S T . Francis Health Care Centre v. Donna Shalala

1
RECOMMENDED FOR FULL-TEXT PUBLICATION
Pursuant to Sixth Circuit Rule 206
ELECTRONIC CITATION: 2000 FED App. 0067P (6th Cir.)
File Name: 00a0067p.06
UNITED STATES COURT OF APPEALS
FOR THE SIXTH CIRCUIT
_________________
S T . FRANCIS HEALTH C ARE
C ENTRE ,
Plaintiff-Appellant,
v.
DONNA S HALALA ,
Defendant-Appellee.
;>

1
No. 98-3965
Appeal from the United States District Court
for the Northern District of Ohio at Toledo.
No. 97-07559—David A. Katz, District Judge.
Argued: October 25, 1999
Decided and Filed: February 25, 2000
Before: JONES, MOORE, and GILMAN, Circuit Judges.
_________________
COUNSEL
ARGUED: Dennis P. Witherell, SHUMAKER, LOOP &
KENDRICK, Toledo, Ohio, for Appellant. Ted Yasuda, U.S.
DEPARTMENT OF HEALTH & HUMAN SERVICES,
OFFICE OF THE GENERAL COUNSEL, REGION V,
Chicago, Illinois, for Appellee. ON BRIEF: Dennis P.

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2 St. Francis Health Care v. Shalala No. 98-3965
Witherell, Jenifer A. Belt, SHUMAKER, LOOP &
KENDRICK, Toledo, Ohio, for Appellant. Ted Yasuda, U.S.
DEPARTMENT OF HEALTH & HUMAN SERVICES,
OFFICE OF THE GENERAL COUNSEL, REGION V,
Chicago, Illinois, for Appellee.
JONES, J., delivered the opinion of the court, in which
MOORE, J., joined. GILMAN, J. (pp. 20-27), delivered a
separate dissenting opinion.
_________________
OPINION
_________________
NATHANIEL R. JONES, Circuit Judge. Plaintiff-
Appellant St. Francis Health Care Centre (“St. Francis”)
appeals the district court’s grant of summary judgment for
Defendant-Appellee Donna Shalala, Secretary of the
Department of Health and Human Services (“Secretary”). St.
Francis contends that the Secretary erred in denying its
request for Medicare reimbursement for the provision of
hospital-based skilled nursing services. For the reasons stated
herein, we AFFIRM.
I.
A.
St. Francis operates a rehabilitation hospital, a hospital-
based skilled nursing facility (“HB-SNF”), a general nursing
facility, and a transitional living center in rural Ohio. Only St.
Francis’s HB-SNF is relevant for purposes of this appeal.
The goal of St. Francis’s HB-SNF is to rehabilitate, rather
than simply maintain patients. Thus, St. Francis routinely
provides “comprehensive rehabilitation therapy” for the vast
majority of its patients. Although St. Francis’s intensive
rehabilitation therapy results in higher per diem costs per
patient compared to its peers, this therapy also results in
shorter patient stays. Thus, a patient’s total costs are less than
they would be at other facilities.
No. 98-3965 St. Francis Health Care v. Shalala 27
I would therefore reverse the grant of summary judgment
for the Secretary and remand with instructions to enter
judgment in favor of St. Francis. Because I would reverse the
trial court’s disposition on the ground discussed above, I find
no need to reach the other issues covered in the majority’s
opinion.

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26 St. Francis Health Care v. Shalala No. 98-3965
The majority also attempts to construe the PRM rule as an
interpretation of the requirement in 42 C.F.R. § 413.30 that a
provider’s costs be “reasonable.” It views the rule as a
parallel provision to the two-tier system established by 42
U.S.C. § 1395yy. That system reduced the cost limit for HB-
SNFs from Level 3 to Level 2, establishing a “discount
factor” to account for what Congress found to be their relative
inefficiency as compared to FS-SNFs. In the majority’s
opinion, the PRM rule similarly factors in the alleged
inefficiency of HB-SNFs and discounts reimbursement for
atypical services accordingly. See Op. at 15-16.
Closer analysis reveals that the PRM rule is not analogous
to the two-tier system. The PRM rule does not function as a
commonly understood “discount factor,” because it
completely denies compensation for the first amounts spent
on atypical services. In other words, an HB-SNF that spends
$100 to provide routine services and anywhere from $1 to $20
on atypical services will receive no reimbursement at all for
its atypical service costs. These expenditures are arbitrarily
deemed to be 100% inefficient or, alternatively, are subjected
to a 100% “discount factor.” To the extent that the same
hospital raises its atypical costs above $20, however, it will be
compensated for those costs. I find it unpersuasive to
construe these results as a “discount factor” or a measure of
“reasonableness.”
Because the PRM rule should be regarded as more
substantive than interpretive, and because it was enacted
without notice and comment, the rule should be declared
invalid. Contrary to the majority’s fears, such a result would
not necessarily require the Secretary to conduct a case-by-case
review of every provider’s reimbursement request. The
Secretary is free to establish guidelines that will
presumptively determine a provider’s eligibility for upward
adjustments, thereby relieving her agency of the burden of
case-by-case analyses. Those guidelines must, however, be
consistent with the dictates of the governing regulation, or
they must be enacted pursuant to the notice and comment
procedures of the APA.
No. 98-3965 St. Francis Health Care v. Shalala 3
1The initial decision of whether the health care provider should be
reimbursed is made by an “intermediary,” which is usually a private health
insurance company. On a yearly basis, the intermediary determines the
amount which Medicare must reimburse the provider in accordance with
Medicare policies and procedures. See 42 U.S.C. §§ 1395g, 1395h(c)(1).
2The 1991 and 1992 per diem amounts were as follows. The
terminology used in this footnote is explained infra:
1991 1992
St. Francis’s Actual Costs $120.94 $139.06
112% of Mean HB-SNF Costs $136.11 $143.98
HB-SNF Statutory RCL $110.58 $116.90
J.A. at 120-21. The Secretary concluded that “[s]ince [St. Francis’s] cost
per day is less than the uniform peer group cost, no exception is allowed.”
J.A. at 442.
Like many health care facilities, a number of St. Francis’s
patients are Medicare recipients. Consequently, Medicare
reimburses St. Francis for the reasonable costs of services
provided to Medicare patients.1 See 42 U.S.C. § 1395x(u) &
(v)(1)(A). Pursuant to Medicare rules and regulations, from
1983 to 1990, St. Francis was reimbursed for such reasonable
actual costs of services provided. Because St. Francis’s actual
costs exceeded the statutory routine cost limits (“RCLs”) for
each of these years, St. Francis requested, and was granted,
an “upward adjustment” to its cost limits. However, in the
1991 and 1992 cost reporting periods, the Medicare
intermediary denied St. Francis’s requests for an “upward
adjustment.”2 St. Francis appealed to the Provider
Reimbursement Review Board (“PRRB”), which reversed the
intermediary’s decision. Thereafter, the Administrator of the
Health Care Financing Administration (“HCFA”), the
Secretary’s delegate, reviewed and reversed the PRRB’s
decision. Pursuant to 42 U.S.C. § 1395oo(f)(1), St. Francis
thereafter filed a Complaint in federal district court seeking
review of the HCFA’s decision. St. Francis and the Secretary
filed cross motions for summary judgment. The district court
denied St. Francis’s motion, and granted the Secretary’s

