Missouri Department of Social Services, DAB No. 922 (1987)

DEPARTMENTAL GRANT APPEALS BOARD

SUBJECT: Missouri Department  of Social Services

Docket No. 87-16
Audit Control No. 07-60224
Decision No. 922

DATE:  December 3, 1987 

DECISION

The Missouri Department of Social Services (State, DSS) appealed a
determination by the Health Care Financing Administration (Agency)
disallowing $1,147,212 in federal financial participation (FFP) claimed
by the State under Title XIX (Medicaid) of the Social Security Act.  The
State sought FFP in payments it made to the Department of Mental Health
(DMH) during the period July 1, 1980 through June 30, 1983, for services
provided by five intermediate care facilities for the mentally retarded
(ICFs/MR) operated by the DMH. 1/  The dispute here concerns the way in
which Missouri allocated certain indirect (or overhead) costs among
various program objectives, including the five ICFs/MR involved here.
The State used inpatient days as the basis for its allocation (i.e., it
distributed the indirect costs in proportion to the number of inpatient
days incurred for each of the facilities or other program objectives).
In the Agency's view, this was inequitable because the State's program
objectives included some which involved few or no inpatients, so that
excessive indirect costs were allocated to the five Medicaid- funded
ICFs/MR.  The Agency determined that it would be more equitable to
allocate the indirect costs on the basis of direct labor costs of each
of the benefitting program objectives.  The indirect costs allocated to
each facility were reflected in the per diem rate for ICF/MR services.
The Agency reduced the per diem reimbursement rate paid to DMH by the
difference between the two approaches.

For the reasons set forth below, we conclude that the disallowance
should be upheld in full.

Background

This is the second time that these costs, which were central services
costs incurred for budgeting, personnel administration, and payroll
services performed by State administrative branches as well as similar
costs incurred by DMH administrative offices, have been the subject of
an appeal before the Board.  See Missouri Department of Social Services,
DGAB No. 630 (1985). These costs were reflected in the rate claimed for
reimbursement by the State as an expenditure under the Medicaid program
for services provided in State-owned ICFs/MR.  Section 1902(a)(13)(E) of
the Act provided for reimbursement of providers on a reasonable
cost-related basis.  The implementing regulations were codified at 42
C.F.R. 447.272-311 (1979).  The regulations established requirements for
provider cost reports and audits. 42 C.F.R. 447.274 and 447.291-296.
The regulations required that the State plan "set forth the methods and
standards" used to set reimbursement rates.  42 C.F.R. 447.301.  The
audit standards required verification by the State agency that a
provider had "accurately attributed allowable costs to costs of
services" and "[t]hat the provider's allowable costs are reasonable."

As of September 30, 1981, section 1902(a)(13)(A) of the Act required
that the State provide in its State plan for payment rates for long-term
care facility services (including services provided at ICFs/MR) that the
State finds, and makes assurances satisfactory to the Secretary, are
reasonable and adequate to meet the costs that must be incurred by
efficiently and economically operated facilities.  The regulations
implementing the changed statutory provision were at 42 C.F.R.
447.251-265 (1981).  The State still had to specify in its plan the
methods and standards used to set payment rates, 42 C.F.R. 253(b)
(1981). The regulations were simplified considerably during the latter
part of the disallowance period to rely on the State's assurances and
the requirements for provider cost reports and periodic state audits.
The Agency reviewed the State's rate-setting methodology pursuant to its
overall responsibility to assure that the State claimed FFP in rates
calculated according to the State plan.

In the prior proceeding, the Agency disallowed FFP in the portion of the
reimbursement rate that reflected all of the indirect costs allocated to
the ICFs/MR for DMH and state-wide administrative costs, on the ground
that the State had not submitted for approval by the Department of
Health and Human Services' Division of Cost Allocation (DCA) the cost
allocation plan (CAP) allocating central services costs to the
institutions. In Missouri, the Board held that DCA approval of this CAP
was not required by Office of Management and Budget Circular A-87 (OMB
A- 87); however, it remanded the matter to the Agency to assess whether
the State's allocation method resulted in a fair distribution of these
indirect costs to the ICF/MR facilities.

