## Facts

- California’s Department of Health Services (DHS) administered the state Medicaid program (Medi-Cal) and set reimbursement rates for outpatient hospital services.
- Hospitals and a hospital association challenged DHS’s outpatient reimbursement rates, and earlier proceedings found aspects of the rate-setting “arbitrary and capricious.”
- On remand, DHS effectively readopted the same rates without conducting or relying on cost-based analysis.
- The hospitals filed a federal action under 42 U.S.C. § 1983, alleging DHS violated 42 U.S.C. § 1396a(a)(30)(A) (Medicaid Act § 30(A)) by failing to consider hospital costs in relation to statutory requirements (efficiency, economy, quality of care, and access).
- The district court granted summary judgment for the DHS Director, and the hospitals appealed.

## Issues

1. Whether Medicaid Act § 30(A) requires a state Medicaid agency setting outpatient hospital reimbursement rates to consider provider costs so rates bear a reasonable relationship to the costs of efficiently and economically operated hospitals providing quality services.
2. Whether DHS violated § 30(A) by setting and readopting outpatient hospital rates without responsible cost studies or other reliable cost data, relying largely on budgetary and non-cost considerations.

## Decision

- The Ninth Circuit reversed the district court’s summary judgment for the Director and remanded with directions.
- The court held § 30(A) requires rates to bear a reasonable relationship to efficiently and economically operated hospitals’ costs of providing quality services, absent a justification for substantial deviation.
- The court held DHS must rely on responsible cost studies (its own or others’) providing reliable data for rate setting.
- The court concluded DHS’s readoption of rates without cost analysis was arbitrary and capricious and contrary to § 30(A).
- The court rejected the view that budgetary constraints alone can justify rates set without considering provider costs.
- The court reviewed summary judgment and interpretation of the federal statute de novo and did not defer to the state agency’s interpretation of federal law.

## Legal Principles

- Medicaid Act § 30(A) imposes substantive constraints on state Medicaid payment methods, requiring payments consistent with efficiency, economy, and quality of care and sufficient to ensure provider participation for adequate access.
- A state must use reliable cost information—typically responsible cost studies—to determine what it costs an efficient and economical provider to furnish quality services as a basis for payment rates.
- § 30(A) does not require reimbursement equal to actual costs or a rigid cost-based formula, but rates must be rationally informed by, and reasonably related to, efficient providers’ costs unless a substantial deviation is justified.
- Fiscal pressure and cost containment goals do not excuse failure to comply with § 30(A)’s requirements linking payment levels to quality and access.

## Conclusion

The Ninth Circuit held that Medicaid Act § 30(A) requires outpatient hospital reimbursement rates to be grounded in reliable cost data and reasonably related to the costs of efficient, economical hospitals providing quality care; because DHS readopted rates without responsible cost studies and relied primarily on budgetary factors, the court reversed and ordered reconsideration of rates consistent with § 30(A).


Orthopaedic Hosp. v. Belshe, 103 F.3d 1491 (9th Cir. 1997)