Virginia Department of Medical Assistance, DAB No. 1207 (1990)

Department of Health and Human Services

DEPARTMENTAL APPEALS BOARD

Appellate Division

SUBJECT: Virginia Department of Medical
Assistance Services
Docket No. 90-141
Decision No. 1207

DATE: November 13, 1990

DECISION

The Virginia Department of Medical Assistance Services (Virginia)
appealed a determination by the Health Care Financing Administration
(HCFA) disallowing $553,038 in federal funding claimed under title XIX
of the Social Security Act (Act) for state fiscal year 1987. The claim
was for the cost of drugs furnished by in-house pharmacies to residents
of 14 intermediate care facilities. 1/ The costs were included on each
facility's cost report and reimbursed directly on a retrospective basis,
while most other costs incurred by a facility were reimbursed through a
prospective per diem rate.

HCFA disallowed the costs on the ground that the state plan did not
provide for retrospective payment of the costs. 2/ Virginia argued that
retrospective payment of the costs was authorized by its state plan.
Virginia asserted, moreover, that its longstanding interpretation of the
plan was that this method of reimbursement was permitted. Thus, the
sole issue here is whether retrospective payment was permitted under the
state plan; there is no allegation that retrospective payment was
precluded by any independent federal authority.

As discussed below, we conclude that the language of the state plan can
reasonably be interpreted to provide for retrospective payment of
in-house pharmacy drug costs, and that this interpretation was intended
by Virginia and is consistent with the overall plan methodology.
Accordingly, we reverse the disallowance in full.

Statutory and regulatory framework

In order to qualify for federal funding, a state's claim for the cost of
medical services must be in accordance with an approved Medicaid state
plan which fulfills certain requirements. Section 1903 of the Act.

Section 1902(a)(30) requires the state plan to --

provide such methods and procedures relating to . . . the payment
for . . . care and services available under the plan . . . as may
be necessary to assure that payments are consistent with
efficiency, economy, and quality of care.

Under section 1902(a)(13) of the Act, nursing facility services 3/ are
to be reimbursed --

through the use of rates (determined in accordance with methods and
standards developed by the State . . .) which the State finds . . .
are reasonable and adequate to meet the costs which must be
incurred by efficiently and economically operated facilities . . .
.

Implementing these provisions, 42 C.F.R. 447.252(b) requires that the
state plan specify the methods and standards used by the state Medicaid
agency to set payment rates. The regulations also require the state
agency to pay for long-term care services "using rates determined in
accordance with methods and standards specified in an approved State
plan." 42 C.F.R. 447.253(g).

State plan provisions

During the period in question, Virginia's title XIX plan provided for
reimbursing nursing homes for their operating costs through a
prospective rate which was based on a facility's most recent cost
report, adjusted by an inflation factor. 4/ Operating costs were
defined as total allowable inpatient costs less plant costs, which
included depreciation, interest, land improvement costs, rental costs,
taxes, and property insurance. The amount paid to a facility for
operating costs was subject to a ceiling which was based on median
allowable cost data from 1981, also adjusted annually by an inflation
factor. 5/ No retrospective payment of operating costs was permitted
under the plan, except for audit adjustments. However, the plan
effectively allowed retrospective adjustment of plant costs since it
provided for reimbursing these costs at the "actual" cost rate. HCFA's
ex. A-2 (Supplement to Attachment 4.19D of the state plan), section
2.1(A). 6/

Two provisions of the state plan referred to drug costs. The first, on
which Virginia relied as authority for retrospective reimbursement of
in-house pharmacy drug costs, stated --

Excluded from allowable costs [considered in final settlement] are
personal physician fees, prescribed legend and non-legend drugs and
ancillary services such as laboratory tests and x-rays. These
excluded services are billed directly to DMAS by the provider and
not costed through the facility.

HCFA's ex. A-2, section 2.9.B.2.

The second provision, which HCFA contended required the inclusion of
in-house pharmacy drug costs in the prospective operating cost rate,
appeared in an appendix to the state plan entitled "Uniform Expense
Classification," and read --

J. PHARMACY EXPENSES 1. Salaries Gross salaries of all
pharmacy personnel

2. Drugs Cost of pharmaceuticals not provided under
direct billing to the Program.

3. Supplies Cost of all non-drug supplies

HCFA's ex. A-1 (Appendix I to Attachment 4.19D of the state plan),
section 6.1.J.2.

