GAB Decision 230 December 1, 1981 Indiana Department of Public Welfare;
Docket No. 80-103-IN-HC Settle, Norval; Garrett, Donald Ford, Cecilia
Indiana appealed a disallowance of $128,456 in Federal financial
participation claimed under Title XIX (Medicaid) of the Social Security
Act for certain administrative costs. The disallowance was originally
taken by the Regional Commissioner of the Social and Rehabilitation
Service (SRS), and was upheld by the Administrator of the Health Care
Financing Administration after the Grantee had requested reconsideration
under 45 CFR 201.14.
Our decision is based on the Grantee's application for review; the
Agency's response to the application for review; the Record for
Reconsideration (SRS Docket No. ME-IN-7501); and the Board's Order to
Show Cause. The Board did not receive a response to the Order, and the
Grantee's representative, in a telephone conversation on November 23,
1981, informed a Board staff member that the Grantee would not be
responding to the Board's Order.
The Board's Order contained the tentative conclusions that the
Grantee had incorrectly included administrative costs of fiscal agents
in the distribution base for indirect costs, and that the Grantee had
incorrectly computed office space costs.
Based on the analysis set forth in the Order to Show Cause, we
sustain the disallowance of $128,456 and incorporate that Order into
this decision.
(2) This is an appeal of a disallowance of $128,456 in Federal
financial participation (FFP), claimed by the State of Indiana
Department of Public Welfare (State, Grantee) under Title XIX (Medicaid)
of the Social Security Act (the Act), in administrative costs for the
period January 1, 1970 through June 30, 1972. The disallowance was
originally taken by the Regional Commissioner of the Social and
Rehabilitation Service (SRS), and was upheld by the Administrator of the
Health Care Financing Administration (HCFA, Agency) after the Grantee
had requested reconsideration under 45 CFR 201.14.
This Order is based on the Grantee's application for review; the
Agency's response to the application for review; and the Record for
Reconsideration (SRS Docket No. ME-IN7501). The Grantee's application
for review indicated that the Grantee would rely on submissions made
during the prior reconsideration proceedings.
Background
The Grantee has participated in the Medicaid program since January 1,
1970. The HEW (now HHS) Audit Agency conducted an audit for the purpose
of determining the adequacy of procedures pertaining to the controls
exercised by the State over the administrative costs that were incurred
under Medicaid.
The audit report found that the Grantee had overstated claims for FFP
in administrative costs by $128,456, because of incorrect cost
allocations resulting in an overstatement of salary and indirect
expenses totalling $65,010 in FFP and an improper calculation of office
space costs totalling $63,446 in FFP.
The Grantee contracted with fiscal agents for processing Medicaid
claims. The auditors determined that the Grantee had improperly
included the administrative costs of these fiscal agents as part of its
direct administrative costs, used as a distribution base for allocating
indirect costs and the salaries paid to certain State Agency officials,
and that this resulted in an improperly high percentage of these costs
being allocated to Medicaid. Further, the auditors found that office
space costs were overstated because the Grantee used unallowable lease
costs, and the incorrect allocation percentage.
(3) The Acting Administrator of HCFA, in his disallowance letter of
June 4, 1980, stated that the Regional Commissioner of the Social and
Rehabilitation Service (SRS) took the position that the cost allocation
ratio used by the State in developing the FFP claim for salary and
indirect costs was inflated because the State included processing
expenses which were attributable to the State's fiscal agents and not
the State. Additionally, office space costs for State-owned facilities
should be calculated on the "use allowance" basis and no on purported
"lease" costs. The Regional Commissioner concluded that the "use
allowance" method was made mandatory by SRS Program Regulation (PR) 1-1,
effective July 1, 1969. Further, he concluded, even if the leaasehold
method was allowable, no tenant-owner relationship could exist between
the State and the State Office Building Commission (Commission).
(Disallowance letter, p. 1.)
The Acting Administrator concluded that the cost allocation
procedures employed by the State were in conflict with cost distribution
principles found in the Office of Management and Budget /1/ (OMB)
Circular A-87. (Disallowance letter, p. 3.)
Applicable Policies
SRS PR 1-1 transmitted to the States copies of a "Guide for State
Government Agencies Establishing Cost Allocation Plans and Indirect Cost
Rates for Grants and Contracts with the Department of Health, Education
and Welfare." (OASC-6). /2/ OASC-6 incorporated OMB Circular A-87 as
Appendix 1. PR 1-1 informed the States that provisions of the Circular
and Guide would become effective on July 1, 1969. OASC-6 provides:
The indirect cost of a program are those costs not readily
identifiable with the program itself but nevertheless incurred by the
State . . . for the joint benefit of the program and of other activities
carried on by the organization. Indirect costs include the costs
incurred by both a State agency performing under a grant or contract and
by a State agency providing central (4) services. . . . Circular A-87
provides for the reimbursement of these costs through the mechanism of
an indirect cost rate. An indirect cost rate . . . is the ratio between
the total indirect expenses and some direct cost base, commonly either
direct salaries and wages or total direct costs, exclusive of any
extraordinary or distorting expenditures such as capital assets, major
subcontracts, alterations and renovations, etc. (p. 2; Emphasis
supplied.)
