        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
                 _________________


                            ;
                             
 ST. FRANCIS HEALTH CARE
                             
 CENTRE,
                             
           Plaintiff-Appellant,
                             
                                       No. 98-3965

                             
         v.                   >
                             
                             
        Defendant-Appellee. 
 DONNA SHALALA,

                             
                            1

       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.

                            1
2     St. Francis Health Care v. Shalala            No. 98-3965      No. 98-3965         St. Francis Health Care v. Shalala      27

Witherell, Jenifer A. Belt, SHUMAKER, LOOP &                            I would therefore reverse the grant of summary judgment
KENDRICK, Toledo, Ohio, for Appellant. Ted Yasuda, U.S.              for the Secretary and remand with instructions to enter
DEPARTMENT OF HEALTH & HUMAN SERVICES,                               judgment in favor of St. Francis. Because I would reverse the
OFFICE OF THE GENERAL COUNSEL, REGION V,                             trial court’s disposition on the ground discussed above, I find
Chicago, Illinois, for Appellee.                                     no need to reach the other issues covered in the majority’s
                                                                     opinion.
  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.
26    St. Francis Health Care v. Shalala           No. 98-3965      No. 98-3965             St. Francis Health Care v. Shalala               3

  The majority also attempts to construe the PRM rule as an            Like many health care facilities, a number of St. Francis’s
interpretation of the requirement in 42 C.F.R. § 413.30 that a      patients are Medicare recipients. Consequently, Medicare
provider’s costs be “reasonable.” It views the rule as a            reimburses St. Francis for the1 reasonable costs of services
parallel provision to the two-tier system established by 42         provided to Medicare patients. See 42 U.S.C. § 1395x(u) &
U.S.C. § 1395yy. That system reduced the cost limit for HB-         (v)(1)(A). Pursuant to Medicare rules and regulations, from
SNFs from Level 3 to Level 2, establishing a “discount              1983 to 1990, St. Francis was reimbursed for such reasonable
factor” to account for what Congress found to be their relative     actual costs of services provided. Because St. Francis’s actual
inefficiency as compared to FS-SNFs. In the majority’s              costs exceeded the statutory routine cost limits (“RCLs”) for
opinion, the PRM rule similarly factors in the alleged              each of these years, St. Francis requested, and was granted,
inefficiency of HB-SNFs and discounts reimbursement for             an “upward adjustment” to its cost limits. However, in the
atypical services accordingly. See Op. at 15-16.                    1991 and 1992 cost reporting periods, the Medicare
                                                                    intermediary2denied St. Francis’s requests for an “upward
   Closer analysis reveals that the PRM rule is not analogous       adjustment.”       St. Francis appealed to the Provider
to the two-tier system. The PRM rule does not function as a         Reimbursement Review Board (“PRRB”), which reversed the
commonly understood “discount factor,” because it                   intermediary’s decision. Thereafter, the Administrator of the
completely denies compensation for the first amounts spent          Health Care Financing Administration (“HCFA”), the
on atypical services. In other words, an HB-SNF that spends         Secretary’s delegate, reviewed and reversed the PRRB’s
$100 to provide routine services and anywhere from $1 to $20        decision. Pursuant to 42 U.S.C. § 1395oo(f)(1), St. Francis
on atypical services will receive no reimbursement at all for       thereafter filed a Complaint in federal district court seeking
its atypical service costs. These expenditures are arbitrarily      review of the HCFA’s decision. St. Francis and the Secretary
deemed to be 100% inefficient or, alternatively, are subjected      filed cross motions for summary judgment. The district court
to a 100% “discount factor.” To the extent that the same            denied St. Francis’s motion, and granted the Secretary’s
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.”
                                                                        1
                                                                          The initial decision of whether the health care provider should be
  Because the PRM rule should be regarded as more                   reimbursed is made by an “intermediary,” which is usually a private health
substantive than interpretive, and because it was enacted           insurance company. On a yearly basis, the intermediary determines the
without notice and comment, the rule should be declared             amount which Medicare must reimburse the provider in accordance with
                                                                    Medicare policies and procedures. See 42 U.S.C. §§ 1395g, 1395h(c)(1).
invalid. Contrary to the majority’s fears, such a result would
not necessarily require the Secretary to conduct a case-by-case         2
                                                                         The 1991 and 1992 per diem amounts were as follows. The
review of every provider’s reimbursement request. The               terminology used in this footnote is explained infra:
Secretary is free to establish guidelines that will
presumptively determine a provider’s eligibility for upward                                                   1991              1992
adjustments, thereby relieving her agency of the burden of              St. Francis’s Actual Costs            $120.94           $139.06
case-by-case analyses. Those guidelines must, however, be               112% of Mean HB-SNF Costs             $136.11           $143.98
                                                                        HB-SNF Statutory RCL                  $110.58           $116.90
consistent with the dictates of the governing regulation, or
they must be enacted pursuant to the notice and comment             J.A. at 120-21. The Secretary concluded that “[s]ince [St. Francis’s] cost
procedures of the APA.                                              per day is less than the uniform peer group cost, no exception is allowed.”
                                                                    J.A. at 442.
4       St. Francis Health Care v. Shalala                No. 98-3965        No. 98-3965         St. Francis Health Care v. Shalala      25

