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August 27, 1993


The opinion of the court was delivered by: Mihm, Chief Judge.


Pending before the Court is Plaintiffs Motion for Summary Judgment and Defendants' Cross-Motion for Summary Judgment. For the reasons set forth below, Plaintiffs Motion for Summary Judgment is granted and Defendants' Motion for Summary Judgment is denied.


Plaintiff, Graham Hospital Association ("Graham"), participates as a fully qualified provider of hospital services and skilled nursing services under the Federal Health Insurance Program for the Aged and Disabled, ("Medicare Program"). See 42 U.S.C. § 1395 et seq. The Medicare Program provides certain hospital insurance benefits to enrolled beneficiaries and establishes a reimbursement system through which providers of hospital services ("providers"), including Graham, are reimbursed for the reasonable and necessary costs which they incur in. furnishing these services to Medicare beneficiaries pursuant to 42 U.S.C. § 1395x(v)(1)(A).

Hospital providers such as Graham record the allowable costs and expenses incurred for services furnished to Medicare beneficiaries for each fiscal year and submit reports to their respective Medicare Fiscal Intermediary ("Intermediary") pursuant to 42 U.S.C. § 1395h. The Intermediary, in this case Blue Cross and Blue Shield Association/Blue Cross and Blue Shield of Illinois, must determine the proper amount of allowable costs to be reimbursed under the Medicare Program to the provider. A provider may appeal the Intermediary's determination of allowable costs to the Provider Reimbursement Review Board ("PRRB") established under 42 U.S.C. § 1395oo(h).

At the end of calendar year 1986, Graham's long term debt consisted of: (1) First Mortgage Revenue Bonds, Series 1975 ("Series 1975 Bonds"): principal balance of $2,900,000 with interest rates between 6.7% and 8.625% per annum, and (2) Series 1981 Revenue Bonds ("Series 1981 Bonds"): principal balance of $6,525,000 with an interest rate of 14.25% per annum. Both series matured no earlier than 1995. When interest rates declined during the mid-1980's, Graham began to look for a way to relieve its burden of the relatively high rate of interest required by the Series 1981 Bonds. In January 1987, through the Illinois Health Facilities Authority, Graham issued bonds in the amount of $10,595,000 dated January 15, 1987 ("Series 1987 Bonds"). The purpose of the issue was to refund the Series 1975 Bonds on April 1, 1987 and advance refund the Series 1981 Bonds as of July 1, 1991, the call date of that issue. The mechanism Graham used to eliminate the Series 1987 Bonds necessarily included the establishment of an irrevocable trust. The proceeds of the Series 1987 Bonds together with other available funds were used (1) to enable the trustee to purchase direct obligations of the United States sufficient to pay the principal off, the redemption premium, and interest on the Series 1981 and 1975 Bonds until and at their respective redemption dates, (2) provide funds for a debt service reserve fund, and (3) pay costs related to issuance of the Series 1981 Bonds, refunding the Series 1975 Bonds and advance refunding the Series 1981 Bonds. The 1981 and 1975 bond issues were extinguished and removed from Graham's books and the Series 1987 Bonds were added.

In connection with refinancing, Graham applied Generally Accepted Accounting Principles ("GAAP") and calculated a loss which was reflected as an extraordinary item in 1987, the year of refinancing. The total amount of this "loss" as a result of the advance refunding was $2,576,781. of that amount, $2,364,769 related to the 1981 Bonds. Graham claimed the loss on defeasance in its 1987 cost report to the Intermediary. The portion of the loss attributed to the 1975 Bonds, $212,012, was allowed by the Intermediary and is not at issue. The recorded loss on the advance refunding for the 1981 Bonds, $2,364,769.33, was comprised of the call premium (2% of $6,525,000, $130,500), unamortized bond expense at $351,778.28, interest expense through the call date (July 1, 1991) $4,096,340.60, less the estimated interest income from the escrow fund investments over the period prior to the call date, $2,213,849.55. The Medicare share of the loss was calculated at $1,250,000. These costs were calculated pursuant to 42 U.S.C. § 1395x(v)(1)(A) which requires the Secretary to promulgate regulations that interpret "reasonable costs" pursuant to "principles generally applied by national organizations." See also 42 C.F.R. § 413.24 (a), which requires that cost data provided by hospitals "must be based on an approved method of cost finding and on the accrual basis of accounting, " and 42 C.F.R. § 413.20 (a), which requires that "[s]tandardized definitions, accounting, statistics, and reporting practices that are widely accepted in hospital and related fields were followed." Because no statute or regulation directly addresses the treatment of a loss incurred on an advanced refunding, Graham relied on GAAP pursuant to ¶ 8 of Accounting Principles Board ("APB") Opinion No. 26*fn1 which states:

  Recognition Currently in Income. Some accountants
  believe a difference on refunding is similar to the
  difference on the other early extinguishments and
  should be recognized currently in income in the period
  of the extinguishment. This view holds that the value
  of the old debt has changed over time and that paying
  the call rice or current market price is the most
  favorable way to extinguish the debt. The change in
  the market value of the debt is caused by a change in
  the market rate of interest, but the change has not
  been reflected in the accounts. Therefore, the entire
  difference is recorded when the specific contract is
  terminated because it relates to the past periods when
  the contract was in effect.... When such debt
  originally issued at par is refunded, few accountants
  maintain that some portion of past interest should be
  capitalized and written off over the remaining life of
  the old debt or over the life of the new debt.