After the remand, the Agency asked the Office of Inspector General (OIG)
to review the State's allocation method.  For the period July 1, 1980
through September 30, 1981, the State allocated these administrative
costs to all DMH programs, including the five ICFs/MR involved in this
proceeding, in a two- step process.  First, a state-wide CAP (approved
by DCA) was used to allocate to DMH its share of state-wide
administrative costs. Second, these costs were combined with DMH central
services costs and allocated to all DMH programs under a CAP that was
approved by the State's Medicare intermediary for Medicare use and by
the DSS for Medicaid use.  This CAP used inpatient days as the basis for
allocation for each provider.  For the period July 1, 1980 through
September 30, 1981 the State used a retrospective reimbursement system.
For the rest of the disallowance period, FY 1981 (July 1, 1980 through
June 30, 1981) costs were used, adjusted by an inflation factor, to
compute a prospective reimbursement rate for providers.

The OIG concluded in its report that the State's method of allocating
indirect costs to these state-owned and operated ICFs/MR by inpatient
days was inequitable, and it recalculated the allocation of indirect
costs using direct salaries and wages, excluding fringe benefits.  (The
salaries and wages methodology was the method for distributing these
costs that had been agreed upon by the Agency and State for subsequent
fiscal years.)  2/ The Agency adopted the OIG's findings and issued the
instant disallowance.

The Agency maintained that the State's use of inpatient days does not
equitably distribute the indirect costs to all benefitting areas because
DMH operated a wide variety of programs, some of which could not be
measured by inpatient days and some of which were primarily
outpatient-oriented.  The Agency disagreed with the State that the
Medicare intermediary's and the DSS's approval of this cost allocation
method either was equivalent to federal approval for Medicaid
reimbursement or obviated the inequity. The Agency also pointed out that
an April 4, 1985 internal State audit report (State Audit Report 85-022)
covering DMH's regional diagnostic centers specifically found that the
use of inpatient days was inequitable.  State's Ex. K.

The State argued that the Medicare intermediary and the DSS approved the
use of inpatient days as the allocation methodology. Under these
circumstances, the State maintained that approval by the Medicare
intermediary and the DSS constituted approval by the Agency of the
allocation methodology and that the Agency was not allowed and should
not be permitted to go behind the Medicare intermediary's finding to
impose an alternative methodology that was agreed to for later years.
The State also asserted that the Agency's reliance on State Audit Report
85-022 as supporting the OIG's report was unfounded and based on
hearsay.  In addition, in its reply brief the State argued that the
ratio of indirect costs allocated to these five facilities to the direct
labor costs of those facilities ranged from 6.8 to 7.2 percent during
the disallowance period and that this amount was well below the
"standard" 10 percent permitted in OMB A-87, Att. A, section G.2.a.
Finally, the State argued in a supplemental brief that it removed from
the indirect cost pool all costs not related to inpatient days.

Analysis

The core issue in this case is whether the State's CAP equitably
allocated costs.  The Agency argued that it did not and it supported its
position by giving several examples where DMH-run facilities or programs
that benefitted from these administrative services were either not
allocated any indirect costs whatsoever or were allocated too few costs
because they were outpatient- oriented.  Rather than meeting the issue
of fairness head on, the State attacked pieces of the Agency's analysis,
and it claimed that approval by the Medicare intermediary and the DSS
was tantamount to approval by the Agency for Medicaid.  As discussed in
section I. below, we agree with the Agency that the use of inpatient
days resulted in an inequitable allocation of indirect costs.  We also
conclude that approval of the State's method of allocation by the
Medicare intermediary and the DSS does not render it per se equitable or
preclude the Agency's review of the allocation of indirect costs as
reflected in the Medicaid rates. 3/  Although the State complained about
the agency's choice of methodology, it never alleged or established that
this methodology produced an inequitable allocation of costs; in fact,
the State has agreed to use this method for subsequent years.
Consequently, for these reasons, which we amplify below, the
disallowance is upheld.