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

that a rule was substantive, in part, because it was               (DEFRA), Pub. L. 98-369, § 2319(b), 98 Stat. 494 (1984).
“mandatory, not advisory”); Guardian Fed. Sav. & Loan              DEFRA added a new section to the Medicare Act which
Ass’n v. Federal Sav. Loan Ins. Corp., 589 F.2d 658, 666-67        addressed the cost differences between HB- and FS-SNFs by
(D.C. Cir. 1978) (“If it appears that a so-called policy           adjusting the cost limits for the two groups. For HB-SNFs,
statement is in purpose or likely effect one that narrowly         instead of employing the previous 112% level (112% of the
limits administrative discretion, it will be taken for what it     mean per diem costs of the peer group), Congress lowered
is—a binding rule of substantive law.”).                           that amount by 50% of the difference between the 112% level
                                                                   for HB-SNFs and FS-SNFs. (ie., 50% ((112% x HB-SNF per
  The Secretary argues that “nothing forbids an agency from        diem costs) - (112% x FS-SNF per diem costs))). Still
changing its interpretations.” I do not quarrel with the           dissatisfied with the cost limits established by DEFRA,
proposition that an agency may change its rulings or               Congress has since enacted measures to contain costs further
interpretations over time. An agency is not free, however, to      and to reduce the differing treatment of HB- and FS-SNFs;
adopt new substantive regulations without notice and               these latter changes post-date the events of this case,
comment. Indeed, in both cases cited by the Secretary in           however.4 Despite this plethora of changes to the medicare
which an agency modified its regulations, the change was           reimbursement plan, Congress has always left intact the
preceded by notice and comment. See American Trucking              Secretary’s authority to make adjustments to cost limits “to
Ass’ns. v. A.T. & S.F. Ry. Co., 387 U.S. 397, 404 (1967)           the extent the Secretary deems appropriate.” 42 U.S.C.
(allowing the Interstate Commerce Commission to adopt              § 1395yy(c).
rules, pursuant to notice and comment, which altered its
previous policies regarding trailer-on-flatcar service); Western                                       C.
Coal Traffic League v. United States, 719 F.2d 772, 777 (5th
Cir. 1983) (allowing the Interstate Commerce Commission to            With this legislative history in the background, this case
change its methodology for evaluating a carrier’s market           involves a Medicare Act provision (42 U.S.C. § 1395yy(a)),
dominance by enacting a new regulation pursuant to notice          a regulation interpreting that provision (42 C.F.R. § 413.30),
and comment).                                                      and a PRM provision (PRM § 2534.5) interpreting the
                                                                   regulation.
  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             4
                                                                         In the Omnibus Budget Reconciliation Act of 1993, Pub. L. 103-66,
power plant “commenced,” even though the order was                 § 13503, 107 Stat. 379 (1993), Congress froze cost limits at the fiscal year
inconsistent with prior adjudicative rulings of the agency);       1993 levels for the next two fiscal years and eliminated the provision
NLRB v. Local 103, Int’l Ass’n of Bridge, Structural and           authorizing additional reimbursement to HB-SNFs for costs associated
Ornamental Iron Workers , 434 U.S. 335 (1978) (affirming a         with the Medicare cost allocation process. This essentially rejected
cease and desist order issued by the National Labor Relations      differing reimbursement for HB- and FS-SNFs.
                                                                        More recently, in the Balanced Budget Act of 1997, Pub. L. 105-33,
Board to a striking, uncertified union, which the union alleged    § 4432(a), 111 Stat. 258, 414-20 (1997), Congress eliminated the two-
was inconsistent with a prior ruling of the agency).               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.
6      St. Francis Health Care v. Shalala           No. 98-3965    No. 98-3965          St. Francis Health Care v. Shalala       23