Analysis

In prior decisions, the Board has articulated the principles it uses in
determining whether to defer to a state's interpretation of its plan
where no federal requirement is at issue and the state therefore has
discretion in fashioning its reimbursement system. In Missouri Dept. of
Social Services, DAB No. 1189 (1990), the Board, citing South Dakota
Dept. of Social Services, DAB No. 934 (1988), stated --

First the Board looks to the language of the plan. If the language
is ambiguous, it looks to whether the state's interpretation gives
reasonable effect to the language of the plan as a whole. In
considering the state's explanation of intent, the Board considers
whether it is reasonable in light of the purpose of the provision
and program requirements. The Board may also consider consistent
administrative practice as evidence of intent.

DAB No. 934, p. 5. In addition, the Board has stated elsewhere --

When confronting conflicting interpretations of state plans, the
Board generally will give greater weight to a state's
interpretation of its own plan, if it is reasonably supported by
the language of the provision involved. [Citations omitted.]

Nebraska Dept. of Social Services, DAB No. 1187 (1990), p. 6.

Based on these principles, we conclude that Virginia's interpretation is
entitled to deference. 7/ Below we discuss the determinative factors.

The language of the state plan

Virginia took the position that the plain language of the state plan, at
section 2.9 B.2. of the Supplement to Attachment 4.19D, required it to
exclude drug costs from operating costs and pay them directly. Virginia
contended that this provision covered all prescribed drugs, including
those supplied by in-house pharmacies.

HCFA took the position that section 2.9 B.2. applied only to nursing
homes which obtained drugs from independent suppliers. In HCFA's view,
the purpose of this provision was to prevent double billing for the same
drugs, once by the independent supplier and once by the nursing home.
Since double billing was not a potential problem in the case of nursing
homes with in-house pharmacies, HCFA argued that the provision did not
apply to them.

We conclude that Virginia reasonably interpreted section 2.9 B.2. as
applying to in-house pharmacy drug costs. There is nothing on the face
of the provision itself which distinguishes drugs provided by
independent suppliers from those provided by in-house pharmacies. The
provision does state that services including drugs are to be billed
directly by the "provider." However, this does not contemplate that the
supplier of the drugs will have a separate provider agreement. Since an
in- house pharmacy would logically be covered by the provider agreement
of the facility in which it was located, such a pharmacy can be
considered a "provider" within the meaning of section 2.9 B.2. 8/

Moreover, section 2.9 B.2. of the Supplement to Attachment 4.19(D) is
not limited in its application to drugs furnished by independent
suppliers simply because, absent the provision, double billing for such
drugs might occur. As discussed later in the decision, there are
reasons for applying the provision to in-house pharmacies as well.
Indeed, it is arguable that section 2.9 B.2. applies only to in-house
pharmacies since the cost of drugs furnished by independent suppliers
would normally not be included in a facility's operating costs even in
the absence of this provision. 9/ To read this provision, as HCFA does,
as stating that the costs specified are not costed through the facility
because they are billed directly by the provider of the goods or
services arguably turns the provision into a truism which adds nothing
to the state plan.

HCFA further contended, however, that Appendix I to Attachment 4.19D of
the state plan classified the cost of drugs provided by in-house
pharmacies as an operating cost rather than a plant cost, and that this
cost was therefore required to be reimbursed through the operating cost
rate. 10/

Virginia, on the other hand, asserted that Appendix I provided that the
cost of drugs provided by in-house pharmacies was allowable without
dictating the method by which the cost should be reimbursed.

Contrary to HCFA's argument, we find that Appendix I does not classify
the cost of drugs furnished by in-house pharmacies as operating costs.
Appendix I lists five general categories of costs: administrative
expenses (section 2.1), dietary (section 3.1), housekeeping expenses
(section 4.1), laundry expenses (section 5.1), and maintenance and
operation of plant (section 6.1). Section 6.1 is further divided into
fourteen categories of costs under which specific costs are listed.
"Pharmacy expenses" is one such category, another is "operating
expenses," and yet another is "plant expenses (non-operating)." Thus,
Appendix I does not simply classify costs as either operating costs or
plant costs. Accordingly, the fact that "pharmacy costs" are listed
separately from "plant expenses (non-operating)" does not mean that the
pharmacy costs are operating costs which must be reimbursed
prospectively.

In addition, if Appendix I classified the cost of drugs furnished by
in-house pharmacies as operating costs, the cost of salaries and
supplies incurred by in-house pharmacies (listed in the same section)
would also be operating costs. However, Virginia contended that it paid
the latter costs, which are not included in the disallowance, on a
retrospective basis, not as operating costs. Virginia's response to
Board questions, pp. 2-3.