I.  The State's method of allocating these costs is inequitable.

The Agency provided several examples of how the State's allocation
methodology did not fairly allocate to benefitting activities costs of
administrative services provided to them. The State, despite ample
opportunity to do so, 4/ did not attempt to refute the basic proposition
that its inpatient days method unfairly concentrated administrative
costs on inpatient-oriented programs; instead, as we discuss below, it
maintained that the method was somehow sanctioned by the Agency or the
regulations. The State in essence argued that its methodology must be
deemed equitable and provided no evidence to demonstrate this.  For
example, the State did not challenge the OIG's finding that some
programs operated directly by the DMH, which, according to the OIG
report, comprised 5 to 6 percent of DMH's total expenditures for FYs
1981 and 1982, and some services provided through direct federal grants
rather than through DMH-operated institutions, were not allocated any
indirect administrative costs by the State's allocation method, since
there were no inpatients in these programs to use as the basis for
allocation.  In addition, the State did not disagree that
outpatient-intensive facilities, such as the State's 11 regional
diagnostic centers, serving 32 percent of DMH's clientele were only
allocated 3 percent of the indirect costs during fiscal years 1981 and
1982.  The State also did not address the OIG's criticism that although
the alcohol and drug abuse cost pool was only allocated to DMH
facilities with alcohol and drug abuse units, the allocation of costs in
that pool was made on the basis of inpatient days at the overall
facility, not just inpatients at the relevant unit.

The State's only attempt to defend the fairness of its allocation
methodology was an allegation in its last brief that DMH removed from
the cost pool all central service costs not related to inpatient days,
such as the costs of patient placement, purchase of services, community
placement services and community placement services salaries, and "M.R."
licenses and M.R. licensure salaries.  5/ This adjustment only
demonstrates that the State determined that certain costs not
benefitting its inpatient facilities could not properly be allocated to
them.  The State has never answered, however, the Agency's contention in
its response brief that central service costs would in general be
associated with employees who provide outpatient-oriented services, and
that costs which should have been allocated to these outpatient
programs, since they benefit from them, were not allocated any costs at
all.  Agency response, pp. 4-5.

Consequently, the Agency's contentions concerning the fundamentally
inequitable distribution of indirect costs by the State's allocation
methodology have gone essentially unchallenged, and we conclude that the
State's CAP produced an inequitable distribution of these costs.

II.  The Medicare intermediary's and DSS's approval of the CAP in this
case does not render it unchallengeable or equitable.

As indicated above, rather than claiming that its allocation plan was
equitable in and of itself, the State's primary argument was that since
the plan had been duly approved during the applicable period by the
State's Medicare intermediary and the DSS, the Agency was without
authority to subsequently disallow costs claimed in accordance with it.
The State also contended that these approvals and the Medicare
intermediary's annual audits of the provider cost reports, which did not
question the allocation methodology until 1984, demonstrated that the
method was reasonable and equitable during the disallowance period.
Finally, the State argued that the amounts claimed were less than those
permitted under a particular OMB A-87 section concerning indirect costs.

The Agency maintained that the regulations cited by the State were
inapplicable and that the Medicare intermediary's and DSS's approval of
the CAP had no effect on whether the portion of the ICF/MR rate
reflecting these costs could be disallowed under Medicaid.  The Agency
also argued that these entities' approvals did not render the CAP
equitable.

