11-1800-11946-2

 

STATE OF MINNESOTA

OFFICE OF ADMINISTRATIVE HEARINGS

FOR THE DEPARTMENT OF HUMAN SERVICES

 

In the Matter of the Rate Appeal of Hilltop Good Samaritan Center

RECOMMENDED ORDER ON WRITTEN CLOSING ARGUMENT

            This matter is pending before Administrative Law Judge Barbara L. Neilson.  A previous ruling on the parties’ cross motions for summary disposition found that genuine issues of material fact remained for hearing.  In lieu of holding an evidentiary hearing, the parties agreed to file affidavits and copies of depositions on which they intended to rely and thereafter submit written closing arguments.  The record with respect to the matter closed on December 6, 2000.

Samuel D. Orbovich, Attorney at Law, Orbovich & Gartner, Suite 417, Hamm Building, 408 St. Peter Street, St. Paul, Minnesota 55102-1187, appeared on behalf of Hilltop Good Samaritan Center.  Steven J. Lokensgard, Assistant Attorney General, Suite 900, 445 Minnesota Street, St. Paul, Minnesota 55101-2127, appeared on behalf of the Department of Human Services.

            Based upon all the files, records and the proceedings herein, and for the reasons set forth in the accompanying Memorandum, the Administrative Law Judge makes the following: 

RECOMMENDATION

IT IS HEREBY RECOMMENDED that the Commissioner enter the following Order:

(1)               Because the City budget category relating to “Capital Outlay” includes $4,085 in funds targeted for road construction, Hilltop’s PILOT costs should be adjusted accordingly.  The fact that the City actually spent an additional $19,608 on street repairs in 1996 above the amount budgeted is irrelevant and should not result in an adjustment of Hilltop’s PILOT costs.  There has been no showing that the City budget category relating to “Debt Service” includes costs attributable to fire, police, sanitation services, and/or road maintenance costs, or that the County budget categories relating to “Debt Service” and “Capital Outlay” include costs attributable to fire, police, sanitation services, and/or road maintenance costs.

(2)               The costs reported by Hilltop and disallowed by the Department should not, in the alternative, be reclassified to the capitalized lease as effective interest rates and finance charges. 

(3)       This Recommendation is made for the reasons set forth in the Memorandum below, which is hereby incorporated by reference in this Recommendation.

 

Dated this 17th day of January, 2001.

 

                                                                             

BARBARA L. NEILSON

Administrative Law Judge

 

 

NOTICE

 

            This Report is a recommendation, not a final decision.  The Commissioner of Human Services will make the final decision after reviewing the record.  The Commissioner may adopt, reject or modify the recommendation contained herein.  Pursuant to Minn. Stat. § 14.61, the final decision of the Commissioner shall not be made until this Report has been made available to the parties to the proceeding for at least ten days.  An opportunity must be afforded to each party adversely affected by this Report to file exceptions and present argument to the Commissioner.  Parties should contact Michael O’Keefe, Commissioner of Human Services, 444 Lafayette Road, St. Paul, Minnesota  55155, telephone (651) 296-2701, to ascertain the procedure for filing exceptions or presenting argument.

 

MEMORANDUM

Background

Hilltop Good Samaritan Center (“Hilltop”) is a non-profit nursing facility.  Those operating nursing homes in Minnesota may receive reimbursement from the Department of Human Services for allowable costs incurred in providing care to residents under the federal Medicaid Act, 42 U.S.C. § 1396a, and the State’s Medical Assistance Program, Minn. Stat. Chapter 256B.  To receive medical assistance payments, nursing homes submit annual cost reports showing costs incurred during the reporting year, which generally runs from October 1 through the following September 30.[1]  During desk audits, DHS auditors review the cost reports and supporting documentation.[2]  The auditors allow, disallow, or reclassify costs reported on the provider’s cost report and, based on adjusted allowable costs, calculate a prospective per diem rate for a rate year running from July 1 through the following June 30.[3]  Providers may appeal specific audit adjustments after they receive the final rate notice.  If the appeal is not resolved informally, the provider may demand a contested case hearing.[4] 