Moreover, Virginia never argued that the in-house pharmacy drug costs
were part of plant costs and should be reimbursed retrospectively on
that basis. Instead, its argument was simply that the state plan did
not provide for reimbursing nursing home costs exclusively on a
prospective basis, and that these drug costs, like plant costs, were
authorized to be reimbursed retrospectively.

Accordingly, we conclude that the language of Virginia's state plan can
reasonably be interpreted to provide for retrospective payment of
in-house pharmacy drug costs. As discussed below, moreover, we further
conclude that this interpretation was intended by Virginia and is not an
interpretation advanced solely to support the claim in question here.
Finally, we conclude that Virginia's interpretation is consistent with
the overall plan methodology.

Consistent contemporaneous practice

Virginia took the position that its policy since at least 1979 had been
to reimburse nursing homes directly for in- house pharmacy drug costs
instead of including these costs in calculating per diem operating cost
rates for the nursing homes. HCFA did not challenge Virginia's
position, which is amply documented in the record. The documentation
includes an internal memorandum to State Department of Health "Cost
Settlement and Audit Staff," dated February 13, 1979, which states in
pertinent part --

For the new prospective system, drugs will not be included in
operating costs. Since most nursing homes do not provide drugs, it
would be inappropriate to add on the cost of living rate and
equally inappropriate to include drugs in the computation of the
statewide average. Therefore, drugs should be handled like plant
cost and the providers should be notified in their settlement
letter that drug cost will be subject to retrospective adjustment
and settlement. (This applied only to the few nursing homes that
have a legitimate drug expense.)

Virginia's ex. 8, p. 3. This provision clearly indicates that nursing
homes with in-house pharmacies were not to include drug costs in the
operating costs used to calculate prospective per diem rates, but were
instead to be reimbursed on a retrospective basis. 11/

Virginia also submitted an affidavit of the current director of the
Division of Cost Settlement and Audit, Department of Medical Assistance
Services, stating that he had determined from a review of the official
records under his control and custody or that of the Division that this
had been Virginia's policy since "at least 1979." Id., p. 1.

As further evidence of its intent to reimburse in-house pharmacy drug
costs retrospectively, Virginia noted that in 1982, when median per diem
operating cost ceilings were established, drug costs were not included
in the allowable costs used to calculate the medians. It is unlikely
that Virginia would have excluded such costs from the medians unless it
had also interpreted the state plan as excluding them from the
calculation of the per diem rates of facilities with in-house
pharmacies. Otherwise, such facilities would reach the ceiling sooner
than facilities with comparable costs which obtained drugs from
independent suppliers.

Thus, the record clearly establishes that Virginia's consistent
administrative practice was to reimburse in- house pharmacy drug costs
on a retrospective basis rather than to include them in the calculation
of a facility's operating cost rate.

Reasonableness in light of methodology

We further conclude that the direct reimbursement of in- house drug
costs is reasonable in light of how Virginia's Medicaid program
operated. As indicated by the February 13, 1979 memorandum discussed
above, very few nursing homes in the state had in-house pharmacies.
Since it was necessary to reimburse drug costs separately from nursing
home costs where there was no in-house pharmacy, it arguably simplified
the administration of the program to reimburse these costs separately
for all nursing homes. By doing so, for example, Virginia was able to
apply the same rate ceiling to all nursing homes regardless of whether
they had in-house pharmacies.

Virginia also asserted that unless in-house pharmacy drug costs were
reimbursed retrospectively, in-house pharmacies would be treated
inequitably because their costs, unlike those of independent suppliers,
would be subject to the prospective operating cost rate ceiling. Thus,
Virginia's interpretation of the plan assures that all pharmacy costs
are treated alike.

Furthermore, the retrospective reimbursement of in-house pharmacy drug
costs was consistent with the payment system adopted by Virginia. As
indicated previously, Virginia originally used a retrospective payment
system and continued to use that system during the period in question
for some types of facilities as well as for plant costs incurred by all
facilities. Thus, the manner in which Virginia reimbursed in-house drug
costs was not an aberration, but a logical part of a mixed payment
system.