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4 St. Francis Health Care v. Shalala No. 98-3965
3Several studies concluded that only 50% of the cost difference
between HB-SNFs and FS-SNFs was attributable to variations in the
intensity of care or case-mix. Inefficiency was deemed the likely cause of
the other 50% of the cost difference.
motion. See St. Francis Health Care Centre v. Shalala, 10
F.Supp.2d 887 (N.D. Ohio 1998). This timely appeal ensued.
B.
The Medicare reimbursement plan developed by Congress
has been refined over the years by Congress and the Secretary.
Beginning in 1972, Congress, faced with rising Medicare
costs, recognized that the original cost-based Medicare
payment structure provided little incentive for providers to
operate efficiently. Congress amended the Medicare Act to
provide that “reasonable costs” reimbursable under Medicare
should exclude “any part of incurred cost found to be
unnecessary in the efficient delivery of needed health
services.” 42 U.S.C. § 1395x(v)(1)(A).
The original cost limits which HCFA established
categorized SNFs as free-standing or hospital-based and as
urban or rural, and permitted reimbursement for SNFs for up
to 115% of the mean cost of their respective category, or
“peer group.” HCFA subsequently reduced the cost limit to
112% of the peer group mean costs. Therefore, while each
facility was entitled to receive 112% of its peer group mean
costs, the four types had different peer group means, and
therefore each type of facility had a different cost limit. The
cost limits for HB-SNFs were significantly higher than for
free-standing SNFs (FS-SNFs). Advocates of separate cost
limits argued that HB-SNFs incurred higher costs because of
the more intensive care they rendered, justifying higher cost
limits. However, opponents argued that all SNFs provide the
same standard of care and separate cost limits were not
warranted.
Congress, aware of results from several studies of the
higher HB-SNF costs,3 enacted the Deficit Reduction Act
No. 98-3965 St. Francis Health Care v. Shalala 25
When an agency functions as an adjudicative body, it is
under no obligation to act with consistency or to provide
notice and an opportunity for comment by interested parties.
See Michigan v. Thomas, 805 F.2d at 184 (“An administrative
agency may reexamine its prior decisions and may depart
from its precedents provided the departure is explicitly and
rationally justified.”). Because the PRM rule under
consideration is a legislative enactment rather than an
adjudicative order, any modifications that it makes to prior
regulations are required to have been preceded by notice and
comment. See 5 U.S.C. § 553.
B. The PRM rule cannot be construed as an
“interpretation” of 42 C.F.R. § 413.30
The majority concludes that by denying compensation to
HB-SNFs for the costs of atypical services below Level 3, the
PRM rule simply fleshes out the meaning of the terms
“reasonableness” of costs and “typicality” of services
contained in 42 C.F.R. § 413.30. Op. at 14. I respectfully
disagree.
The regulation in question, 42 C.F.R. § 413.30, allows
providers to seek compensation for “items or services [that]
are atypical in nature and scope.” In denying compensation
for costs that do not exceed Level 3, the PRM rule seemingly
confuses atypical costs with atypical services. The fact that
a provider’s costs are atypically high does not necessarily
mean that it is providing atypical services. Conversely, the
fact that a hospital has below-average costs does not
necessarily establish the absence of atypical services.
The facts underlying the present case confirm this point,
because it is undisputed that St. Francis provided atypical
services at a cost below Level 3 for the years in question.
There is thus a critical difference between atypical costs and
atypical services. The PRM rule, which focuses on atypical
costs, does not define or flesh out the meaning of the atypical
services referred to in the prior regulation.