The primary issue in this case concerns the allowability of payments made in lieu of taxes that were reported by Hilltop for the reporting year ending September 30, 1995 (rate year beginning July 1, 1996) and adjusted by the Department on desk audit.  Pursuant to Minn. Stat. § 256B.43, subd. 2b(g), non-profit nursing facilities are allowed to include as operating costs any payments made in lieu of real estate taxes (“PILOT”).  But the law limits such payments to the portion of the taxes that the facility would have paid for certain services (fire, police, sanitation, road maintenance) if it were a for-profit facility.  Costs incurred by a nursing facility that relate to real estate taxes, or payments made in lieu of real estate taxes, are generally reported on Line 7012 of a facility’s cost report, and fall into the Real Estate Taxes and Special Assessments cost category.

On cross motions for summary disposition, the parties disputed whether it was appropriate for the Department to disallow all costs Hilltop paid to the City of Watkins except for that portion of the city budget making up the Public Works and Public Safety categories.  DHS contended that only these two categories include the four services identified and allowed by statute.  Hilltop maintained that the entire $54,088.18 it reported in PILOT costs went directly to the City of Watkins’ general fund for the four services identified by the statute.  That is, despite the breakdown of City expenditures obtained by DHS, Hilltop contended that none of the monies Hilltop paid to the City of Watkins went to parks or schools or other non-allowable services.  Accordingly, Hilltop argued that the entire $54,088.18 it reported in PILOT costs should be allowed. 

On January 20, 2000, the Administrative Law Judge issued an Order on the parties’ cross motions for summary disposition.  In that Order, the Judge granted the Department’s motion in part as to its argument that Minn. Stat. § 256B.431, subd. 2b(g), requires that PILOT costs be disallowed to the extent that the costs exceed the amount that a for-profit facility would have paid to a city or township and county for fire, police, sanitation services, and road maintenance costs.  Thus, even if the agreement between Hilltop and the City of Watkins provided that all of the money paid by Hilltop would go to the services identified by statute, the Administrative Law Judge indicated that Hilltop is still only entitled to claim the costs it would have paid for these services if it were a for-profit facility.  The Judge emphasized that the statute looks at how much a nursing facility would have paid for these services if real estate taxes had been levied on the property for those purposes, not how much the facility has agreed to pay for these services in a contract with the municipality, and stated that a nursing facility could not avoid the statutory PILOT cost limitation by entering into its own agreement with the local government.  The Judge concluded that the Department’s two-step calculation was a logical and reasonable interpretation of the statute and upheld the Department’s view that providers could not avoid the statutory PILOT cost limitation by entering into their own agreement with local government concerning cost distribution.  The Judge granted Hilltop’s motion in part as to its argument that the Department was improperly attempting to apply an unpromulgated interpretive rule when it disallowed Hilltop’s County PILOT costs based upon the lack of a PILOT agreement with the County or actual payment to the County.  The parties’ motions for summary disposition were otherwise denied.  The Judge determined that genuine issues of material fact remained for hearing as to whether the City budget categories relating to “Debt Service” and “Capital Outlay” included costs attributable to fire, police, sanitation services, or road maintenance costs and whether Hilltop’s PILOT costs should be adjusted accordingly.  During a subsequent telephone conference call, the parties agreed that a similar inquiry should be made with respect to the costs contained in the Meeker County budget.

By mutual agreement of the parties, the hearing was held in abeyance for a period of time in order to permit the parties an opportunity to engage in settlement discussions.  After those discussions failed to resolve the matter, the Department filed a Motion in Limine seeking to exclude evidence relating to Hilltop’s argument that the costs reported by Hilltop and disallowed by the Department should, in the alternative, be reclassified to the capitalized lease as effective interest rates and finance charges, and thereby be placed in the property cost category.  On July 19, 2000, the Administrative Law Judge issued an Order denying the Department’s Motion in Limine and requiring that Hilltop be permitted to address its assertion that the costs reported by Hilltop and disallowed by the Department should, in the alternative, be placed in the property cost category.  The discovery period was reopened to permit the parties to conduct additional discovery relating to this issue.  By letter dated November 17, 2000, the parties informed the Administrative Law Judge that they would each file affidavits, depositions, and written argument on the remaining issues in this case in lieu of participating in an evidentiary hearing. 