HCFA asserted, however, that while retrospective payment of drug costs
was justified in the case of independent suppliers because the nursing
homes had no control over the charges, the same rationale did not apply
in the case of in-house pharmacies, whose costs could be contained by
the nursing homes in which they were located. It is not clear that the
nursing homes had the ability to contain the cost of the drugs furnished
by in-house pharmacies. In any event, HCFA did not cite any authority
which requires that costs over which a facility has some control be
reimbursed prospectively. .Conclusion

For the reasons set forth above, we conclude that Virginia reasonably
interpreted its state plan to authorize retrospective reimbursement of
the cost of drugs furnished by in-house pharmacies. Accordingly, we
reverse the disallowance of $553,038.


________________________ Judith A.
Ballard

________________________ Norval D.
(John) Settle

________________________ Donald F.
Garrett Presiding Board Member

1. The parties agreed that at least 13 of the facilities were
privately owned. Virginia disputed HCFA's assertion that one facility,
Lake Taylor, was state-owned. Virginia's reply brief, p. 4, n. 4.

2. In giving notice of its determination, HCFA also stated that the
drug costs were unallowable because the in-house pharmacies did not have
separate provider agreements. However, HCFA later modified this
position, as discussed in note 8.

3. Before it was amended by section 4211(h)(2)(A) of Public Law
100-203, this provision referred to "skilled nursing facility, and
intermediate care facility services."

4. The plan also provided that certain specialized facilities
(including institutions for mental diseases providing skilled nursing
and intermediate care facility services for individuals age 65 and
older, and mental retardation facilities) were to continue to be
reimbursed in accordance with the retrospective payment system
previously in effect. HCFA's ex. A-2 (Supplement to Attachment 4.19D of
the state plan), p. 5.

5. Other features of the plan included a provision for incentive
payments based on the difference between per diem operating costs and
the per diem ceiling, and the application of "the lower of costs or
charges" principle.


6. Both parties agreed that the state plan authorized the
retrospective reimbursement of plant costs during state fiscal year
1987, the period in question here, although HCFA noted that section
2.1(A) was not effective until October 1, 1986, one quarter into the
fiscal year.


7. Since reversal of the disallowance is required based on these
principles, we need not address Virginia's argument that HCFA is
estopped from taking the disallowance because it knew before the period
in question that Virginia interpreted its plan to permit retrospective
reimbursement of in-house pharmacy drug costs.

8. As noted earlier, the disallowance letter stated that the drug
costs in question could not be billed directly because the in-house
pharmacies did not have separate provider agreements. HCFA later
explained that it was not taking the position that in-house pharmacies
were required to have (or even eligible for) separate provider
agreements, but was simply making the point that the state plan only
authorized retrospective payment of drug costs to independent pharmacies
with separate provider agreements. HCFA's response to Board questions,
p. 2. As indicated here, however, we are not persuaded that this is a
reasonable interpretation of the state plan.


9. The state plan did provide elsewhere that the costs of goods or
services furnished to the provider by a related organization are
includable in the allowable cost of the provider at the cost to the
related organization (rather than at the presumably higher rate actually
charged to the provider). HCFA's ex. A-2, section 2.10. HCFA asserted
that section 2.10 provided for direct reimbursement of costs incurred by
related organizations, and inferred from this that costs not billed by a
related organization but rather by an operating division of the
facility, such as an in-house pharmacy, were subject to the prospective
payment system. However, as Virginia noted, section 2.10 does not in
fact state how the costs of a related organization are to be charged,
but merely provides that they are allowable costs of the provider. Thus,
whether an in-house pharmacy is a related organization or an operating
division, section 2.10 has no bearing on how its costs should be
charged.


10. HCFA originally appeared to argue that all costs listed in
Appendix I were required to be reimbursed through the operating cost
rate. HCFA's brief, pp. 13- 14. HCFA later stated that Appendix I was
"not limited only to costs used in the calculation of the prospective
rate." HCFA's response to Board questions, p. 5.

11. In addition, Virginia submitted an excerpt from the Nursing Home
Manual published by the Department of Medical Assistance Services and
furnished to nursing home providers participating in Virginia's Medicaid
program. Virginia's ex. 8, p. 2. (Although this document is undated,
Virginia stated that it "was current as of the date the Appeal File was
filed and effective during the audit period in question." Virginia's
response to Board questions, p. 4.) Virginia also submitted Medicaid
Memo NMH-39, from the director of the Virginia Medical Assistance
Program to all participating nursing homes, dated June 1, 1977. Id.,
attachment. Both of these documents provide that in-house pharmacy drug
costs are to be billed as ancillary costs. Virginia stated that
ancillary costs are reimbursed separately from operating and plant
costs. Id., p. 4.