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24 St. Francis Health Care v. Shalala No. 98-3965
that a rule was substantive, in part, because it was
“mandatory, not advisory”); Guardian Fed. Sav. & Loan
Ass’n v. Federal Sav. Loan Ins. Corp., 589 F.2d 658, 666-67
(D.C. Cir. 1978) (“If it appears that a so-called policy
statement is in purpose or likely effect one that narrowly
limits administrative discretion, it will be taken for what it
is—a binding rule of substantive law.”).
The Secretary argues that “nothing forbids an agency from
changing its interpretations.” I do not quarrel with the
proposition that an agency may change its rulings or
interpretations over time. An agency is not free, however, to
adopt new substantive regulations without notice and
comment. Indeed, in both cases cited by the Secretary in
which an agency modified its regulations, the change was
preceded by notice and comment. See American Trucking
Ass’ns. v. A.T. & S.F. Ry. Co., 387 U.S. 397, 404 (1967)
(allowing the Interstate Commerce Commission to adopt
rules, pursuant to notice and comment, which altered its
previous policies regarding trailer-on-flatcar service); Western
Coal Traffic League v. United States, 719 F.2d 772, 777 (5th
Cir. 1983) (allowing the Interstate Commerce Commission to
change its methodology for evaluating a carrier’s market
dominance by enacting a new regulation pursuant to notice
and comment).
In the remaining cases cited by the Secretary, the
challenged modification was an adjudicative ruling as to a
specific party rather than a general legislative rule. See
Montana Power Co. v. Environmental Protection Agency, 608
F.2d 334, 347 (9th Cir. 1979) (affirming an Environmental
Protection Agency order determining when construction of a
power plant “commenced,” even though the order was
inconsistent with prior adjudicative rulings of the agency);
NLRB v. Local 103, Int’l Ass’n of Bridge, Structural and
Ornamental Iron Workers , 434 U.S. 335 (1978) (affirming a
cease and desist order issued by the National Labor Relations
Board to a striking, uncertified union, which the union alleged
was inconsistent with a prior ruling of the agency).
No. 98-3965 St. Francis Health Care v. Shalala 5
4In the Omnibus Budget Reconciliation Act of 1993, Pub. L. 103-66,
§ 13503, 107 Stat. 379 (1993), Congress froze cost limits at the fiscal year
1993 levels for the next two fiscal years and eliminated the provision
authorizing additional reimbursement to HB-SNFs for costs associated
with the Medicare cost allocation process. This essentially rejected
differing reimbursement for HB- and FS-SNFs.
More recently, in the Balanced Budget Act of 1997, Pub. L. 105-33,
§ 4432(a), 111 Stat. 258, 414-20 (1997), Congress eliminated the two-
tiered system of cost limits as well as the retrospective cost-based
reimbursement plan. In their place, Congress enacted a prospective
payment system based on a federal per diem rate.
(DEFRA), Pub. L. 98-369, § 2319(b), 98 Stat. 494 (1984).
DEFRA added a new section to the Medicare Act which
addressed the cost differences between HB- and FS-SNFs by
adjusting the cost limits for the two groups. For HB-SNFs,
instead of employing the previous 112% level (112% of the
mean per diem costs of the peer group), Congress lowered
that amount by 50% of the difference between the 112% level
for HB-SNFs and FS-SNFs. (ie., 50% ((112% x HB-SNF per
diem costs) - (112% x FS-SNF per diem costs))). Still
dissatisfied with the cost limits established by DEFRA,
Congress has since enacted measures to contain costs further
and to reduce the differing treatment of HB- and FS-SNFs;
these latter changes post-date the events of this case,
however.4 Despite this plethora of changes to the medicare
reimbursement plan, Congress has always left intact the
Secretary’s authority to make adjustments to cost limits “to
the extent the Secretary deems appropriate.” 42 U.S.C.
§ 1395yy(c).
C.
With this legislative history in the background, this case
involves a Medicare Act provision (42 U.S.C. § 1395yy(a)),
a regulation interpreting that provision (42 C.F.R. § 413.30),
and a PRM provision (PRM § 2534.5) interpreting the
regulation.

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6 St. Francis Health Care v. Shalala No. 98-3965
1. 42 U.S.C. § 1395yy: The Statutory Framework for
Cost Limits
Congress established the RCLs to be applied to different
SNFs in 42 U.S.C. § 1395yy:
The Secretary, in determining the amount of the
payments which may be made under this subchapter with
respect to routine service costs of extended care services
shall not recognize as reasonable (in the efficient delivery
of health services) per diem costs of such services to the
extent that such per diem costs exceed the following per
diem limits . . . .
42 U.S.C. § 1395yy(a). The provision then establishes that
the RCL for FS-SNFs “shall be equal to” 112% of the “mean
per diem routine service costs” of FS-SNFs. Id. at
§ 1395yy(a)(1). For HB-SNFs, the RCL “shall be equal to”
the sum of the following: the FS-SNFs cost limit plus 50% of
the amount by which 112% percent of the HB-SNFs mean per
diem routine service cost exceeds the FS-SNFs cost limit. Id.
at § 1395yy(a)(3). Despite these statutory limits, Congress,
recognizing the Secretary’s expertise in this area, afforded the
Secretary the discretion to make “upward adjustments” to
these statutory RCLs:
The Secretary may make adjustments in the limits set
forth in subsection (a) of this section with respect to any
skilled nursing facility [SNF] to the extent the Secretary
deems appropriate, based upon case mix or
circumstances beyond the control of the facility. The
Secretary shall publish the data and criteria to be used for
purposes of this subsection on an annual basis.
42 U.S.C. § 1395yy(c).
2. 42 C.F.R. § 413.30: The Secretary’s Regulation for
Adjusting Cost Limits
Pursuant to the discretion Congress afforded the Secretary
in 42 U.S.C. § 1395yy(c), the Secretary implemented 42
No. 98-3965 St. Francis Health Care v. Shalala 23
all of their costs, including those costs above the applicable
cost limit. Indeed, in the years prior to 1991, the Secretary
routinely granted upward adjustments to St. Francis,
reimbursing all of its direct expenditures for atypical services.
Under the PRM rule, however, the Secretary no longer
determines whether amounts spent on atypical services
between Levels 2 and 3 should be compensated. The costs of
such atypical services, even if they otherwise conform to the
four requirements of 42 C.F.R. § 413.30(f), are never
recoverable.
A rule that adds a new requirement to a set of existing
requirements is substantive, and requires notice and comment
before it can be enacted. See Ohio Dep’t of Human Svcs. v.
Dep’t of Health & Human Svcs., 862 F.2d 1228, 1235 (6th
Cir. 1988) (holding that the department’s adoption of a
“maintenance amount ceiling” for noninstitutionalized
spouses of institutionalized Medicaid recipients required
notice and comment because it added a requirement that was
not compelled by or implicit in the existing regulations); see
also Perales v. Sullivan, 948 F.2d 1348, 1354 (2d Cir. 1991)
(determining that a rule was substantive when it required state
Medicaid submissions to provide assurance that the state
possessed supporting documentation); Linoz v. Heckler, 800
F.2d 871, 877 (9th Cir. 1986) (concluding that a department
provision excluding payment for ambulance service from one
hospital to another solely to obtain the services of a specialty
physician was a substantive rule where “instead of simply
clarifying a pre-existing regulation, [it] carved out a per se
exception”). The case of Shalala v. Guernsey Memorial
Hosp., 514 U.S. 87 (1995), upon which the majority relies, is
consistent with the cases just cited. See id. at 100 (“We can
agree that APA rulemaking would still be required if PRM
§ 233 adopted a new position inconsistent with any of the
Secretary’s existing regulations).
Moreover, other courts have held that rules like the PRM
rule, which impose binding constraints on an agency’s
existing discretion, are generally considered substantive. See
Ohio Dep’t of Human Svcs., 862 F.2d at 1234 (concluding