    1. 42 U.S.C. § 1395yy: The Statutory Framework for             all of their costs, including those costs above the applicable
                        Cost Limits                                cost limit. Indeed, in the years prior to 1991, the Secretary
                                                                   routinely granted upward adjustments to St. Francis,
 Congress established the RCLs to be applied to different          reimbursing all of its direct expenditures for atypical services.
SNFs in 42 U.S.C. § 1395yy:                                        Under the PRM rule, however, the Secretary no longer
                                                                   determines whether amounts spent on atypical services
    The Secretary, in determining the amount of the                between Levels 2 and 3 should be compensated. The costs of
    payments which may be made under this subchapter with          such atypical services, even if they otherwise conform to the
    respect to routine service costs of extended care services     four requirements of 42 C.F.R. § 413.30(f), are never
    shall not recognize as reasonable (in the efficient delivery   recoverable.
    of health services) per diem costs of such services to the
    extent that such per diem costs exceed the following per         A rule that adds a new requirement to a set of existing
    diem limits . . . .                                            requirements is substantive, and requires notice and comment
                                                                   before it can be enacted. See Ohio Dep’t of Human Svcs. v.
42 U.S.C. § 1395yy(a). The provision then establishes that         Dep’t of Health & Human Svcs., 862 F.2d 1228, 1235 (6th
the RCL for FS-SNFs “shall be equal to” 112% of the “mean          Cir. 1988) (holding that the department’s adoption of a
per diem routine service costs” of FS-SNFs. Id. at                 “maintenance amount ceiling” for noninstitutionalized
§ 1395yy(a)(1). For HB-SNFs, the RCL “shall be equal to”           spouses of institutionalized Medicaid recipients required
the sum of the following: the FS-SNFs cost limit plus 50% of       notice and comment because it added a requirement that was
the amount by which 112% percent of the HB-SNFs mean per           not compelled by or implicit in the existing regulations); see
diem routine service cost exceeds the FS-SNFs cost limit. Id.      also Perales v. Sullivan, 948 F.2d 1348, 1354 (2d Cir. 1991)
at § 1395yy(a)(3). Despite these statutory limits, Congress,       (determining that a rule was substantive when it required state
recognizing the Secretary’s expertise in this area, afforded the   Medicaid submissions to provide assurance that the state
Secretary the discretion to make “upward adjustments” to           possessed supporting documentation); Linoz v. Heckler, 800
these statutory RCLs:                                              F.2d 871, 877 (9th Cir. 1986) (concluding that a department
                                                                   provision excluding payment for ambulance service from one
    The Secretary may make adjustments in the limits set           hospital to another solely to obtain the services of a specialty
    forth in subsection (a) of this section with respect to any    physician was a substantive rule where “instead of simply
    skilled nursing facility [SNF] to the extent the Secretary     clarifying a pre-existing regulation, [it] carved out a per se
    deems appropriate, based upon case mix or                      exception”). The case of Shalala v. Guernsey Memorial
    circumstances beyond the control of the facility. The          Hosp., 514 U.S. 87 (1995), upon which the majority relies, is
    Secretary shall publish the data and criteria to be used for   consistent with the cases just cited. See id. at 100 (“We can
    purposes of this subsection on an annual basis.                agree that APA rulemaking would still be required if PRM
                                                                   § 233 adopted a new position inconsistent with any of the
42 U.S.C. § 1395yy(c).                                             Secretary’s existing regulations).
    2. 42 C.F.R. § 413.30: The Secretary’s Regulation for            Moreover, other courts have held that rules like the PRM
                    Adjusting Cost Limits                          rule, which impose binding constraints on an agency’s
  Pursuant to the discretion Congress afforded the Secretary       existing discretion, are generally considered substantive. See
in 42 U.S.C. § 1395yy(c), the Secretary implemented 42             Ohio Dep’t of Human Svcs., 862 F.2d at 1234 (concluding
22    St. Francis Health Care v. Shalala           No. 98-3965      No. 98-3965         St. Francis Health Care v. Shalala          7

                       II. ANALYSIS                                 C.F.R. § 413.30, which “set[s] forth the general rules under
                                                                    which HCFA may establish limits on provider costs
A. The PRM rule is substantive                                      recognized as reasonable in determining Medicare program
                                                                    payments” and “also sets forth rules governing exemptions,
  This court has set out the following broad guidelines for         exceptions, and adjustments to limits established under this
determining the nature of an administrative rule: “An               section that HCFA may make as appropriate in consideration
interpretive rule simply states what the administrative agency      of special needs or situations of particular providers.” Id. at
means, and only reminds affected parties of existing                § 413.30(a). The regulation provides as follows:
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         (a)(2) General principle. Reimbursable provider costs
F.2d 176, 182-83 (6th Cir. 1986) (citations and internal              may not exceed the costs estimated by HCFA to be
quotation marks omitted). The exemption for interpretive              necessary for the efficient delivery of needed health
rules must be narrowly construed by the courts in view of the         services. HCFA may establish estimated cost limits for
important purposes served by the APA’s procedural                     direct or indirect overall costs or for costs of specific
requirements. See, e.g., Caraballo v. Reich, 11 F.3d 186, 195         items or services or groups of items or services. These
(D.C. Cir. 1993).                                                     limits will be imposed prospectively and may be
                                                                      calculated on a per beneficiary, per admission, per
  In defending its conclusion that the PRM rule is interpretive       discharge, per diem, per visit, or other basis.
rather than substantive, the majority emphasizes that the                                         ***
controlling statute, 42 U.S.C. § 1395yy, leaves the exemption-        (f) Exceptions. Limits established under this section may
granting process to the Secretary’s discretion.            Her        be adjusted upward for a provider under the
department’s prior regulation on the subject preserves that           circumstances specified in paragraphs (f)(1) through
discretion, subject to the four requirements listed above. See        (f)(5) of this section. An adjustment is made only to the
42 C.F.R. § 413.30(f). The majority therefore maintains that          extent the costs are reasonable, attributable to the
the PRM rule is simply a guide to the Secretary’s exercise of         circumstances specified, separately identified by the
discretion. It concludes that “the [PRM] rule does not effect         provider, and verified by the intermediary.
new substantive reimbursement standards inconsistent with
prior regulations—the central characteristic of a substantive         (1) Atypical services. The provider can show that the–
rule.” Op. at 18.                                                     (i) Actual cost of items or services furnished by a
                                                                      provider exceeds the applicable limit because such items
   I respectfully disagree. At a minimum, the PRM rule adds           or services are atypical in nature and scope, compared
a fifth, unwaivable requirement to the four reimbursement             to the items or services generally furnished by providers
criteria set out in 42 C.F.R. § 413.30. At a maximum, the             similarly classified; and
PRM rule conflicts with the prior regulation. In either case,         (ii) Atypical items or services are furnished because of
it imposes new financial restrictions on the HB-SNFs that it          the special needs of the patients treated and are necessary
regulates, thus requiring notice and comment prior to its             in the efficient delivery of needed health care.
enactment. See 5 U.S.C. § 553.
                                                                    42 C.F.R. § 413.30 (emphasis added).
   Before the PRM rule was promulgated, the Secretary was
free to reimburse HB-SNFs that provided atypical services for
8        St. Francis Health Care v. Shalala               No. 98-3965        No. 98-3965          St. Francis Health Care v. Shalala        21