OMB Circular A-87 sets forth as a basic guideline for allocating
costs that --
A cost is allocable to a particular cost objective to the extent of
benefits received by such objective. (Attachment A, Section C.2.a.;
OASC-6, p. 24.)
OMB Circular A-87, Attachment B, addresses the allowability of space
costs at section C.2. Section C.2. provides that rental cost of space
in a privately owned building is allowable, but refers to section B.11.
with respect to space in "publicly owned" buildings. Section B.11.a.
states, in part,
Grantees may be compensated for the use of buildings, capital
improvements, and equipment through use allowances or depreciation. . .
. (OASC-6, p. 32.)
DISCUSSION
Fiscal Agents' Costs
The auditors found that the State claimed approximately $5 million in
Federal funds for administering the Medicaid Program during the period
January 1, 1970 through June 30, 1972, and about $4.4 million of that
amount was paid to the fiscal agents for administrative costs incurred
by them. (Audit report ACN 05-50001, p. 4.) According to the auditors,
inclusion of the fiscal agents' processing costs in the direct cost base
during the period July 1, 1970 to June 30, 1971 resulted in an improper
cost allocation.
The auditors stated that the State Agency personnel "were aware of
the allocation error; they had detected the error prior to our finding
it and corrected their procedures for calculating the percentage factors
(to assure the exclusion of the fiscal agents' costs) starting with the
July 1971 allocations." (Audit reports, pgs. 34-35.)
(5) The Agency, based on the audit report, determined that for the
period July 1, 1970 to June 30, 1971 the Grantee improperly included as
direct costs the costs paid to Indiana's fiscal agents and their
subcontractor for the processing of Medicaid claims. The Agency
explains that those costs were not "in-house" costs incurred by the
Grantee for administering the Medicaid program. (Agency response, p.
6.)
The Grantee disputed the comment made by the auditors that it was
aware of the error. The Grantee contended that FFP was properly claimed
in accordance with an approved 1962 cost allocation plan. Additionally,
the Grantee attributes its change in procedures effective July 1971
(which eliminated the fiscal agents' costs from the calculation of the
applicable percentages) to the fact that, subsequent to that date,
State-appropriated funds were allocated to a special account for payment
of the fiscal agents' costs and this had the effect of removing the
costs from consideration in the cost allocation plan. (Appendix to the
Audit report, State Agency Comments, pgs. 34-35.)
The Agency contended that the Grantee could not rely on a 1962 cost
allocation plan to meet Medicaid requirements when Indiana did not
participate in the program until 1970. Further, the Agency relied on
OMB Circular A-87 as a basis for determining that Grantee could not
include as part of its own cost the administrative cost of the fiscal
agents because "any extraordinary or distorting expenditures such as
capital expenditures and major subcontracts" were to be excluded under
the Circular. (See OASC-6, p. 2.)
Additionally, the Agency, in its response, stated that the Grantee
did not have an agreement with the Federal government pursuant to OMB
Circular A-87, covering the audit period, until November 18, 1971.
(Agency response, p. 12.)
A review of the November 18, 1971 Negotiation Agreement indicates
that this agreement was effective for the fiscal years ending June 30 of
1970, 1971, and 1972, and was entered into pursuant to OMB Circular
A-87. (Record for Reconsideration, Tab 22.) The Grantee has not shown
why this agreement would not apply during July 1, 1970 to June 30, 1971
nor has the Grantee shown how its 1962 Cost Allocation Plan would apply,
or, indeed how approval of that plan would constitute approval of
inclusion of fiscal agents' costs in the distribution base.
It appears that the Agency correctly determined that the fiscal
agents' costs were extraordinary or distorting expenses, related to a
major subcontract, which should have been excluded from the direct cost
base in accordance with OASC-6. The Grantee has not denied that it had
notice of OASC-6 and the Circular requirements, and PR 1-1 indicates
that a copy of OASC-6, incorporating A-87, was transmitted to all
states. It would appear that inclusion of the fiscal agents' costs in
the distribution base results in costs being allocated to Medicaid (6)
which did not benefit that program. While "in-house" administrative
costs have a rational relationship to the State agency's indirect costs
and salaries, the State has not shown how fiscal agents administrative
costs have such a relationship.
The Agency position is also supported by the later exclusion of the
fiscal agents' costs from the distribution base. The Grantee's argument
that this was solely due to its revised methods of accounting for
payments to the fiscal agents would not appear persuasive in view of the
incentive that the Grantee would have to include costs in the
distribution base to the extent allowable, regardless of its method of
paying these costs.
Thus, it appears preliminarly that improperly high percentages were
used to calculate the Medicaid portion of the allocated costs, resulting
in unallowable costs being charged to Medicaid.