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22 St. Francis Health Care v. Shalala No. 98-3965
II. ANALYSIS
A. The PRM rule is substantive
This court has set out the following broad guidelines for
determining the nature of an administrative rule: “An
interpretive rule simply states what the administrative agency
means, and only reminds affected parties of existing
duties. . . . On the other hand, if by its action the agency
intends to create new law, rights or duties, the rule is properly
considered to be a legislative rule.” Michigan v. Thomas, 805
F.2d 176, 182-83 (6th Cir. 1986) (citations and internal
quotation marks omitted). The exemption for interpretive
rules must be narrowly construed by the courts in view of the
important purposes served by the APA’s procedural
requirements. See, e.g., Caraballo v. Reich, 11 F.3d 186, 195
(D.C. Cir. 1993).
In defending its conclusion that the PRM rule is interpretive
rather than substantive, the majority emphasizes that the
controlling statute, 42 U.S.C. § 1395yy, leaves the exemption-
granting process to the Secretary’s discretion. Her
department’s prior regulation on the subject preserves that
discretion, subject to the four requirements listed above. See
42 C.F.R. § 413.30(f). The majority therefore maintains that
the PRM rule is simply a guide to the Secretary’s exercise of
discretion. It concludes that “the [PRM] rule does not effect
new substantive reimbursement standards inconsistent with
prior regulations—the central characteristic of a substantive
rule.” Op. at 18.
I respectfully disagree. At a minimum, the PRM rule adds
a fifth, unwaivable requirement to the four reimbursement
criteria set out in 42 C.F.R. § 413.30. At a maximum, the
PRM rule conflicts with the prior regulation. In either case,
it imposes new financial restrictions on the HB-SNFs that it
regulates, thus requiring notice and comment prior to its
enactment. See 5 U.S.C. § 553.
Before the PRM rule was promulgated, the Secretary was
free to reimburse HB-SNFs that provided atypical services for
No. 98-3965 St. Francis Health Care v. Shalala 7
C.F.R. § 413.30, which “set[s] forth the general rules under
which HCFA may establish limits on provider costs
recognized as reasonable in determining Medicare program
payments” and “also sets forth rules governing exemptions,
exceptions, and adjustments to limits established under this
section that HCFA may make as appropriate in consideration
of special needs or situations of particular providers.” Id. at
§ 413.30(a). The regulation provides as follows:
***
(a)(2) General principle. Reimbursable provider costs
may not exceed the costs estimated by HCFA to be
necessary for the efficient delivery of needed health
services. HCFA may establish estimated cost limits for
direct or indirect overall costs or for costs of specific
items or services or groups of items or services. These
limits will be imposed prospectively and may be
calculated on a per beneficiary, per admission, per
discharge, per diem, per visit, or other basis.
***
(f) Exceptions. Limits established under this section may
be adjusted upward for a provider under the
circumstances specified in paragraphs (f)(1) through
(f)(5) of this section. An adjustment is made only to the
extent the costs are reasonable, attributable to the
circumstances specified, separately identified by the
provider, and verified by the intermediary.
(1) Atypical services. The provider can show that the–
(i) Actual cost of items or services furnished by a
provider exceeds the applicable limit because such items
or services are atypical in nature and scope, compared
to the items or services generally furnished by providers
similarly classified; and
(ii) Atypical items or services are furnished because of
the special needs of the patients treated and are necessary
in the efficient delivery of needed health care.
42 C.F.R. § 413.30 (emphasis added).

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8 St. Francis Health Care v. Shalala No. 98-3965
5The PRM, or Provider Reimbursement Manual, is a set of non-
binding rules that the Secretary issues in order to provide guidance to
providers and intermediaries and clarify the Secretary’s reimbursement
policies and regulations.
6While the exceptions at issue pertain to fiscal years 1991 and 1992,
they are governed by PRM § 2534.5 because they were filed on August
22, 1994, and December 28, 1994.
7There are four different SNF peer groups: (1) Urban Hospital-based;
(2) Urban Freestanding; (3) Rural Hospital-based; and (4) Rural
Freestanding. See PRM § 2534.5(B). St. Francis’s peer group is Urban
Hospital-based.
3. PRM5 § 2534.5
a. The Provision
In July 1994, HCFA established a new methodology for
handling exception requests—the methodology which St.
Francis challenges in this case.6 The methodology is set forth
in Transmittal No. 378, PRM § 2534.5 (“Determination of
Reasonable Costs in Excess of Cost Limit or 112 percent of
Mean Cost”) and pertains to cost reporting periods after
July 1, 1984:
In determining reasonable cost, the provider’s per diem
costs in excess of the cost limit are subject to a test for
low occupancy and are compared to per diem costs of a
peer group7 of similarly classified providers.
***
. . . With cost reporting periods beginning prior to July 1,
1984, for each free-standing group and each hospital-
based group, each cost center’s ratio is applied to the
cost limit [i.e., the RCL] applicable to the cost reporting
period for which the exception is requested. For each
hospital-based group with cost reporting periods
beginning on or after July 1, 1984, the ratio is applied to
112% of the group’s mean per diem cost (not the cost
limit), adjusted by the wage index and cost reporting year
No. 98-3965 St. Francis Health Care v. Shalala 21
Facilities that provide atypical services, which tend to be
more expensive, may seek upward adjustments for
expenditures above their cost limits. Under the
reimbursement review process originally set up by 42 C.F.R.
§ 413.30(f), the Health Care Financing Administration
granted upward adjustments to HB-SNFs that demonstrated
that their costs were (1) reasonable, (2) attributable to atypical
services, (3) separately identified, and (4) independently
verified. See 42 C.F.R. § 413.30(f). In the years 1984-1990,
St. Francis received full compensation under this regulation
for its direct service costs that exceeded its cost limit, having
demonstrated that its extra expenses were reasonable and
legitimately due to the costs of providing atypical services.
For example, if St. Francis’s routine costs had averaged $100
per person per day during those years, and its atypical direct
service costs had totaled $30 per day, then the facility would
have recovered the $30 above its cost limit upon making the
showing called for in the regulation.
The PRM rule changed this system. Under the PRM rule,
St. Francis’s atypical service expenditures are recoverable
only to the extent that its total costs exceed Level 3. Using
the same illustrative numbers as before, if St. Francis’s
routine service costs are $100 and its atypical service costs are
$30, it would recover only $10 (($130 total costs)-($120
Level 3)) of the $30 it expended on atypical services. When
a provider’s total costs do not exceed Level 3, none of its
atypical service costs are recoverable. Thus, in 1991 and
1992, when St. Francis’s requests for an upward adjustment
were evaluated under the PRM rule, the facility could not
recover any of its expenditures above its cost limit (Level 2)
because its total costs did not exceed Level 3. This was true
even though the Secretary acknowledges that St. Francis’s
expenditures were legitimately spent for the provision of
atypical services.