                         3. PRM5 § 2534.5                                      Facilities that provide atypical services, which tend to be
                                                                             more expensive, may seek upward adjustments for
    a. The Provision                                                         expenditures above their cost limits.                Under the
                                                                             reimbursement review process originally set up by 42 C.F.R.
  In July 1994, HCFA established a new methodology for                       § 413.30(f), the Health Care Financing Administration
handling exception requests—the      methodology which St.                   granted upward adjustments to HB-SNFs that demonstrated
Francis challenges in this case.6 The methodology is set forth               that their costs were (1) reasonable, (2) attributable to atypical
in Transmittal No. 378, PRM § 2534.5 (“Determination of                      services, (3) separately identified, and (4) independently
Reasonable Costs in Excess of Cost Limit or 112 percent of                   verified. See 42 C.F.R. § 413.30(f). In the years 1984-1990,
Mean Cost”) and pertains to cost reporting periods after                     St. Francis received full compensation under this regulation
July 1, 1984:                                                                for its direct service costs that exceeded its cost limit, having
                                                                             demonstrated that its extra expenses were reasonable and
    In determining reasonable cost, the provider’s per diem                  legitimately due to the costs of providing atypical services.
    costs in excess of the cost limit are subject to a test for              For example, if St. Francis’s routine costs had averaged $100
    low occupancy      and are compared to per diem costs of a               per person per day during those years, and its atypical direct
    peer group7 of similarly classified providers.                           service costs had totaled $30 per day, then the facility would
                                 ***                                         have recovered the $30 above its cost limit upon making the
    . . . With cost reporting periods beginning prior to July 1,             showing called for in the regulation.
    1984, for each free-standing group and each hospital-
    based group, each cost center’s ratio is applied to the                    The PRM rule changed this system. Under the PRM rule,
    cost limit [i.e., the RCL] applicable to the cost reporting              St. Francis’s atypical service expenditures are recoverable
    period for which the exception is requested. For each                    only to the extent that its total costs exceed Level 3. Using
    hospital-based group with cost reporting periods                         the same illustrative numbers as before, if St. Francis’s
    beginning on or after July 1, 1984, the ratio is applied to              routine service costs are $100 and its atypical service costs are
    112% of the group’s mean per diem cost (not the cost                     $30, it would recover only $10 (($130 total costs)-($120
    limit), adjusted by the wage index and cost reporting year               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
     5
      The PRM, or Provider Reimbursement Manual, is a set of non-            were evaluated under the PRM rule, the facility could not
binding rules that the Secretary issues in order to provide guidance to      recover any of its expenditures above its cost limit (Level 2)
providers and intermediaries and clarify the Secretary’s reimbursement       because its total costs did not exceed Level 3. This was true
policies and regulations.                                                    even though the Secretary acknowledges that St. Francis’s
     6                                                                       expenditures were legitimately spent for the provision of
      While the exceptions at issue pertain to fiscal years 1991 and 1992,   atypical services.
they are governed by PRM § 2534.5 because they were filed on August
22, 1994, and December 28, 1994.
     7
     There 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.
20   St. Francis Health Care v. Shalala           No. 98-3965      No. 98-3965           St. Francis Health Care v. Shalala           9

