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Click here for the full text of this decision FACTS:Fourteen Texas hospitals sued the Texas Health and Human Services Commission (HHSC), asking that HHSC’s cutoff date for submitting paid claims data to determine reimbursement rates for inpatient Medicaid services be declared invalid. The hospitals claim the cutoff date is improper either because it is an invalid rule under the Administrative Procedures Act (APA) or because it conflicts with relevant provisions of the Texas Human Resources Code and HHSC’s administrative rules. Additionally, the hospitals assert that HHSC failed to follow its administrative appeals rules in reviewing the hospitals’ claims. A general understanding of the Medicaid program and the process HHSC uses to reimburse for Medicaid services is necessary before addressing their complaints. Medicaid is a health insurance program, jointly operated and funded by the federal and state governments, for the medical care of low-income and other eligible persons. While federal law establishes Medicaid’s basic parameters, each state decides eligible groups, types and range of services, payment levels for services and administrative services. Specifically, each state prepares a written plan describing the nature and scope of its Medicaid program. Once the plan is approved by the secretary of health and human services, the state is responsible for operating the program to conform with the federal guidelines. In Texas, HHSC is the agency charged with this responsibility. Under the approved plan, HHSC is responsible for reimbursing hospitals that provide services to Medicaid patients. The reimbursement methodology in Texas is a prospective payment system. Under this system, HHSC sets the rates paid to hospitals for each service in advance, which allows hospitals to know the rate at which they will be reimbursed for specific services. The prospective payment system encourages hospitals to control costs for inpatient Medicaid services so they can earn a profit under the predetermined rates. To implement this system, HHSC adopted specific rules to determine the prospective payment rates. Although the rate-calculation rules are detailed and complex, they generally involve three components: 1. the data that forms the basis for the rate calculation; 2. the formula that converts the data into reimbursement rates; and 3. the process HHSC uses to collect the data and calculate rates. The first component, the data used for the rate calculation, is comprised of both cost and claims data. Cost data are derived from the hospitals’ cost reports that allocate a portion of their total costs to the Medicaid program based on how many days Medicaid patients stay in the hospital, charges associated with such patients and other factors. Claims data are derived from hospital claims requesting payment for services rendered to Medicaid patients under existing reimbursement rates. The second component, the rate-calculation formula, converts the cost and claims data into reimbursement rates that approximate a hospital’s cost for treating a Medicaid patient. The formula achieves this goal by taking a group of hospitals with similar Medicaid cost experiences, deriving those hospitals’ approximate costs to treat an average Medicaid case, then adjusting that cost to reflect the relative expense of a particular service. The result is the new rate to be paid to that hospital group for that service. Specifically, the rate for a service is determined by multiplying the relative weight of the patient’s diagnosis-related group by the standard dollar amount for the hospital’s payment division. Although several steps are involved in calculating the diagnosis-related groups and standard dollar amounts, the foundation for the calculations is the “base year.” The third component for determining prospective rates for Medicaid services is HHSC’s process for collecting the data. This process requires that the prospective reimbursement rates be recalculated at least every three years to account for inflation and medical advances that effect the cost of medical services. HHSC’s current policy is to recalculate the rates on a three-year cycle. The first year is the base year, and only claims data from Medicaid patients admitted in this base year may be included in the rate calculation. The next year HHSC collects the data and converts it into prospective reimbursement rates. These rates then go into effect in the third year and remain effective for three years during which this process is repeated. During the third year, HHSC makes changes only if a hospital successfully appeals a mathematical or data entry error. For example, the base year at issue in this dispute was the state fiscal year from Sept. 1, 1999, to Aug. 31, 2000. The process for collecting data and generating rates occurred between Sept. 1, 2000, and Aug. 31, 2001. These rates were in effect from Sept. 1, 2001, through Aug. 31, 2004. The hospitals’ appeal focused on HHSC’s interpretation of what constitutes a “base year.” HHSC’s rules define the “base year” as “[a] 12-consecutive-month period of claims data selected by the [department] or its designee.” HHSC requires that the “12-consecutive-month period” run concurrently with the State’s fiscal year from Sept. 1 to Aug. 31. HHSC gathers all claims data for Medicaid patients admitted during that fiscal year but uses only the claims that Medicaid actually pays to assure that the data is from Medicaid-eligible claimants. Most important to this appeal, HHSC imposes a “cutoff” date, selecting claims data only from base-year claims that are paid within the fiscal year plus a six-month grace period (the Feb. 28 cutoff). Put simply, when