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20 St. Francis Health Care v. Shalala No. 98-3965
______________
DISSENT
______________
RONALD LEE GILMAN, Circuit Judge, dissenting. A
fundamental requirement of the Administrative Procedure Act
(APA) is that interested persons be given notice of proposed
substantive regulations and an opportunity to comment. See
5 U.S.C. § 553. The majority concludes that the rule in
question, Provider Reimbursement Manual § 2534.5 (the
PRM rule), is exempt from the APA’s notice and comment
requirement because it is an “interpretive” rule. See id.
§ 553(b)(A). I believe that the PRM rule is substantive.
Because the rule was enacted without notice and an
opportunity for comment, it should therefore be declared
invalid.
I. BACKGROUND
As explained by the majority, the governing statute
establishes different cost limits for free-standing versus
hospital-based skilled nursing facilities. Free-standing skilled
nursing facilities (FS-SNFs) have a cost limit equal to 112%
of the mean per diem costs of all FS-SNFs, which the parties
refer to as Level 1. The cost limit for hospital-based skilled
nursing facilities (HB-SNFs) is computed through a two step
process: first, one determines 112% of the mean per diem
costs of all HB-SNFs, which the parties refer to as Level 3,
and that number is then compared with Level 1. The amount
midway between Levels 1 and 3 is the cost limit for HB-
SNFs, which the parties refer to as Level 2. Thus, in the
majority’s illustrative scenario, $80 is Level 1, the cost limit
for FS-SNFs, $120 is Level 3, equaling 112% of the average
per diem cost of HB-SNFs, and $100 is Level 2, the cost limit
for HB-SNFs. All of these numbers represent the average
daily cost, per person, of operating various skilled nursing
facilities.
No. 98-3965 St. Francis Health Care v. Shalala 9
adjustment factor applicable to the cost reporting period
for which the exception is requested.
The SNF’s actual per diem cost . . . is compared to the
appropriate component of the disaggregated cost limit or
112 percent of the hospital-based mean per diem cost. If
the SNF’s per diem cost exceeds the peer group per diem
cost for any cost center, the higher cost must be
explained. Excess per diem costs which are not
attributable to the circumstances upon which the
exception is requested and cannot be justified may result
in either a reduction in the amount of the exception or a
denial of the exception.
PRM § 2534.5 (emphasis added). In short, for HB-SNF costs
above the RCL, the methodology permits reimbursement for
only those costs in excess of 112% of the mean per diem cost
which are attributable to the HB-SNF’s atypical services. The
approach creates a “gap” between the HB-SNF RCL and the
112% level within which HB-SNFs cannot recover any of
their costs above the RCL. It is the propriety of this “gap,”
as well as the consequences it has on facilities like St. Francis
which happen to fall within it, which is at issue in this case.
b. Illustration of PRM § 2534.5
Because the operation of the PRM is somewhat complex,
the following illustration, provided by the district court, is
helpful:
Assume: FS-SNF statutory RCL = 112% of the FS-SNF mean = $80
Assume: 112% of the HB-SNF mean = $120
Then: HB-SNF statutory RCL = 112% of the FS-SNF mean +
50%(112% of the HB-SNF mean -
112% of the FS-SNF mean)
= $80 + .50($120 - $80) = $80 + $20
= $100
Based on the aforementioned statutory/regulatory language,
a HB-SNF with the per diem actual costs listed below and the