                      ______________                                 adjustment factor applicable to the cost reporting period
                                                                     for which the exception is requested.
                         DISSENT
                      ______________                                    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
  RONALD LEE GILMAN, Circuit Judge, dissenting. A                    the SNF’s per diem cost exceeds the peer group per diem
fundamental requirement of the Administrative Procedure Act          cost for any cost center, the higher cost must be
(APA) is that interested persons be given notice of proposed         explained. Excess per diem costs which are not
substantive regulations and an opportunity to comment. See           attributable to the circumstances upon which the
5 U.S.C. § 553. The majority concludes that the rule in              exception is requested and cannot be justified may result
question, Provider Reimbursement Manual § 2534.5 (the                in either a reduction in the amount of the exception or a
PRM rule), is exempt from the APA’s notice and comment               denial of the exception.
requirement because it is an “interpretive” rule. See id.
§ 553(b)(A). I believe that the PRM rule is substantive.           PRM § 2534.5 (emphasis added). In short, for HB-SNF costs
Because the rule was enacted without notice and an                 above the RCL, the methodology permits reimbursement for
opportunity for comment, it should therefore be declared           only those costs in excess of 112% of the mean per diem cost
invalid.                                                           which are attributable to the HB-SNF’s atypical services. The
                                                                   approach creates a “gap” between the HB-SNF RCL and the
                    I. BACKGROUND                                  112% level within which HB-SNFs cannot recover any of
                                                                   their costs above the RCL. It is the propriety of this “gap,”
  As explained by the majority, the governing statute              as well as the consequences it has on facilities like St. Francis
establishes different cost limits for free-standing versus         which happen to fall within it, which is at issue in this case.
hospital-based skilled nursing facilities. Free-standing skilled
nursing facilities (FS-SNFs) have a cost limit equal to 112%         b. Illustration of PRM § 2534.5
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       Because the operation of the PRM is somewhat complex,
nursing facilities (HB-SNFs) is computed through a two step        the following illustration, provided by the district court, is
process: first, one determines 112% of the mean per diem           helpful:
costs of all HB-SNFs, which the parties refer to as Level 3,
and that number is then compared with Level 1. The amount          Assume:   FS-SNF statutory RCL    = 112% of the FS-SNF mean = $80
midway between Levels 1 and 3 is the cost limit for HB-            Assume:   112% of the HB-SNF mean = $120
SNFs, which the parties refer to as Level 2. Thus, in the          Then:     HB-SNF statutory RCL    = 112% of the FS-SNF mean +
majority’s illustrative scenario, $80 is Level 1, the cost limit                                     50%(112% of the HB-SNF mean -
for FS-SNFs, $120 is Level 3, equaling 112% of the average                                           112% of the FS-SNF mean)
per diem cost of HB-SNFs, and $100 is Level 2, the cost limit                                        = $80 + .50($120 - $80) = $80 + $20
for HB-SNFs. All of these numbers represent the average
daily cost, per person, of operating various skilled nursing                                         = $100
facilities.                                                          Based on the aforementioned statutory/regulatory language,
                                                                   a HB-SNF with the per diem actual costs listed below and the
10     St. Francis Health Care v. Shalala                      No. 98-3965   No. 98-3965             St. Francis Health Care v. Shalala              19

RCLs directly above would be entitled to the corresponding                   anchored in its prior argument that PRM § 2534.5
maximum reimbursement rates:                                                 “contradicts the plain language of the applicable regulation
                                                                             that it purports to interpret,” St. Francis’s Br. at 35, a
                               Actual Costs        Maximum Reimbursement     contention with which we disagree. Similarly, the dissenting
                                    $150                           $130      opinion’s APA argument also emerges from its underlying
                                    $140                           $120      view that the PRM cannot be considered an interpretation of
                                    $130                           $110
112% of HB-SNF mean ($120)          $120                           $100      42 C.F.R. § 413.30 because it “confuses” the key terms of that
                                    $110      <---(the “gap”)-->   $100      regulation and is unrelated to the reasonableness of atypical
HB-SNF statutory RCL ($100)         $100                           $100      service costs. Again, based on our discussion supra and in
                                    $90                            $90
112% of FS-SNF mean ($80)           $80                            $80       light of the deference owed to an agency interpreting its own
(i.e., FS-SNF statutory RCL)                                                 regulations, we simply disagree with this conclusion. Thus,
                                                                             the Secretary was not required to comply with the APA’s
Note that SNFs with actual costs between $100 (the HB-SNF                    notice and comment procedures in issuing PRM § 2534.5.11
RCL) and $120 (the 112% level), are only recompensed for
$100 (the RCL amount). This is the “gap” St. Francis decries.                                                   IV.

   Another way to conceptualize this formula is that there are                 Because we do not find PRM § 2534.5 to be an arbitrary or
three possible categories of actual costs: the provider’s actual             capricious interpretation of the statute and regulation at issue,
costs can be (1) less than or equal to the statutory RCL; (2)                we AFFIRM.
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                    11
                                                                                     We also find unpersuasive St. Francis’s argument regarding the
total amount by which the actual costs exceed the 112% of the                Secretary’s “inconsistent” interpretation of its regulations. As this Court
mean (category 3). Accordingly, category (2) represents a                    has stated, “[a]dministrative agencies are not bound by their own prior
“gap” for which a provider will not be reimbursed above the                  construction of a statute . . . . We therefore review the Commission’s
RCL amount despite having costs above the RCL. That                          construction of the statute without regard to the shift it represents from
provider does not have the opportunity to show that its costs                [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
were reasonable and for atypical services.                                   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”)).
18   St. Francis Health Care v. Shalala          No. 98-3965      No. 98-3965          St. Francis Health Care v. Shalala       11