APB Opinion 26 at AR. 253. This paragraph, among others, provided the primary basis for the Board's conclusion that:

  A difference between the reacquisition price and the
  net carrying amount of the extinguished debt should be
  recognized currently in income of the period of
  extinguishment as losses or gains and identified as a
  separate item.... Gains and losses should not be
  amortized to future periods.

APB Opinion at AR. 256.


In response to Graham's fiscal report for 1987, the Intermediary allowed $229,000 of the loss in fiscal year 1987 and applied § 233 of Part 1 of the Provider Reimbursement Manual (HSFA Pub. 15-A) to the remainder transaction. Section 233 required amortization of the remainder of the defeasance loss over the remaining life of the 1981 Bonds. Plaintiff appealed the Intermediary's determination to the PRRB pursuant to 42 U.S.C. § 1395oo(a)(3).

On October 16, 1991, the Deputy Administrator of the Health Care Financing Administration gave notice of his intention to review the PRRB's September 30, 1991 decision. The Secretary's final determination, rendered November 27, 1991, reversed the decision of the PRRB. The Secretary noted that under 42 U.S.C. § 1395f(b), providers of health care services to Medicare beneficiaries are entitled to be reimbursed for the "reasonable cost" of the capital-related component of providing such services. The Secretary acknowledged that the loss claimed by Graham in this case is a capital-related cost which is still reimbursed on a cost basis. "Reasonable cost" is defined in the Social Security Act as:

  The reasonable cost of any services shall be the cost
  actually incurred, ... and shall be determined in
  accordance with regulations establishing the method or
  methods to be used, and the items to be included, in
  determining such costs.... In prescribing the
  regulations referred to in the preceding sentence, the
  Secretary shall consider, among other things, the
  principles generally applied by national organizations
  or established prepayment organizations. .. in
  computing the amount of payment, to be made by persons
  other than the recipients of services, to providers of
  services on account of services furnished to such
  recipients by such providers. Such regulations may
  provide for determination of the costs of services on
  a per diem, per unit, per capita, or other basis, may
  provide for using different methods in different
  circumstances, may provide for the use of estimates of
  costs of particular items or services, may provide for
  the establishment of limits on the direct or indirect
  overall incurred costs or incurred costs of specific
  items or services or groups of items or services to be
  recognized as reasonable based on estimates of the
  costs necessary in the efficient delivery of needed
  health services to individuals covered.... Such
  regulations shall (i) take into account both direct
  and indirect costs of providers of services .. . in
  order that, under the methods of determining costs,
  the necessary costs of efficiently delivering covered
  services to individuals covered by the insurance
  programs established by this subchapter will not be
  borne by individuals not so covered, and the costs
  with respect to individuals not so covered will not be
  borne by such insurance programs, and (ii) provide for
  the making of suitable retroactive corrective
  adjustments where, for a provider of services for any
  fiscal period, the aggregate reimbursement produced by
  the methods of determining costs provides to be either
  inadequate or excessive. (Emphasis added).

42 U.S.C. § 1395x(v)(1)(A). In addition to the regulations, the Secretary noted that the Provider Reimbursement Manual ("PRM"), an extensive set of interpretative guidelines, provides more specific detail and clarification of the law and regulations for the determination of "reasonable costs." In the event that there is no law or regulation specifically addressing the Medicare reimbursement policy regarding a particular issue, the Secretary stated that the PRM provides guidance and the proper interpretation and application of program policy.*fn2

With regard to the issue in this case, the Administrator acknowledged that there is no law or regulation which specifically addresses the treatment of a bond refunding transaction for the purpose of computing medicare reimbursement. However, she found that the specific policy outlined in § 233 of the PRM, which was published in May 1983, was effective for all cost reporting periods beginning on or after July 1, 1983. She reasoned that because the refinancing transaction at issue occurred in the fiscal year ending June 30, 1987, § 233 applies. This section, an interpretation of 42 C.F.R. § 413.9, requires the gain or loss on a refunding transaction to be spread over a number of years. Furthermore, the Administrator noted that this policy more accurately reflects the economic reality of a refunding bond issue with respect to the cost of furnishing services to Medicare beneficiaries over time. See Humana, Inc. v. Heckler, 758 F.2d 696, 705 n. 68 (D.C.Cir. 1985). See also Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 99 S.Ct. 773, 58 L.Ed.2d 785 (1979) (the needs of a government program are not always consistent with GAAP).

Finally, the Administrator found that the statutory prohibition against cross-subsidization requires that costs recognized in one year but attributable to health services rendered over a number of years be amortized and reimbursed during those years when Medicare beneficiaries used those services. See Research Medical Center v. Schweiker, 684 F.2d 599, 603 (8th Cir. 1982) (court required capitalization of construction interest over time); Gosman v. United States, 573 F.2d 31, 215 Ct.Cl. 617 (1978) (a Court of Claims declined to use GAAP in favor ...

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