Accordingly, the two remaining issues for decision in this matter are the following:

(3)               whether the City or County budget categories relating to “Debt Service” and “Capital Outlay” include costs attributable to fire, police, sanitation services, or road maintenance costs, and whether Hilltop’s PILOT costs should be adjusted accordingly; and

(4)               whether costs reported by Hilltop and disallowed by the Department should, in the alternative, be reclassified to the capitalized lease as effective interest rates and finance charges, and thereby be placed in the property cost category.

Each of these issues will be discussed in detail below.

Debt Service and Capital Outlay Budget Categories

In the ruling on the summary disposition motions, the Judge determined that the percentage of Hilltop’s total reported costs reflecting costs associated with services in the “General Government,” “Urban and Economic Development” or “Culture and Recreation” categories were appropriately disallowed by DHS.  With respect to the other cost categories disallowed by DHS, however, such as “Debt Service” and “Capital Outlay,” the Judge found that genuine issues of material fact existed as to whether these categories included costs attributable to the four identified services.  Thus, the Administrative Law Judge ordered that a hearing should be held to determine the amount of allowable costs in the Debt Service and Capital Outlay categories relating to the four services covered by the statute.  The parties agreed that the inquiry should include both the City and the County budgets. 

            In its final submissions regarding this issue, Hilltop offered the affidavit of Deb Kramer, the clerk of the City of Watkins, and the Department offered the affidavit of Gloria Tiongson, a senior DHS auditor.  Hilltop argues that the City of Watkins generated $4,085 through the 1996 levy and this amount should be included in Hilltop’s PILOT costs in the rate year under appeal.  The Department agrees that $4,085 of Capital Outlay funds was targeted for road construction and that this amount should be added in calculating the allowable PILOT payment.[5]  Therefore, the Administrative Law Judge recommends that Hilltop’s allowable PILOT costs be adjusted accordingly. 

The parties agree that the City actually spent $19,608 on street repairs during 1996, which is more than the amount that was budgeted.  Hilltop asserts that this cost should be included in the PILOT cost computation because the City actually paid this amount in one of the four service areas identified in the PILOT statute, and argues that DHS should not be permitted to benefit from its failure to promulgate clear rules and directives notifying all interested stakeholders what costs would be included in the four PILOT cost categories.  The Department contends that the amount the City actually spent on covered services is irrelevant because the Department calculates the amount of taxes that would go toward the covered services based on budgets for the year in question, not actual expenses.[6] 

Minn. Stat. § 256B.431, subd. 2b(g) requires that the Department consider “the amount which the nursing home would have paid to a city or township and county for fire, police, sanitation services, and road maintenance costs had real estate taxes been levied on that property for those purposes.”  As discussed in the prior ruling on the cross motions for summary disposition, the Department’s two-step calculation of the allowable amount reflects a logical and reasonable interpretation of the statute.  Given the wording of the statute and the time of year when the Department sets the rate for a nursing facility, it is appropriate and necessary for the Department to base the calculation on budgeted amounts rather than actual expenditures.  Thus, the Administrative Law Judge is persuaded that the amount actually spent by the City on street repairs is irrelevant, and recommends that no further adjustment be made in Hilltop’s allowable PILOT costs. 

Reclassification to Capitalized Lease

Hilltop contends that, in the alternative, the PILOT costs disallowed by the Department should be reclassified to the capitalized lease as effective interest rates and finance charge, and thereby be placed in the property cost category.  In its final submissions regarding this issue, Hilltop offered the affidavit of Robert J. Rau (a former DHS senior auditor and audit director who currently serves as a consultant and provides reimbursement services to long-term care facilities), the affidavit of Ann Richter (an employee of the Evangelical Lutheran Good Samaritan Society), and the transcripts of the depositions of Mr. Rau and Greg TaBelle (the current director of the Department’s audit division), and the Department offered the affidavit of Mr. TaBelle and the deposition of Mr. Rau. 