omitted). Such rules “do not have the force and effect of law                                   II.
and are not accorded that weight in the adjudicatory process,”
and do not effect a “substantive change” which is inconsistent       This Court reviews an order granting summary judgment de
with existing regulations. Id. See also Friedrich v. Secretary    novo and uses the same legal standard as used by the district
of HHS, 894 F.2d 829 (6th Cir. 1990) (holding that a national     court. See Terry Barr Sales Agency, Inc. v. All-Lock Co., 96
coverage determination by the Secretary was an interpretive       F.3d 174, 178 (6th Cir. 1996). Summary judgment is
rule). Lower court decisions looking at PRMs have been            appropriate “if the pleadings, depositions, answers to
consistent with Guernsey, concluding that they are                interrogatories, and admissions of file, together with the
interpretive rules and do not require notice and comment          affidavits, if any, show that there is no genuine issue as to any
rulemaking. See, e.g., St. Mary’s Hosp. v. Blue Cross & Blue      material fact and that the moving party is entitled to judgment
Shield Ass’n/Blue Cross & Blue Shield, 788 F.2d 888, 891 (2d      as a matter of law.” Fed. R. Civ. P. 56(c); accord Terry Barr,
Cir. 1986)(stating that PRM rules “have consistently been         96 F.3d at 178. Moreover, “the inferences to be drawn from
held to be ‘interpretive rules,’ and thus exempt from the         the underlying facts . . . must be viewed in the light most
notice and comment requirements”); Columbus Community             favorable to the party opposing the motion.” Matsushita Elec.
Hosp., Inc. v. Califano, 614 F.2d 181, 187 (8th Cir. 1980)        Indus Co. v. Zenith Radio Corp., 475 U.S. 574, 587
(stating that PRMs are agency interpretive rules) .               (1986)(citation omitted). However, “[f]actual disputes that
                                                                  are irrelevant or unnecessary will not be counted.” Anderson
   Even beyond the simple fact that PRMs are generally            v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986).
categorized as interpretive, the work done by PRM § 2534.5
places it within the Guernsey Court’s definition of an               In reviewing the Secretary’s interpretation of regulations,
interpretive rule. The rule does not effect new substantive       courts may overturn the Secretary’s decision only if it is
reimbursement standards inconsistent with prior                   “arbitrary, capricious, an abuse of discretion or otherwise not
regulations—the central characteristic of a substantive rule.     in accordance with the law.” Thomas Jefferson Univ. v.
See Guernsey, 514 U.S. at 99; Warder v. Shalala, 149 F.3d         Shalala, 512 U.S. 504, 512 (1994) (citation omitted); see also
73, 80 (1st Cir. 1998). Rather, as explained above, the PRM       Harris County Hosp. Dist. v. Shalala, 64 F.3d 220, 221 (5th
reasonably interprets a statute and regulation which placed the   Cir. 1995). Further, courts are to “give substantial deference
determination of general terms such as the “reasonableness”       to an agency’s interpretation of its own regulations.” Thomas
of costs and the “typicality” of services in the hands of the     Jefferson Univ., 512 U.S. at 512; see Martin v. Occupational
Secretary. We agree with the Secretary that the PRM partially     Safety and Health Review Comm’n, 499 U.S. 144, 151 (1991)
performs this role by providing the means by which HB-            (“Because applying an agency’s regulation to complex or
SNFs’ systemic unreasonable costs are accounted for in            changing circumstances calls upon the agency’s unique
determining exceptions. Thus, just as in Friedrich, the PRM       expertise and policymaking prerogatives, we presume that the
“creates no new law.” 894 F.2d at 837. “Rather, it interprets     power authoritatively to interpret its own regulations is a
the statutory language . . . as applied to a particular medical   component of the agency’s delegated lawmaking powers.”);
service or method of treatment.” Id.; see also Warder, 149        Harris, 64 F.3d at 221 (“The Secretary’s interpretation of
F.3d at 80 (finding an administrative ruling to be interpretive   Medicare regulations is given controlling weight unless it is
because “it addresse[d] an area of ambiguity” and did not         plainly erroneous or i nconsistent with the
“stake out any ground the basic tenor of which [was] not          regulation.”)(internal quotations omitted). In sum, if “it is a
already outlined in the law itself”) (internal quotations and     reasonable regulatory interpretation . . . we must defer to it.”
citation omitted). St. Francis’s arguments to the contrary are
12    St. Francis Health Care v. Shalala           No. 98-3965      No. 98-3965         St. Francis Health Care v. Shalala     17