In support of its argument that the approval of the CAP by the Medicare
intermediary and the DSS negated the Agency's authority to disallow
costs claimed under it, the State asserted that during the disallowance
period the State's Medicaid plan specified that Medicare cost principles
would be used in reimbursing ICFs/MR.  According to the State, at that
time, Medicare cost finding methods were allegedly entitled to automatic
approval by the State Medicaid Agency pursuant to 42 C.F.R. 447.276(c)
(1980).  The Medicare Provider Reimbursement Manual (Manual) in effect
during the same period expressly permitted publicly owned and operated
Medicare providers to recover central government support services costs
based on an acceptable cost allocation plan negotiated and approved by
the Medicare intermediary.  Manual, Part I, section 2156.2. According to
the State, inpatient days was the preferred method of allocation of
pooled home office costs during this period. Manual, section
2150.3(D)(1). 6/ The State explained that, under the Medicare manual,
the Medicare intermediary approved and audited the allocation plan at
issue in this case for Medicare providers during the applicable period.
Also, the allocation plan was subsequently submitted for approval to the
DSS which, according to the State, has the primary responsibility for
the conduct of cost-finding and periodic audits with respect to Medicaid
providers, see 42 C.F.R. 447.260 and 644.265 (1983).  The DSS approved
this cost allocation method.  Since these two entities allegedly had the
authority to approve the cost allocation plan and since both approved
the plan before and after its use, the State argued that the Agency
should not be allowed, and, indeed, had no authority, to challenge the
fairness of the plan retroactively.

The regulations cited by the State  7/, which it argued implement the
direction of section 962 of the Omnibus Reconciliation Act of 1980 that
states be assigned primary responsibility for the conduct of
cost-finding and periodic audits of providers, do not apply to preclude
the Agency's audit of the rate paid for ICF/MR services and consequent
review of underlying costs such as the indirect costs at issue here.
In fact, the Board has held that where the provider in question is
State-owned, the State's application of its rate-setting methods should
be closely scrutinized.  See, e.g., Massachusetts Department of Public
Welfare, DGAB No. 730 (1986).  Notwithstanding the use of Medicare
principles in the rate-setting process, the Agency may independently
assess whether the rate set met the requirements of the State plan for
Medicaid reimbursement.

Ordinarily, a State would be able to rely on the Medicare intermediary's
and DSS's approval of its allocation methodology as evidence of the
reasonable application by the State of the Medicare principles.  In the
present case, however, the disputed cost allocation is clearly
inequitable.  Moreover, the State is erroneously construing Manual
section 2150.3(D)(1) as requiring the use of inpatient days for
allocating these costs.  Manual section 2150.3(D)(1) specifically
provides for the use of inpatient days only for provider chains of
health care facilities where the entire chain consists of inpatient
health care facilities.  As we have noted above, a primary fault of the
State's inpatient-day based allocation methodology is that it allocated
few or no costs to DMH-operated outpatient and other types of programs
to which costs ought to have been allocated. Consequently, the
circumstances here are not analogous to home- office costs for a
provider chain consisting of only inpatient facilities, so that the
State clearly misapplied Manual section 2150.3(D)(1).  In fact, the more
directly applicable section of the Manual, section 2156, should have put
the State on notice that, as the Agency argued, the appropriate method
for the allocation of such costs was usually on a labor costs basis.

The object here is to allocate certain state-wide and DMH-wide costs to
the ICF/MR facilities in order to properly determine the costs to
operate those facilities.  In this connection, the State is also
erroneously construing 42 C.F.R. 447.276 (effective until September 30,
1981), as requiring "automatic approval" by DSS of this allocation
method as a cost-finding method approved by the Medicare intermediary.
That section refers to cost-finding methods in section 405.453(d), where
cost-finding is defined at section 405.453(b) (1980) as

            the process of recasting the data derived from the accounts
            ordinarily kept by a provider to ascertain costs of the
            various types of services rendered.  It is the determination
            of these costs by the allocation of direct costs and
            proration of indirect costs.

In other words, the methods which might be entitled under the cited
regulation to automatic adoption by the State upon approval of the
Medicare intermediary are methods of determining the costs of services
provided by individual providers.  The methods discussed in the
regulation do not address or even appear related to the calculation of
the amount of central services costs to be allocated to a facility prior
to the calculation of the costs of its services.  Also, as the Agency
noted, once these costs have been allocated to the facilities, an
inpatient day-based allocation may be appropriate in the calculation of
ICF/MR services.