determining what claims go into the rate calculation, HHSC considers only the claims of Medicaid patients admitted during the base year that are actually paid within six months of the base-year’s end. Claims for all patients admitted during the base year, but not paid by Feb. 28, are not included in determining the prospective reimbursement rates. Between Feb. 28 and Aug. 31, HHSC recalculates the standard dollar amount and diagnosis-related group relative weights, informs hospitals of the proposed new rates, hears appeals and finalizes the new rates before they go into effect on Sept. 1 of that year. The problem with this process, according to the hospitals, is that HHSC does not use 12 consecutive months of claims data in computing rates as its rules require. Instead, the hospitals argue that HHSC’s six-month cutoff arbitrarily excludes relevant Medicaid claims simply because they are not paid quickly enough. The hospitals submit that under HHSC’s interpretation of the rule, only 95-97 percent of base-year claims are used to calculate the rates, while the rules actually require a “true cost average.” Dissatisfied with this process, the hospitals sought administrative review of the reimbursement rates from fiscal year 2000, asking HHSC to include claims data excluded by the Feb. 28 cutoff. HHSC denied the hospitals’ request and refused to refer the case to the State Office of Administrative Hearings for a formal hearing. The hospitals then sued HHSC for declaratory and injunctive relief to enjoin it from applying the Feb. 28 cutoff. The APA authorizes declaratory relief when determining the validity or applicability of a rule, if the plaintiff alleges “that the rule or its threatened application interferes with or impairs, or threatens to interfere with or impair, a legal right or privilege of the plaintiff.” The trial court granted the hospitals’ request for a temporary injunction, but at a subsequent trial on the merits a visiting judge ruled against the hospitals on all claims. The 3rd Court of Appeals affirmed. Another appeal followed. HOLDING:Affirmed in part, reversed and remanded in part. The hospitals presented two arguments on appeal. First, they asked that the Texas Supreme Court declare the Feb. 28 cutoff invalid either because it constituted an improperly promulgated rule or because it conflicted with the applicable provisions of the Texas Human Resources Code and the Texas Administrative Code. Second, the hospitals argued that HHSC failed to refer their administrative appeal relating to the rate issue for formal hearing, as required by HHSC’s rules and the Texas Human Resources Code. First, the court stated that the Feb. 28 cutoff is a statement of general applicability that implements law or describes procedure. The term “general applicability” under the APA references “statements that affect the interest of the public at large such that they cannot be given the effect of law without public input.” The cutoff, the court stated, further implements policy and describes HHSC’s data collection procedure. The cutoff also affects the hospitals’ private rights, because it is a key formula component that determines prospective reimbursement rates. Texas Human Resources Code �32.028(d), the enabling statute, requires that HHSC adopt “reasonable rules and standards governing the determination of rates paid for inpatient hospital services on a prospective payment basis,” the court stated. Specifically, the court stated that HHSC must “assure that the payment rates are reasonable and adequate to meet the costs incurred by the hospital in rendering services to Medicaid recipients.” The Feb. 28 cutoff is a significant component for calculating prospective reimbursement rates, and the hospitals complain that its effect is to skew those rates to their disadvantage. Whether this is true, the court stated, it is a matter that the agency should explore as a part of its rule-making process. A presumption favors adopting rules of general applicability through the formal rule-making procedures the APA sets out. These procedures include providing notice, publication and public comment on the proposed rule. The process assures notice to the public and affected persons and an opportunity to be heard on matters that affect them. When an agency promulgates a rule without complying with the proper rule-making procedures, the rule is invalid, the court stated. Although the court did not decide whether the Feb. 28 cutoff was appropriate to the determination of whether hospitals receive reasonable and adequate reimbursement for inpatient Medicaid services it held that HHSC should have incorporated the cutoff into the language of the “base year rule.” Because the Feb. 28 cutoff is a rule, and that HHSC did not follow the proper rule-making procedures, the court declared the rule invalid. Finding no good reason to invalidate the rule immediately, the court remanded the rule to the agency for further action. In addition, the court noted that the 3rd Court concluded that “[b]ecause the mathematical or data entry errors alluded to by the Hospitals did not pertain to individual claims but, rather, to how the claims selection process in the aggregate could lead to mathematical or data entry errors, [the 3rd Court held] that [HHSC] was not required to act on the Hospitals’ requests for formal reviews and . . . could properly deny requests for review that challenge the prospective payment methodology.” Thus, because the hospitals’ additional argument essentially sought a formal review of HHSC’s methodology, the court affirmed that part of the 3rd Court’s judgment. OPINION:Medina, J., delivered the opinion of the court.

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