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10 St. Francis Health Care v. Shalala No. 98-3965
RCLs directly above would be entitled to the corresponding
maximum reimbursement rates:
Actual Costs Maximum Reimbursement
$150 $130
$140 $120
$130 $110
112% of HB-SNF mean ($120) $120 $100
$110 <---(the “gap”)--> $100
HB-SNF statutory RCL ($100) $100 $100
$90 $90
112% of FS-SNF mean ($80) $80 $80
(i.e., FS-SNF statutory RCL)
Note that SNFs with actual costs between $100 (the HB-SNF
RCL) and $120 (the 112% level), are only recompensed for
$100 (the RCL amount). This is the “gap” St. Francis decries.
Another way to conceptualize this formula is that there are
three possible categories of actual costs: the provider’s actual
costs can be (1) less than or equal to the statutory RCL; (2)
greater than or equal to the statutory RCL but less than 112%
of its peer group mean; or (3) greater than or equal to 112%
of its peer group mean. Pursuant to PRM § 2534.5, if the
provider’s actual costs are less than or equal to the statutory
RCL, the provider is reimbursed the full amount of its actual
costs (category 1); if the provider’s costs are greater than or
equal to the statutory RCL, but less than 112% of the HB-SNF
mean, the provider is only reimbursed in the amount of the
statutory RCL (category 2); if the provider’s costs are greater
than or equal to 112% of the HB-SNF mean, the provider is
reimbursed in the amount of the statutory RCL, plus any
additional amount attributable to atypical services up to the
total amount by which the actual costs exceed the 112% of the
mean (category 3). Accordingly, category (2) represents a
“gap” for which a provider will not be reimbursed above the
RCL amount despite having costs above the RCL. That
provider does not have the opportunity to show that its costs
were reasonable and for atypical services.
No. 98-3965 St. Francis Health Care v. Shalala 19
11We also find unpersuasive St. Francis’s argument regarding the
Secretary’s “inconsistent” interpretation of its regulations. As this Court
has stated, “[a]dministrative agencies are not bound by their own prior
construction of a statute . . . . We therefore review the Commission’s
construction of the statute without regard to the shift it represents from
[its] prior construction . . . .” Crounse Corp. v. ICC, 781 F.2d 1176, 1186
(6th Cir. 1986) (citing NLRB v. Local Union No. 103, International Ass’n
of Bridge, Structural & Ornamental Iron Workers, 434 U.S. 335, 351
(1978) (stating that when an administrative agency “chang[es] its mind[,]
the courts still sit in review of the administrative decision and should not
approach the statutory construction issue de novo and without regard to
the administrative understanding of the statutes”)).
anchored in its prior argument that PRM § 2534.5
“contradicts the plain language of the applicable regulation
that it purports to interpret,” St. Francis’s Br. at 35, a
contention with which we disagree. Similarly, the dissenting
opinion’s APA argument also emerges from its underlying
view that the PRM cannot be considered an interpretation of
42 C.F.R. § 413.30 because it “confuses” the key terms of that
regulation and is unrelated to the reasonableness of atypical
service costs. Again, based on our discussion supra and in
light of the deference owed to an agency interpreting its own
regulations, we simply disagree with this conclusion. Thus,
the Secretary was not required to comply with the APA’s
notice and comment procedures in issuing PRM § 2534.5.11
IV.
Because we do not find PRM § 2534.5 to be an arbitrary or
capricious interpretation of the statute and regulation at issue,
we AFFIRM.

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18 St. Francis Health Care v. Shalala No. 98-3965
omitted). Such rules “do not have the force and effect of law
and are not accorded that weight in the adjudicatory process,”
and do not effect a “substantive change” which is inconsistent
with existing regulations. Id. See also Friedrich v. Secretary
of HHS, 894 F.2d 829 (6th Cir. 1990) (holding that a national
coverage determination by the Secretary was an interpretive
rule). Lower court decisions looking at PRMs have been
consistent with Guernsey, concluding that they are
interpretive rules and do not require notice and comment
rulemaking. See, e.g., St. Mary’s Hosp. v. Blue Cross & Blue
Shield Ass’n/Blue Cross & Blue Shield, 788 F.2d 888, 891 (2d
Cir. 1986)(stating that PRM rules “have consistently been
held to be ‘interpretive rules,’ and thus exempt from the
notice and comment requirements”); Columbus Community
Hosp., Inc. v. Califano, 614 F.2d 181, 187 (8th Cir. 1980)
(stating that PRMs are agency interpretive rules) .
Even beyond the simple fact that PRMs are generally
categorized as interpretive, the work done by PRM § 2534.5
places it within the Guernsey Court’s definition of an
interpretive rule. The rule does not effect new substantive
reimbursement standards inconsistent with prior
regulations—the central characteristic of a substantive rule.
See Guernsey, 514 U.S. at 99; Warder v. Shalala, 149 F.3d
73, 80 (1st Cir. 1998). Rather, as explained above, the PRM
reasonably interprets a statute and regulation which placed the
determination of general terms such as the “reasonableness”
of costs and the “typicality” of services in the hands of the
Secretary. We agree with the Secretary that the PRM partially
performs this role by providing the means by which HB-
SNFs’ systemic unreasonable costs are accounted for in
determining exceptions. Thus, just as in Friedrich, the PRM
“creates no new law.” 894 F.2d at 837. “Rather, it interprets
the statutory language . . . as applied to a particular medical
service or method of treatment.” Id.; see also Warder, 149
F.3d at 80 (finding an administrative ruling to be interpretive
because “it addresse[d] an area of ambiguity” and did not
“stake out any ground the basic tenor of which [was] not
already outlined in the law itself”) (internal quotations and
citation omitted). St. Francis’s arguments to the contrary are
No. 98-3965 St. Francis Health Care v. Shalala 11
II.
This Court reviews an order granting summary judgment de
novo and uses the same legal standard as used by the district
court. See Terry Barr Sales Agency, Inc. v. All-Lock Co., 96
F.3d 174, 178 (6th Cir. 1996). Summary judgment is
appropriate “if the pleadings, depositions, answers to
interrogatories, and admissions of file, together with the
affidavits, if any, show that there is no genuine issue as to any
material fact and that the moving party is entitled to judgment
as a matter of law.” Fed. R. Civ. P. 56(c); accord Terry Barr,
96 F.3d at 178. Moreover, “the inferences to be drawn from
the underlying facts . . . must be viewed in the light most
favorable to the party opposing the motion.” Matsushita Elec.
Indus Co. v. Zenith Radio Corp., 475 U.S. 574, 587
(1986)(citation omitted). However, “[f]actual disputes that
are irrelevant or unnecessary will not be counted.” Anderson
v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986).
In reviewing the Secretary’s interpretation of regulations,
courts may overturn the Secretary’s decision only if it is
“arbitrary, capricious, an abuse of discretion or otherwise not
in accordance with the law.” Thomas Jefferson Univ. v.
Shalala, 512 U.S. 504, 512 (1994) (citation omitted); see also
Harris County Hosp. Dist. v. Shalala, 64 F.3d 220, 221 (5th
Cir. 1995). Further, courts are to “give substantial deference
to an agency’s interpretation of its own regulations.” Thomas
Jefferson Univ., 512 U.S. at 512; see Martin v. Occupational
Safety and Health Review Comm’n, 499 U.S. 144, 151 (1991)
(“Because applying an agency’s regulation to complex or
changing circumstances calls upon the agency’s unique
expertise and policymaking prerogatives, we presume that the
power authoritatively to interpret its own regulations is a
component of the agency’s delegated lawmaking powers.”);
Harris, 64 F.3d at 221 (“The Secretary’s interpretation of
Medicare regulations is given controlling weight unless it is
plainly erroneous or i nconsistent with the
regulation.”)(internal quotations omitted). In sum, if “it is a
reasonable regulatory interpretation . . . we must defer to it.”