Finally, the State claimed that the indirect cost rates for these
facilities were allowable under OMB A-87, Attachment A, section G.2.a.
The State maintained that, when calculated by taking the total of the
indirect costs passed to the facilities and dividing the direct labor
for the facilities to arrive at a direct labor basis for each facility,
its indirect cost rates for the disputed facilities ranged from 6.8% to
7.2% of direct labor, well under the 10% "standard" indirect rate
permitted by the cited section. The Agency argued that, based on the
Board's previous Decision in this case, OMB A-87 is not applicable to
vendor payment costs or relevant to the issue of whether the CAP used by
the State is equitable.

The Agency is correct that, in the earlier Missouri case, the Board
concluded that "OMB A-87 cost principles simply do not apply in
determining what costs can be used to calculate a Medicaid reimbursement
rate."  Missouri, p. 2 (Emphasis in original).  In other words, OMB A-87
would apply in general to determine indirect costs properly charged to
federal grants, but would not apply to determine indirect costs properly
used in figuring a reimbursement rate for the provider payments that
themselves are a direct cost of providing Medicaid services.   To the
extent the cited provision would provide a useful guide as to a
reasonable level of indirect costs, this is not persuasive here given
that the State's chosen allocation method is inequitable on its face and
contrary to the basic principles of A-87 because it indisputably does
not allocate costs to benefitting cost objectives.  See A-87, Att. A,
section C.2.a.  Thus, we conclude that the section cited by the State
does not establish the propriety of State's allocation methodology.
.Conclusion

Based on the foregoing, we uphold the Agency's disallowance in the
amount of $1,147,212.

 

                          _________________________ Cecelia Sparks Ford


                          __________________________ Donald F. Garrett


                          _________________________ Norval D. (John)
                          Settle Presiding Board Member

 


1.    The five ICFs/MR were Nevada Habilitation Center, St. Louis
Developmental Disabilities Treatment Center, Bellefontaine Habilitation
Center, Marshall Habilitation Center, and Higginsville Habilitation
Center.

2.    At one point the State argued that the Agency was attempting to
circumvent the earlier Board decision by using for the disallowance
period the percentage rate negotiated by the parties for these costs for
later years to calculate the allowable indirect costs.  Subsequently,
the State recognized that the Agency did not use the rate itself;
instead, the Agency used the same methodology in order to calculate the
amount of indirect costs allocated to each facility.


3.    As indicated above, the State and the Agency both argued
extensively about the applicability, effect, and reliability of State
Audit Report 85-022, which covered the State's regional diagnostic
centers for one year of the disallowance period.   Since it was only
cited as secondary support for the Agency's finding that the State's
allocation method was inequitable, and since that finding is amply
otherwise supported by the record in this case, we will not address the
parties' contentions on this internal audit.


4.    The State filed a response to the OIG audit report prior to
issuance of the disallowance letter, an appeal brief, a reply to the
Agency's response, and a rebuttal brief in response to the Agency's
answers to questions posed by the Board.

5.    The State did not define what it meant by the term "M.R.;" from
the context we assume it stands for mentally retarded.

6.    The Agency suggested in its final brief that although the State
cited Manual section 2150.3.2, the correct section to be addressed in
this case was actually section 2150.3(D)(1), which applies to accounting
periods beginning before January 1, 1983.  The State did not disagree
with this in its subsequent brief, so we have referred to that section
in our analysis.

7.    Although the State cited "42 CFR 644.265" in its reply brief, no
such section existed.  In responding to this argument, the Agency took
this reference to mean 42 CFR 447.265, and the State did not contradict
this assumption in its subsequent brief.  Section 447.260 provides that
the State Medicaid agency must provide for the filing of uniform cost
reports by each participating provider; section 447.265 states that the
State agency will provide for periodic audits of participating