Shalala v. Guernsey Memorial Hosp., 514 U.S. 87, 94-95              unreasonable costs as determined by Congress, HB-SNFs and
(1995).                                                             FS-SNFs are treated relatively the same.
                              III.                                     Third, St. Francis misunderstands how PRM § 2534.5
                                                                    operates when it attacks it for being irrational on policy
  Because we agree that the Secretary’s interpretation is not       grounds. Specifically, St. Francis believes that the regime is
arbitrary or capricious, we affirm the district court’s holding.    irrational because it deems costs below the 112% level to be
                                                                    unreasonable, but reasonable when they exceed that amount.
                               A.                                   See St. Francis’s Br. at 34. But this is not an accurate
                                                                    characterization of the PRM’s effect. As the district court
  St. Francis offers several reasons that the Secretary’s legal     stated, the “discount” applies to the costs of all HB-SNFs
interpretation of C.F.R. § 413.30(f)--embodied in PRM               above the RCL; all have costs which are deemed to be
§ 2534.5--falls short of the requirement that agency                unreasonable, and all are “systematically undercompensate[d]
interpretations not be “arbitrary, capricious, an abuse of          in exactly the same manner.” St. Francis, 10 F.Supp.2d at
discretion, or otherwise not in accordance with law.” 5             894. The only difference rendered is that once excess costs
U.S.C. § 706(2)(A). Most importantly, St. Francis asserts that      span beyond the 112% threshold, a portion of the excess costs
PRM § 2534.5 contradicts plain statutory and regulatory             resulting from atypical services can be reimbursed. Yet the
language. It contends that both 42 U.S.C. § 1395yy(a) and 42        discount factor reflecting the “unreasonable” costs of HB-
C.F.R. § 413.30 “dictate” that a provider who demonstrates          SNFs still impacts upon all HB-SNFs above the 112% level;
that its costs in excess of its cost limit are 1) due to the        in other words, there is still an amount of their costs which,
provision of atypical services and 2) reasonable, attributable,     deemed unreasonable by the PRM, those HB-SNFs cannot
identified and verified, is entitled to reimbursement in full       recover. See supra n. 9.
above the cost limit. St. Francis’s Br. at 24. Therefore, St.
Francis argues, PRM § 2534.5 contradicts the plain language                       3. St. Francis’s APA Argument
of the statute and regulation by imposing a blanket (and
“arbitrary”) limit requiring that costs be excepted only to the        Finally, we can not agree with St. Francis’s argument that
extent that total costs exceed that limit.                          PRM § 2534.5 is invalid because it was not adopted pursuant
                                                                    to the notice and comment procedures set forth in the APA,
  St. Francis offers several other arguments to bolster its case.   5 U.S.C. § 553(b). In Guernsey, the Court sustained another
First, St. Francis asserts that PRM § 2354.5 does not square        of the Secretary’s PRMs concerning reimbursement. In doing
with the legislative intent behind the Medicare Act                 so, the Court stated that the PRM at issue was not subject to
provisions. It points to a Senate Finance Committee report          the notice and comment requirement of the APA because it
which it claims makes clear that facilities like St. Francis        was a “prototypical example of an interpretive rule.” 514
should be able to recover all of their reasonable costs,            U.S. at 99. See 5 U.S.C. § 553(b)(A) (establishing that notice
regardless of whether they are a FS-SNF or a HB-SNF. See            and comment are not required for “interpretive rules, general
St. Francis’s Br. at 29. Second, St. Francis argues that PRM        statements of policy, or rules of agency organization,
§ 2534.5 is unreasonable on policy grounds because it treats        procedure or practice”). Specifically, the Court defined
FS-SNFs and HB-SNFs disparately. The regime places FS-              interpretive rules as those “issued by an agency to advise the
SNFs that provide atypical services at a distinct advantage,        public of the agency’s construction of the statutes and rules
reimbursing them for all their costs. On the other hand, HB-        which it administers.” Guernsey, 514 U.S. at 99. (citation
SNFs receive less than full reimbursement for providing the
16     St. Francis Health Care v. Shalala                  No. 98-3965         No. 98-3965          St. Francis Health Care v. Shalala       13

established by Congress in 4210U.S.C. § 1395yy and elaborated                  same services at the same cost; the regime thus penalizes
upon by 42 C.F.R. § 413.30.                                                    them and provides a disincentive to provide such services. St.
                                                                               Francis argues that this result “turns the tables” on the true
                       2. Policy Arguments                                     policy intent; indeed, it maintains that Congress originally
                                                                               intended that HB-SNFs should “receive more than
   We also agree with the district court that St. Francis’s                    freestanding facilities because it recognized that [HB-SNFs]
policy arguments against PRM § 2534.5 are unavailing. First,                   incur more costs in providing the same services” than the FS-
given the clear Congressional conclusion that HB-SNFs suffer                   SNFs. St. Francis’s Br. at 32. Third, St. Francis argues that
from general cost inefficiencies, the Secretary, through the                   because HCFA previously interpreted the applicable
intermediary, should not be required to review each                            regulations differently, the new interpretation is not entitled
provider’s submitted reimbursement request to determine if                     to deference. Finally, St. Francis asserts that PRM § 2534.5
its costs were reasonable. Particularly in light of SNFs’ vastly               is procedurally invalid because it is a substantive rule, yet it
different services and patient populations, such a requirement                 was not passed pursuant to the notice and comment
would impose a high burden and cost on the Secretary — a                       requirements of the Administrative Procedure Act, 5 U.S.C.
burden not required by the statute or the regulation. It was                   § 553 (“APA”).
neither arbitrary nor capricious for the Secretary instead to
introduce a discount factor to account for the systemic cost                                                  B.
inefficiencies identified by Congress, while still allowing HB-
SNFs to obtain reimbursement when they demonstrate that                          We agree with the district court that St. Francis has not
costs above the 112% threshold are due to atypical services.                   shown that PRM § 2534.5 is an arbitrary or capricious
                                                                               interpretation of either 42 U.S.C. § 1395yy or 42 C.F.R.
  Second, St. Francis errs when it argues that PRM § 2534.5                    § 413.30.
unfairly disadvantages HB-SNFs relative to FS-SNFs for “no
legitimate reason.” St. Francis’s Br. at 32. This assertion                                 1. Statutory and Regulatory Text
simply ignores Congress’s conclusion that FS-SNFs are more
efficient than HB-SNFs, and thus should be reimbursed more                       St. Francis’s first argument is that PRM § 2534.5 “is
favorably. Stated differently, once discounted for their                       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
     10                                                                        Secretary broad discretion and because she exercised this
        We agree with the Secretary’s arguments regarding legislative
history. First, the history is sparse and generally inconclusive, and should   discretion consistent with the clear policy choices Congress
be given little weight when the text of the statute so clearly resolves this   made in the statute.
dispute. Second, even the history to which St. Francis points does not
contradict the Secretary’s reading of the statutory language. The language       Neither Congress in 42 U.S.C. § 1395yy nor the Secretary
from the Senate report that St. Francis emphasizes is that “[f]acilities
eligible for exceptions could receive, where justified, up to all of their     in 42 C.F.R. § 413.30 mandated that a HB-SNF be
reasonable costs.” Senate Comm. on Finance, 98th Cong., 2d Sess.,              reimbursed any amount above the statutory RCL set forth in
Deficit Reduction Act of 1984: Explanation of Provisions Approved by           § 1395yy. St. Francis therefore overstates its case when it
the Committee on March 21, 1984, Vol. 1 at 947 (Comm. Print 1984)              claims the language of these provisions “dictates that a
(emphasis added). PRM § 2534.5, through the discretion granted to the          provider who demonstrates that its costs in excess of its cost
Secretary by the plain text of the Medicare Act, is indeed consistent with
this directive because it provides a general formula for determining the       limit are 1) due to the provision of atypical services and 2)
extent to which an HB-SNF’s costs are “reasonable.”                            reasonable, attributable, identified and verified, is entitled to
14       St. Francis Health Care v. Shalala             No. 98-3965        No. 98-3965             St. Francis Health Care v. Shalala            15

