GAB Decision 298
May 24, 1982 Michigan Department of Social Services; Docket No.
81-164-MI-HC Settle, Norval; Teitz, Alexander Garrett, Donald
The Michigan Department of Social Services (Grantee) appealed the
disallowance of $20,814 by the Health Care Financing Administration
(Agency) of federal financial participation claimed under the Medicaid
program for fiscal years 1974 through 1976. The Agency determined that
certain costs included by the Grantee in establishing the reimbursement
rates for a Medicaid provider were not allowable.
The Grantee subsequently conceded that the Agency's disallowance of
pension fund payments ($11,375) /1/ and travel expenses ($190) was
correct. See, Grantee's May 10, 1982 letter.
The only remaining issue (involving $9,249) is whether certain funds
borrowed from a related organization and placed in certificates of
deposit, should be considered "investment funds" and the income from
those funds offset against other allowable interest expenses of the
provider.
There are no material issues of fact in dispute. We have, therefore,
determined to proceed to decision based on the written record, including
the parties' written comments following a telephone conference call
conducted by the Board.
Discussion
1. Background
During the period of the disallowance, a nursing home borrowed a
substantial (2) amount of money from a related organization. The
nursing home paid interest on the loan to the related organization. The
principal of the loan was invested in certificates of deposit which paid
interest.
The parties agreed that the interest expense itself, paid for money
borrowed from a related party and used to invest in certificates of
deposit, is neither necessary nor proper under 42 CFR 405.419 /2/ and,
therefore, is not an allowable cost. The Grantee contended, however,
that the borrowed funds should not be considered "investment funds,"
and
the income from those funds should not be offset against other allowable
interest expense.
In support of its argument, the Grantee relied on section 1218.2 of
HIM-15 /3,/, the Provider Reimbursement Manual. Section 1218.2 defines
invested funds in part as "funds diverted to income producing activities
which are not related to patient care." The Grantee argued that,
The word 'diverted' implies that the ultimate disposition or source
of the funds was other than that which was originally intended.
Grantee's May 10, 1982 letter, p. 2.
The Grantee contended that the funds referred to in section 1218.2
must be intended and used for health care operations. The Grantee
argued that in this case the funds involved were the result of related
(3) party borrowing as such, "their source or ultimte disposition was
not the operating funds of the existing nursing facilities." Id. The
Grantee concluded that since the instant funds did not meet the section
1218.2 definition of invested funds, there should not be an offset of
allowable interest expense by the income generated from the related
party borrowings.
The Grantee argued further that the effect of the offset is that it:
penalizes the provider and reduces its expense beyond the amount that
would be recognized had it not borrowed the funds.
Id.
The Agency asserted that the regulation on interest expense, 42 CFR
405.419(c), provides that:
where interest on loans by partners, stockholders, or related
organizations is disallowed as a cost solely because of the relationship
factor, the principal of such loans shall be treated as invested funds
in the computation of the provider's equity capital under Sec. 405.429.
Therefore, the Agency argued, the regulation does not "support the
distinction the State is attempting to make between funds diverted from
general or operating funds and borrowed funds." Agency's May 12, 1982
letter, p. 4. The Agency concluded that these borrowed funds would be
treated as invested funds "regardless of the purpose for which they were
used." Id.
The Agency argued that the intent of 42 CFR 405.419 is to encourage
the provider to use borrowed funds to reduce the principal of
outstanding indebtedness before investing the funds. The Agency
asserted that this would reduce the need for further borrowing and,
thereby, reduce the interest expense incurred by the provider. Id.
2. Analysis of Interest Expense
With regard to interest expense, 42 CFR 405.419 states, in part:
(2) Necessary. Necessary requires that the interest:
(iii) Be reduced by investment income . . . .
(4) The Grantee does not contest that before interest expense is to
be considered necessary under the regulation, it must be reduced by
investment income. The Grantee argues, however, that the certificates
of deposit are not "invested funds" as defined in HIM-15, Sec. 1218.2.
We find the Grantee's argument unpersuasive. The Grantee's
interpretation of the meaning of the word "diverted" in Sec. 1218.2
of
the manual loses sight of the context within which it is used. As the
Grantee argues, it is safe to state that the source and disposition of
the funds referred to in Sec. 1218.2 is health care operations.The
Grantee, however, is incorrect in stating that this is not the case
here. The provider in question is a corporation whose business is the
provision of health care. Upon receipt of the borrowed funds, those
funds became available for the general operations of the business, i.
e., health care. The subsequent investment in certificates of deposit
by the provider diverted those funds from the provision of patient care.
Under Sec. 1218.2, the funds are, therefore, invested funds.
The fact that the borrowed funds were not commingled with other
operating funds is irrelevant. The funds were available for providing
patient care services but were instead used to generate income by
investing in certificates of deposit. Under HIM-15 and under any
reasonable reading of the regulations these funds were defined as
invested funds, the income from which must be set off against other
allowable interest expense in accordance with 42 CFR 405.419(2)(iii).
We also find unpersuasive the Grantee's argument that the offset
required by the regulations operates as an unduly harsh penalty under
these circumstances since the Grantee is unable to claim an interest
expense for interest on the loan from the related organization. We
agree with the Agency that the regulation makes no exception for this
type of situation. Further, had the provider used the borrowed funds to
reduce the principal of outstanding indebtedness or to provide health
services, the effect would have been twofold:
(1) the provider would have incurred less interest expense from the
reduction in existing borrowed funds or the reduced need to borrow funds
to provide services; and
(2) no investment income would have been generated from the borrowed
funds and, therefore, no offset would have been required.
Accordingly, we believe that an offset was required under the facts
here. (5) Conclusion
For the reasons stated above, we find that the certificates of
deposit are invested funds and that, in accordance with 42 CFR 405.419(
2)(iii), the income generated from the investment must be offset against
other allowable interest expense. We therefore uphold the disallowance
of interest expense of $9,249. Further, since the Grantee conceded the
issues of pension fund payments ($11,375) and travel ($190), we sustain
the entire disallowance of $20,814. /1/ Although the Grantee conceded
that the pension costs were unallowable in the year claimed, it
maintained that the pension costs are allowable costs for program
reimbursement in subsequent years. See, Grantee's May 10, 1982 letter p.
1. That issue is not before the Board in this appeal. /2/ The
Medicare regulations are applicable here because Medicaid regulations
for the period in question required that a State Medicaid plan include a
policy for reimbursement for services provided. 45 CFR 250.30(a)(1).
The State of Michigan adopted, with some exceptions which are not
relevant here, the "Principles of Reimbursement for Provider Costs and
for Services by Hospital -- Based Physicians" as contained in HHS
publication HIR-4, which repeats the federal Medicare reimbursement
regulations at 42 CFR 401 et seq. See, Grantee's Appeal File, Ex. III.
/3/ In earlier briefs the Grantee had argued that the Grantee, in
adopting the Medicare principles of reimbursement, had not adopted the
Agency's interpretation of those regulations, namely, HIM-15. Since the
Grantee is now relying on HIM-15 to support its position and because we
decide this issue based on the regulations themselves, it is not
necessary for the Board to decide whether the Grantee could have adopted
an interpretation that differed from the Agency's interpetation of the
Medicare regulations.
OCTOBER 22, 1983