Office Space
The auditors found that the Grantee overstated the costs claimed for
FFP for office space expenses by $63,446 for the time period January 1,
1970 to June 30, 1972. According to the auditors, this occurred as a
result of space costs that were improperly based on an annual lease
cost-charge and of overcharges attributable to the use of the incorrect
percentages which, as discussed above, resulted from improper inclusion
of the administrative costs of the Grantee's fiscal agents. (Audit
report, p. 35.)
The auditors found that the annual cost charge represented a cost
that was paid to the Commission under a "lease agreement." The
Commission negotiated lease agreements with State agencies for use and
occupancy of the State Office Building. The auditors had previously
made certain findings with respect to this arrangement. (See Audit
Report ACN 05-20213, pp. 5-6.) These findings may be summarized as
follows:
(1) Title in the building was vested in the State, not in the
Commission. Therefore, there was not an owner-tenant relationship.
(2) The money received by the Commission was used to pay interest and
redeem debentures. As a result, payments made by the occupants
represented costs applicable to long-term indebtedness rather than space
usage.
(3) The cost principles (OMB A-87) provide for recovery of the cost
of State-owned buildings and equipment through depreciation write-offs
or use-allowances but not through leasing arrangements.
(7) Additionally, the auditors were of the opinion that the amount
recovered by the State each year was not reasonable. The auditors
stated,
At the current annual charge of $2.4 million to the various State
agencies, the $20 million depreciable cost of the Building and equipment
would be recovered in less than 10 years. The Internal Revenue Service
regulations generally provide for annual depreciation rates of about 2
percent of the office buildings. (Audit report, p. 36.)
The Grantee contended that the percentages and space costs were in
accordance with its approved 1962 Cost Allocation Plan. The Grantee
contended that, since SRS Program Regulation 1-1 (C-1) at Audit report,
Exhibit B), issued March 12, 1970, stated "agreements with grantees
entered into prior to this effective date will remain in effect," its
1962 plan applied to the time period in question.
The Agency stated that the Grantee's reliance on its 1962 Cost
Allocation Plan is unpersuasive, since Indiana did not participate in
the Medicaid program until 1970, and Indiana was sent a copy of OMB
Circular A-87, by transmittal dated May 9, 1968, stating that the
principles contained therein would govern the allowable costs as of July
1, 1969. (Agency Response, pgs. 9-10.) The Agency interprets the
reference in PR 1-1 (C-1) to agreements remaining in effect to refer
only to agreements under A-87.
As stated above, Grantee has not provided any evidence to show why
the November 18, 1971 Negotiation Agreement would not apply to this
period, and supersede the 1962 plan.
It appears from a review of SRS Program Regulation 1-1 (C-1), that
the Agency's interpretation is correct, and that the provision cited by
the Grantee referred to any agreements made pursuant to PR 1-1 and in
accordance with the provisions of OMB Circular A-87. PR 1-1 (C-1)
identifies as its "subject" cost allocation under OASC-6 and its
"content" interpretation of PR 1-1, Appendix 1, which sets out OMB
Circular A-87 principles.
Grantee has not shown why OMB Circular A-87, Attachment B, B.11,
which provides for the compensation for the use of public buildings to
be through use allowances or depreciation, should not apply in this
case.
The auditors stated in the audit report, and the Grantee has not
denied, that title in the building in question was vested in the State.
Therefore, it would appear that a legitimate owner-tenant relationship
did not exist, that the building was publicly owned, and that the
Grantee must, therefore, be compensated for the building's use through
depreciation or a use allowance rather than rental costs.
(8) Moreover, the Grantee has not denied that its space cost
allocations were done on the same basis as allocation of indirect costs,
with the fiscal agents' costs included in the distribution base. Thus,
based on our preliminary analysis set forth above, it would also appear
that allocation of space costs to Medicaid was improperly inflated.
Order
No material facts appear to be in dispute. It does not appear likely
that an evidentiary hearing will be required or that an informal
conference will be useful. It appears tentatively that this case should
be decided on written record and argument.
Now, therefore, it is hereby directed that, within 30 days of receipt
of this Order, Grantee show cause in writing why the Board should not
proceed to decision, identifying the respects, if any, in which the
foregoing summary is materially incomplete or inaccurate, the issues of
material fact, if any, which are in dispute and the reasons, if any, why
the appeal should not be denied on the grounds that Grantee incorrectly
included administrative costs of fiscal agents in the distribution base
for indirect costs, and that Grantee should have been compensated for
the space costs through use allowances or depreciation.
Grantee may accompany its submission by any briefing on any aspect of
the case that it considers relevant. Its submission need not and
preferably should not repeat any arguments already in the record before
the Board.
The Agency may respond if it wishes but it is not required to submit
any briefing at this time. The Agency will be afforded an opportunity
to reply if Grantee's response raises any issues that appear to require
further consideration by the Board. /1/ Formerly Bureau of the Budget
/2/ The Agency, in its response, refers to the Guide for Local
Government Agencies (OASC-8), but PR-1-1 refers to "A Guide for State
Government Agencies" (OASC-6), which is the publication the Board will
refer to in the discussion. There are no relevant differences in the
two publications. PR 1-1 is included in the Record for Reconsideration
at Tab 24.
OCTOBER 22, 1983