reimbursement in full above the cost limit.” St. Francis’s Br.             these unreasonable costs comports with the general
at 24 (emphasis added). Instead, both provisions are phrased               recognition by Congress that “certain systemic inefficiencies
in the permissive, merely stating that the Secretary “may”                 . . . associated with unreasonable costs [] are associated with
adjust cost limits upward. 42 U.S.C. § 1395yy(c); 42 C.F.R.                HB-SNFs.” St. Francis, 10 F.Supp.2d at 892. In fact, the
§ 413.30(f). Moreover, neither provision provides guidance                 PRM calculation reduces the reimbursement to HB-SNFs by
as to the level of adjustment the Secretary must make.                     the very same proportion that Congress deemed to be
Specifically, 42 C.F.R. § 413.30 provides that although limits             inefficient — half  of the difference in costs between FS-SNFs
“may” be adjusted when “atypical,” they should only be                     and HB-SNFs.9 Likewise, the guideline comports with 42
adjusted upward “to the extent the costs are reasonable.” 42               C.F.R. § 413.30, which allows the Secretary to determine the
C.F.R. § 413.30(f). As the Secretary argued, this explicitly               extent to which costs for atypical services are “reasonable.”
placed the determination of “typicality” of services   versus              42 C.F.R. § 413.30(f).
“reasonableness” of costs within her discretion.8
                                                                             In sum, PRM § 2534.5 does not create the “two-tier”
  Having noted what the statute does not do, it is important               system in contravention of the statute and regulation. To the
to note what it does do. As discussed supra, Congress                      contrary, the Secretary merely acted within the discretion she
responded to studies demonstrating that about half of the                  was granted by putting into place the very cost ratio
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
                                                                               9
upward adjustments in reimbursements, it also did not specify                   Once again, if we take $80 as 112% of the FS-SNF mean, and $120
how the Secretary should do so in light of this new regime                 as 112% of the HB-SNF mean, the results of the application of PRM
accounting for HB-SNFs’ inefficiency. Yet again, she was                   § 2534.5 are as follows:
granted discretion to make this determination.                                                            Actual Costs       Amount Reimbursed
                                                                                                              $150                    $130
   Given these aspects of the statute, we agree with the district                                             $140                    $120
court that the Secretary’s interpretation of the regulation and                                               $130                    $110
                                                                           112% of HB-SNF mean ($120)         $120                    $100
statute in the PRM is reasonable, not arbitrary. First, we                                                    $110 <---(the “gap”)--> $100
agree with the Secretary that the best way to characterize the             HB-SNF statutory RCL ($100)        $100                    $100
effect of the PRM is that it applies a “discount factor” to all                                               $90                     $90
                                                                           112% of FS-SNF mean ($80)          $80                     $80
HB-SNFs to account for the “unreasonable costs” above those                (i.e., FS-SNF statutory RCL)
of FS-SNFs. As the district court recognized, discounting for
                                                                           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
     8                                                                     difference between 112% of the HB-SNF mean and 112% of the FS-SNF
     This is consistent with other parts of the Medicare Act, which also   mean (which is $40). Thus, in determining upward adjustments as
“authorize[] the Secretary to promulgate regulations ‘establishing the     Congress bid her to, the Secretary is using the very ratio—and the very
method or methods to be used’ for determining reasonable costs.”           assumptions regarding the inefficiencies of HB-SNFs—that the statute
Guernsey, 514 U.S. at 91 (quoting 42 U.S.C. § 1395x(v)(1)(A)).             prescribed for establishing the RCL for HB-SNFs.