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12 St. Francis Health Care v. Shalala No. 98-3965
Shalala v. Guernsey Memorial Hosp., 514 U.S. 87, 94-95
(1995).
III.
Because we agree that the Secretary’s interpretation is not
arbitrary or capricious, we affirm the district court’s holding.
A.
St. Francis offers several reasons that the Secretary’s legal
interpretation of C.F.R. § 413.30(f)--embodied in PRM
§ 2534.5--falls short of the requirement that agency
interpretations not be “arbitrary, capricious, an abuse of
discretion, or otherwise not in accordance with law.” 5
U.S.C. § 706(2)(A). Most importantly, St. Francis asserts that
PRM § 2534.5 contradicts plain statutory and regulatory
language. It contends that both 42 U.S.C. § 1395yy(a) and 42
C.F.R. § 413.30 “dictate” that a provider who demonstrates
that its costs in excess of its cost limit are 1) due to the
provision of atypical services and 2) reasonable, attributable,
identified and verified, is entitled to reimbursement in full
above the cost limit. St. Francis’s Br. at 24. Therefore, St.
Francis argues, PRM § 2534.5 contradicts the plain language
of the statute and regulation by imposing a blanket (and
“arbitrary”) limit requiring that costs be excepted only to the
extent that total costs exceed that limit.
St. Francis offers several other arguments to bolster its case.
First, St. Francis asserts that PRM § 2354.5 does not square
with the legislative intent behind the Medicare Act
provisions. It points to a Senate Finance Committee report
which it claims makes clear that facilities like St. Francis
should be able to recover all of their reasonable costs,
regardless of whether they are a FS-SNF or a HB-SNF. See
St. Francis’s Br. at 29. Second, St. Francis argues that PRM
§ 2534.5 is unreasonable on policy grounds because it treats
FS-SNFs and HB-SNFs disparately. The regime places FS-
SNFs that provide atypical services at a distinct advantage,
reimbursing them for all their costs. On the other hand, HB-
SNFs receive less than full reimbursement for providing the
No. 98-3965 St. Francis Health Care v. Shalala 17
unreasonable costs as determined by Congress, HB-SNFs and
FS-SNFs are treated relatively the same.
Third, St. Francis misunderstands how PRM § 2534.5
operates when it attacks it for being irrational on policy
grounds. Specifically, St. Francis believes that the regime is
irrational because it deems costs below the 112% level to be
unreasonable, but reasonable when they exceed that amount.
See St. Francis’s Br. at 34. But this is not an accurate
characterization of the PRM’s effect. As the district court
stated, the “discount” applies to the costs of all HB-SNFs
above the RCL; all have costs which are deemed to be
unreasonable, and all are “systematically undercompensate[d]
in exactly the same manner.” St. Francis, 10 F.Supp.2d at
894. The only difference rendered is that once excess costs
span beyond the 112% threshold, a portion of the excess costs
resulting from atypical services can be reimbursed. Yet the
discount factor reflecting the “unreasonable” costs of HB-
SNFs still impacts upon all HB-SNFs above the 112% level;
in other words, there is still an amount of their costs which,
deemed unreasonable by the PRM, those HB-SNFs cannot
recover. See supra n. 9.
3. St. Francis’s APA Argument
Finally, we can not agree with St. Francis’s argument that
PRM § 2534.5 is invalid because it was not adopted pursuant
to the notice and comment procedures set forth in the APA,
5 U.S.C. § 553(b). In Guernsey, the Court sustained another
of the Secretary’s PRMs concerning reimbursement. In doing
so, the Court stated that the PRM at issue was not subject to
the notice and comment requirement of the APA because it
was a “prototypical example of an interpretive rule.” 514
U.S. at 99. See 5 U.S.C. § 553(b)(A) (establishing that notice
and comment are not required for “interpretive rules, general
statements of policy, or rules of agency organization,
procedure or practice”). Specifically, the Court defined
interpretive rules as those “issued by an agency to advise the
public of the agency’s construction of the statutes and rules
which it administers.” Guernsey, 514 U.S. at 99. (citation