In support of its argument, Hilltop argues that the DHS has a long history of reclassifying costs on audits because Rule 50 expressly recognizes that some costs may fit in more than one category.  For example, Hilltop points out that Rule 50 provides that an “indirect cost” is one that is “incurred for a common or joint purpose and is identified with more than one cost category but is not readily identified with a specific cost category.”[7]  Hilltop also emphasizes that Rule 50 specifies that costs must be classified to the appropriate cost categories[8] and requires that DHS consider “the cost effects of transactions” and ensure that the “substance of the transaction . . . prevail[s] over form.”[9]  Hilltop emphasizes that, under the Hillcrest Health Care Center case,[10] DHS must consider the purpose of a cost when deciding its appropriate classification. 

Hilltop contends that the purpose of the costs involved in the present case relates to the assumption of the lease, since the City required Hilltop to enter into a PILOT agreement as a prerequisite to approval of the capitalized lease and the agreement pays the City for providing police, sanitation, streets, and fire protection.  It argues that the fact that the facility was contractually obligated to make payments to the City as a cost of doing business means that the costs are comparable to fees or interest paid to a lending institution to generate a loan.  Moreover, Hilltop asserts that the costs charged by a governmental entity are less suspect than costs charged by private vendors or lessors.  Because the Department regards “capitalized” leases as the equivalent of a sale transaction, Hilltop asserts that the Department must transpose the terms of the lease to fit the provisions of Rule 50 relating to the treatment of principal, interest and related expenses.[11]  Although Rule 50 does not include a provision that identifies which costs of a capitalized lease should be treated as effective interest, Hilltop asserts that it is appropriate to look to a rule provision that identifies examples of effective interest for mortgages[12] as an analogy when recognizing capitalized lease costs.  That rule provision provides that the “effective interest rate of each allowable debt, including points, financing charges, and amortization bond premiums or discounts” is limited to the effective interest rate on the debt or 16 percent, whichever is less.[13]  The Department does not view the list of items in the rule as exhaustive and has itself added bond trustee fees to the list.[14]  When this approach is applied to the costs at issue in the present case, Hilltop argues, with the support of Mr. Rau’s deposition testimony, that the costs are “comparable to fees or interest paid to a lending institution to generate a loan.”[15]  Accordingly, Hilltop contends that the costs are appropriately classified to the capitalized lease as part of the facility’s property-related payment rate. 

Hilltop further argues that pronouncements by the Financial Accounting Standards Board (“FASB”) do not have any bearing on whether Rule 50 recognizes that the cost may serve a joint and common purpose.  Finally, Hilltop contends that it is appropriate to allow the facility to seek reimbursement under the rule provisions that allow providers to classify costs that are incurred for a joint or common purpose and not reward the Department’s failure to promulgate rules to eliminate ambiguity concerning what costs could be recovered through the PILOT agreement and what costs could be recovered through the lease. 

The Department argues that the reclassification would be inappropriate and contrary to the plain language of the statutory provision relating to PILOT costs and the clear intent of the Legislature.  DHS also asserts that the reclassification would not be consistent with Rule 50 and with Generally Accepted Accounting Principles (“GAAP”) and stresses that it would not make sense to allow costs subject to a limit imposed by the Legislature to be allowed in another cost category.

Based upon a careful consideration of these competing arguments, the Administrative Law Judge is persuaded that it would not be appropriate to allow the PILOT costs disallowed by the Department to be reclassified to the capitalized lease as effective interest rates and finance charge.  There are several reasons for this conclusion. 

First, even though the “Agreement for Payment of User Fees in Lieu of Taxes” apparently was required by the City as a prerequisite to Hilltop obtaining the lease, the disputed costs nevertheless are fairly considered to be payments in lieu of real estate taxes.  The plain language of Minn. Stat. § 256B.431, subd. 2b(g) requires that PILOT costs be included “as an operating cost of that nursing facility.”  By implication, such costs should not be treated as a property cost.  These costs are “readily identified with a specific cost category” and do not, in the view of the Administrative Law Judge, fall within the definition of an indirect cost “incurred for a common or joint purpose” as set forth in Minn. R. 9549.0020, subp. 27.

