocating 100% of the costs of HIPAA planning activities to Medicaid, there was no need for CMS to separately authorize this allocation methodology. CMS therefore did not establish that the allocation here was inconsistent with the cost principles in OMB Circular A-87, as implemented by HHS.

Conclusion

Based on the foregoing analysis, we reverse the disallowance in its entirety.

Judith A. Ballard

Cecilia Sparks Ford

Donald F. Garrett
Presiding Board Member

1. Section 74.27(a) is itself incorporated by reference in the MMIS regulations, which provide that CMS will approve the APD if, among other things, "the costs of the system are determined in accordance with 45 CFR 74.171" (subsequently revised and redesignated as 45 C.F.R. � 74.27(a)). 42 C.F.R. � 433.112(b)(7). In addition, a 9/8/00 letter to State Medicaid directors advised states that "[f]unding for changes to States' MMIS that are necessary to implement HIPAA will be governed by current funding policy for MMIS specified in part 11 of the State Medicaid Manual . . . ." MDHS Ex. 7, at 2 (unnumbered). The State Medicaid Manual states in relevant part that "[t]he costs of the system are determined in accordance with OMB Circular No. A-87 as referenced in 45 CFR 74.171." CMS Ex. 5, at 2 (unnumbered).

2. We quote here from the version of OMB Circular A-87 which was issued by OMB in 1995. 60 Fed. Reg. 26,484 (May 17, 1995). A 1997 amendment did not affect the provisions of � C.3.

3. MDHS also raised other arguments which we do not address since we need not rely on them to reverse the disallowance.