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16 St. Francis Health Care v. Shalala No. 98-3965
10We agree with the Secretary’s arguments regarding legislative
history. First, the history is sparse and generally inconclusive, and should
be given little weight when the text of the statute so clearly resolves this
dispute. Second, even the history to which St. Francis points does not
contradict the Secretary’s reading of the statutory language. The language
from the Senate report that St. Francis emphasizes is that “[f]acilities
eligible for exceptions could receive, where justified, up to all of their
reasonable costs.” Senate Comm. on Finance, 98th Cong., 2d Sess.,
Deficit Reduction Act of 1984: Explanation of Provisions Approved by
the Committee on March 21, 1984, Vol. 1 at 947 (Comm. Print 1984)
(emphasis added). PRM § 2534.5, through the discretion granted to the
Secretary by the plain text of the Medicare Act, is indeed consistent with
this directive because it provides a general formula for determining the
extent to which an HB-SNF’s costs are “reasonable.”
established by Congress in 42 U.S.C. § 1395yy and elaborated
upon by 42 C.F.R. § 413.30.10
2. Policy Arguments
We also agree with the district court that St. Francis’s
policy arguments against PRM § 2534.5 are unavailing. First,
given the clear Congressional conclusion that HB-SNFs suffer
from general cost inefficiencies, the Secretary, through the
intermediary, should not be required to review each
provider’s submitted reimbursement request to determine if
its costs were reasonable. Particularly in light of SNFs’ vastly
different services and patient populations, such a requirement
would impose a high burden and cost on the Secretary — a
burden not required by the statute or the regulation. It was
neither arbitrary nor capricious for the Secretary instead to
introduce a discount factor to account for the systemic cost
inefficiencies identified by Congress, while still allowing HB-
SNFs to obtain reimbursement when they demonstrate that
costs above the 112% threshold are due to atypical services.
Second, St. Francis errs when it argues that PRM § 2534.5
unfairly disadvantages HB-SNFs relative to FS-SNFs for “no
legitimate reason.” St. Francis’s Br. at 32. This assertion
simply ignores Congress’s conclusion that FS-SNFs are more
efficient than HB-SNFs, and thus should be reimbursed more
favorably. Stated differently, once discounted for their
No. 98-3965 St. Francis Health Care v. Shalala 13
same services at the same cost; the regime thus penalizes
them and provides a disincentive to provide such services. St.
Francis argues that this result “turns the tables” on the true
policy intent; indeed, it maintains that Congress originally
intended that HB-SNFs should “receive more than
freestanding facilities because it recognized that [HB-SNFs]
incur more costs in providing the same services” than the FS-
SNFs. St. Francis’s Br. at 32. Third, St. Francis argues that
because HCFA previously interpreted the applicable
regulations differently, the new interpretation is not entitled
to deference. Finally, St. Francis asserts that PRM § 2534.5
is procedurally invalid because it is a substantive rule, yet it
was not passed pursuant to the notice and comment
requirements of the Administrative Procedure Act, 5 U.S.C.
§ 553 (“APA”).
B.
We agree with the district court that St. Francis has not
shown that PRM § 2534.5 is an arbitrary or capricious
interpretation of either 42 U.S.C. § 1395yy or 42 C.F.R.
§ 413.30.
1. Statutory and Regulatory Text
St. Francis’s first argument is that PRM § 2534.5 “is
inconsistent with the plain language of the governing statute
and regulation.” St. Francis’s Br. at 23. We disagree with
this contention because the statute explicitly granted the
Secretary broad discretion and because she exercised this
discretion consistent with the clear policy choices Congress
made in the statute.
Neither Congress in 42 U.S.C. § 1395yy nor the Secretary
in 42 C.F.R. § 413.30 mandated that a HB-SNF be
reimbursed any amount above the statutory RCL set forth in
§ 1395yy. St. Francis therefore overstates its case when it
claims the language of these provisions “dictates that a
provider who demonstrates that its costs in excess of its cost
limit are 1) due to the provision of atypical services and 2)
reasonable, attributable, identified and verified, is entitled to

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14 St. Francis Health Care v. Shalala No. 98-3965
8This is consistent with other parts of the Medicare Act, which also
“authorize[] the Secretary to promulgate regulations ‘establishing the
method or methods to be used’ for determining reasonable costs.”
Guernsey, 514 U.S. at 91 (quoting 42 U.S.C. § 1395x(v)(1)(A)).
reimbursement in full above the cost limit.” St. Francis’s Br.
at 24 (emphasis added). Instead, both provisions are phrased
in the permissive, merely stating that the Secretary “may”
adjust cost limits upward. 42 U.S.C. § 1395yy(c); 42 C.F.R.
§ 413.30(f). Moreover, neither provision provides guidance
as to the level of adjustment the Secretary must make.
Specifically, 42 C.F.R. § 413.30 provides that although limits
“may” be adjusted when “atypical,” they should only be
adjusted upward “to the extent the costs are reasonable.” 42
C.F.R. § 413.30(f). As the Secretary argued, this explicitly
placed the determination of “typicality” of services versus
“reasonableness” of costs within her discretion.8
Having noted what the statute does not do, it is important
to note what it does do. As discussed supra, Congress
responded to studies demonstrating that about half of the
greater cost of HB-SNFs was due to inefficiency by
establishing a two-tier system which prevents HB-SNFs from
being reimbursed for those inefficient costs. Hence, for HB-
SNFs, Congress set the new statutory cost limit at fifty
percent of the difference between 112% of the mean per diem
costs for HB-SNFs and FS-SNFs. Of course, just as Congress
did not address how the Secretary should generally grant
upward adjustments in reimbursements, it also did not specify
how the Secretary should do so in light of this new regime
accounting for HB-SNFs’ inefficiency. Yet again, she was
granted discretion to make this determination.
Given these aspects of the statute, we agree with the district
court that the Secretary’s interpretation of the regulation and
statute in the PRM is reasonable, not arbitrary. First, we
agree with the Secretary that the best way to characterize the
effect of the PRM is that it applies a “discount factor” to all
HB-SNFs to account for the “unreasonable costs” above those
of FS-SNFs. As the district court recognized, discounting for
No. 98-3965 St. Francis Health Care v. Shalala 15
9Once again, if we take $80 as 112% of the FS-SNF mean, and $120
as 112% of the HB-SNF mean, the results of the application of PRM
§ 2534.5 are as follows:
Actual Costs Amount Reimbursed
$150 $130
$140 $120
$130 $110
112% of HB-SNF mean ($120) $120 $100
$110 <---(the “gap”)--> $100
HB-SNF statutory RCL ($100) $100 $100
$90 $90
112% of FS-SNF mean ($80) $80 $80
(i.e., FS-SNF statutory RCL)
Once at or above the 112% level, the difference between an HB-SNF’s
actual costs and the amount it is reimbursed is $20, which is half of the
difference between 112% of the HB-SNF mean and 112% of the FS-SNF
mean (which is $40). Thus, in determining upward adjustments as
Congress bid her to, the Secretary is using the very ratio—and the very
assumptions regarding the inefficiencies of HB-SNFs—that the statute
prescribed for establishing the RCL for HB-SNFs.
these unreasonable costs comports with the general
recognition by Congress that “certain systemic inefficiencies
. . . associated with unreasonable costs [] are associated with
HB-SNFs.” St. Francis, 10 F.Supp.2d at 892. In fact, the
PRM calculation reduces the reimbursement to HB-SNFs by
the very same proportion that Congress deemed to be
inefficient — half of the difference in costs between FS-SNFs
and HB-SNFs.9 Likewise, the guideline comports with 42
C.F.R. § 413.30, which allows the Secretary to determine the
extent to which costs for atypical services are “reasonable.”
42 C.F.R. § 413.30(f).
In sum, PRM § 2534.5 does not create the “two-tier”
system in contravention of the statute and regulation. To the
contrary, the Secretary merely acted within the discretion she
was granted by putting into place the very cost ratio

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