Second, the statute clearly specifies a limitation that must be placed on allowable PILOT costs by stating that the costs are only allowed to the extent that they represent the amount a facility would have been required to pay for certain services if it were not exempt from property taxes.  The approach urged by Hilltop would be contrary to the statute because it would allow the facility to claim an amount in excess of the amount allowed by the plain language of the statute.  Even though it is evident that DHS auditors reclassify costs claimed by facilities to what they view to be the correct cost category, the Department does not have authority to allow costs that are subject to a limit imposed by the Legislature to be claimed in another cost category.  For example, although the DHS reclassifies licensing fees claimed by a facility to a different cost category if they exceed the licensing fee amount that the facility is required to pay to the Department of Health, this is done based upon the auditor’s assumption that any amount claimed that is above the required amount represents some other licensing fee that was reported on the wrong line of the cost report.  This reclassification is not done as a way of allowing an otherwise non-allowable cost.[16]  Despite the fact that the PILOT agreement involved in this case was with a governmental entity and was necessary for Hilltop to obtain the lease, the Judge concludes that the reclassification urged by Hilltop would be improper because it would circumvent the limit set by the Legislature on the amount of PILOT payments that may be allowed.  The limitation established by the Legislature overrides the rule provisions upon which Hilltop relies.

Finally, it is evident that the reporting of PILOT payments as “effective interest” would conflict with Rule 50 and with GAAP.  Hilltop seeks to have this interest reported without any associated debt.  However, Rule 50 requires that facilities report interest only in connection with a related debt.  Part 9549.0060, subp. 7(A), provides that “interest expense including points, finance charges, and amortization bond premiums or discounts” is allowed “only on the debt which is allowed under subpart 5 and within the interest rate limits in subpart 6.”  Thus, it would be contrary to Rule 50 to allow Hilltop to report interest without reporting the debt associated with the interest.  Moreover, nursing facilities are required under Rule 50 to file cost reports in accordance with GAAP, to the extent that it does not conflict with rule or statute.[17]  It is evident that GAAP does not permit Hilltop to include the disallowed PILOT costs with its reported capitalized lease. In accordance with GAAP, the Department applies FASB Statement Number 13 and FASB Interpretation Number 19 to nursing facilities as well as intermediate care facilities for the mentally retarded.[18]  In determining what other costs should be added to the lease payments to calculate a capitalized lease, FASB Statement Number 13 specifically excludes “executory costs such as insurance, maintenance, and taxes in connection with the lease property.”  Executory costs are considered to be costs that could vary over the course of a lease.  Because the amount of Hilltop’s disallowed PILOT costs is uncertain from year to year, such costs would be considered to be executory costs that should not be considered in the calculation of a capitalized lease.  Because FASB pronouncements reflect GAPP, it is clear that the inclusion of the disallowed PILOT costs in the calculation of the capitalized lease would violate GAAP.[19]  Therefore, the Administrative Law Judge recommends that the disallowed PILOT costs not be deemed to be effective interest or finance charges that should be included in the calculation of the capitalized lease.

Conclusion

The Legislature, through Minn. Stat. § 256B.431, subd. 2b(g), has directed the manner in which DHS must recognize PILOT costs.  The DHS is precluded by the statute from allowing disallowed PILOT costs as “interest” in the property-related cost category or from allowing PILOT costs in excess of the limitation set forth in the statute.  Accordingly, it is recommended that Hilltop’s PILOT costs be increased as discussed in the summary disposition ruling and in Issue 1 above (resulting in the recognition of $13,752 in PILOT payments on the cost report at issue), but that the remainder of Hilltop’s PILOT costs NOT be reclassified to the property cost category as effective interest or finance charges attributable to the capitalized lease.

B.L.N.