78 N.Y.2d 158 (1991)
An administrative regulation will be upheld only if it has a rational basis and is not unreasonable, arbitrary, or capricious; a challenger must demonstrate that the regulation is so lacking in reason that it is essentially arbitrary.
Summary
The New York State Association of Counties (NYSAC) challenged a regulation issued by the Department of Health (DOH) that reduced Medicaid reimbursement rates to nursing homes by 3.035%. This “recalibration” was based on the DOH’s belief that improved accuracy in patient assessment (Resource Utilization Group (RUG-II) reporting or “paper optimization”) led to inflated reimbursement rates, not actual changes in patient needs. The Court of Appeals held that the regulation lacked a rational basis because the DOH failed to adequately document and substantiate its conclusion that the increase in the Case Mix Index (CMI) was solely attributable to “paper optimization” and not patient deterioration. Thus, the regulation was deemed arbitrary and capricious.
Facts
Prior to 1986, Medicaid reimbursement rates for nursing homes were based on a per-day, per-patient cost, adjusted for inflation. In 1986, DOH introduced the RUG-II system, designed to align reimbursement with patient resource needs. Facilities were required to complete Patient Review Instruments (PRIs) to categorize patients into 16 Resource Utilization Groups (RUGs), which then determined their CMI. Reimbursement rates were initially based on 1985 PRI data. In August 1986, DOH proposed a 3.035% reduction in payment rates, claiming that improved PRI accuracy increased facilities’ CMIs, leading to overpayments. DOH compared CMIs for 1985 and 1986, excluding short-stay patients, and concluded that “paper optimization” caused the increase. The recalibration was implemented retroactively to January 1, 1987.
Procedural History
NYSAC filed a CPLR Article 78 proceeding challenging the regulation. The Supreme Court denied DOH’s motion to dismiss and converted the proceeding into a declaratory judgment action, ultimately ruling in favor of NYSAC. The Appellate Division reversed, finding the action time-barred and upholding the regulation’s constitutionality. NYSAC appealed to the Court of Appeals.
Issue(s)
1. Whether NYSAC’s lawsuit was timely commenced within the statute of limitations.
2. Whether the recalibration regulation (10 NYCRR 86-2.31) lacked a rational basis and was arbitrary and capricious.
Holding
1. Yes, because NYSAC’s lawsuit was commenced within four months of its members’ receipt of rate recomputation notices, which first apprised them of their actual reimbursement rates.
2. Yes, because the DOH failed to adequately document and substantiate its conclusion that the increase in CMI was solely attributable to “paper optimization” and not to patient deterioration.
Court’s Reasoning
The Court reasoned that the DOH’s determination did not become final until NYSAC members received their rate recomputation notices, allowing them to assess the regulation’s impact. Up until that point, facilities did not reasonably understand how the 3.035% reduction would impact them. As to the regulation’s rationality, the Court emphasized that administrative rules must be scrutinized for genuine reasonableness and rationality in the specific context. Quoting Matter of Marburg v. Cole, the Court stated, “[t]he challenger must establish that a regulation `is so lacking in reason for its promulgation that it is essentially arbitrary.’” The Court found that the DOH’s regulation clashed with the intent of the RUG-II methodology, which was to incentivize facilities to provide more intensive care. The record lacked evidence to support the DOH’s claim that the CMI increase was solely due to improved PRI completion. The Court noted that the 3.035% reduction was the result of negotiation and compromise, not a rational, documented, empirical determination. Further, the Court stated that the regulation had a disparate impact on facilities. The dissenting opinion argued that the Commissioner’s inference that the increase in CMI resulted from “paper optimization” was reasonable and supported by evidence and that the court was improperly substituting its judgment for the agency’s expertise. The majority rejected this argument stating, “the courts should not be relegated to searching for and fashioning justifications for agency actions, based on `simple processes of elimination’ at the appellate review stage”.