Health Net v. Dept. Mental Health

Filed 12/11/08 Health Net v. Dept. Mental Health CA3

NOT TO BE PUBLISHED

California Rules of Court, rule 8.1115(a), prohibits courts and parties from citing or relying on opinions not certified for publication or ordered published, except as specified by rule 8.1115(b). This opinion has not been certified for publication or ordered published for purposes of rule 8.1115.

IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA

THIRD APPELLATE DISTRICT

(Sacramento)

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The issues in this appeal arise from the implementation by the Department of Health Services (DHS) of a two-plan model that permits Medi-Cal beneficiaries in selected counties to choose between a commercial plan or a governmental plan for the provision of health care services. Health Net of California, Inc. (Health Net) was selected to provide the commercial plan and, in response to disagreements with DHS, filed separate petitions for writ of administrative mandamus, which were heard in 2004 and 2006.

While the roles of the Legislature, the state budget, and the actuary loom large in Health Nets challenge to how much DHS should have paid for Medi-Cal beneficiaries health care services for several years, the dispositive issues raised on appeal involve implementation of the terms of Health Nets contract with the state. We reject Health Nets assertions that under the terms of the contract retroactive adjustments of rate increases include the payment of an unspecified and uncertain amount of interest and that the rate-setting methodology required the actuary to identify a separate component for administrative costs in the capitation rates. We agree with Health Net and the superior court, however, that by following a mandate to freeze rates based on the state budget, the actuary failed to follow the detailed rate-setting methodology set forth in attachment 1 to the contract. (Welf. & Inst. Code, 14301, subd. (a).) We also agree that DHS was not entitled, under the contract, to a prepayment discount for payments that were in fact many months late.

We therefore affirm the denial of the petition for writ of administrative mandamus heard in 2004 insofar as it requests payment of interest on retroactive rate adjustments but reverse insofar as it seeks to allow Health Net to recover prepayment discounts deducted from retroactive adjustments. We affirm the denial of the petition heard in 2006 insofar as it rejects Health Nets request for additional compensation for administrative costs but reverse insofar as it erroneously concludes that the actuarys breach of contract was inconsequential. We remand to DHS to calculate the rates for rate year 2001-2002 without imposing a mandated freeze based on the state deficit and by applying the trend factors required by contract.

PART I: THE INTEREST CASES

In 12 California counties, beneficiaries of Californias Medicaid program (Medi-Cal) can choose between two prepaid health plans, a commercial plan or a local initiative, under what has come to be known as the two-plan model. (Cal. Code Regs., tit. 22, 53800, subd. (a), 53810, subd. ll.) DHS is the agency responsible for implementing the Medi-Cal program. In 1996 Health Net and DHS executed a two-plan model managed care contract (the contract). Health Net agreed to provide all covered services to eligible Medi-Cal beneficiaries in Contra Costa, Fresno, Los Angeles, and Tulare Counties regardless of cost in return for a fixed capitation rate per member per month. DHS agreed to recalculate the capitation rates annually. In 1998 the parties amended the contract.

The Disputes and Appeals section of the contract sets forth a detailed claims presentation procedure. It provides that [w]ithin fifteen (15) days of the date the dispute concerning performance of this Contract arises or otherwise becomes known to the Contractor, the Contractor will notify the Contracting Officer in writing of the dispute, describing the conduct (including actions, inactions, and written or oral communications) which it is disputing. Health Nets failure to timely submit a notification of dispute (NOD) or any required supporting documentation waives all claims regarding the dispute. While the dispute is pending, Health Net must proceed diligently with the performance of this Contract . . . .

Threshold Issues

Notices of Dispute

Section 3.21.2 of the contract, entitled Notification of Dispute, states that [w]ithin fifteen (15) days of the date the dispute concerning performance of this Contract arises or otherwise becomes known to the Contractor, the Contractor will notify the Contracting Officer in writing of the dispute . . . . The rates are to be effective on October 1 of each rate year and implemented by December 1. DHS contends the NODs were not timely because they were not filed within 15 days of December 1 of each rate year. The trial court agreed that December 1 was the trigger date. The question thus posed is whether December 1 always triggers the running of the 15-day period to give notice when rate adjustments are not made whether or not the Legislature has appropriated the funding, or DHS has or has not announced the rates or when it will pay.

DHS asserts that on each December 1 Health Net was aware that no new rates were implemented and, thus, it had an interest claim. According to DHS, the claim for interest is inextricably intertwined with the delayed rate implementation. In other words, as soon as the rates were delayed, interest accrued and a claim arose. The contract suggests otherwise.

In fact, as DHS readily admits, it could not implement new rates until the Legislature appropriated the funding. The contract provided for that reality and, as DHS also acknowledges, contains a contingency clause that [a]ll . . . rate adjustments beyond September 1997 are subject to future appropriations of funds by the Legislature and the Department of Finance approval.

The contract also describes how adjustments will be made when payments are delayed. Section 5.5, paragraph B states: In the event there is any delay in a determination to increase or decrease capitation rates, so that a Change Order may not be processed in time to permit payment of new rates commencing October 1, the payment to Contractor shall continue at the rates then in effect. Those continued payments shall constitute interim payment only. Upon final approval of the Change Order providing for the rate change, DHS shall make adjustments for those months for which interim payment was made. Paragraph C further states: Notwithstanding paragraph B, payment of the new annual rates shall commence no later than December 1, provided that a Change Order providing for the new annual rates has been issued by DHS. We begin with the pertinent chronology.

Several rate years are at issue, beginning with 1997-1998. The dispute for that rate year was the most protracted because, according to Health Net, DHS would not implement new rates until Health Net agreed to voluminous amendments to the contract. The rate year began in October 1997 but no rate increases had been paid as of November 1998. On November 9, 1998, Health Net signed amendment 7 to the contract with the assurance that it would receive the rate increases DHS had withheld since December 1997. On November 18, 1998, Health Net first learned that DHS would not pay interest on the overdue rate increases when DHS asked Health Net to verify an amount that did not include interest. Health Net filed its first NOD on November 30, 1998, seeking interest on the delayed rate implementation.

The 1998-1999 rate year had begun on October 1, 1998, but DHS did not publish the preliminary rates until January 21, 1999. On May 7, 1999, DHS issued a change order for the 1998-1999 actuarially determined rates and informed Health Net that rate increases would be delayed until June 1999, and no interest would be paid. Health Net filed its second NOD on May 21, 1999, complaining again that DHS improperly withheld interest on the delayed rate implementation and improperly retained a 5.6 percent prepayment discount even though it had not prepaid the capitation payments at the beginning of the month. In June 1999 DHS implemented the rate increases for 1998-1999 but took the prepayment discount even though it was over eight months into the rate year.

In late October 1999 DHS announced that because of the budget process, the rate adjustment would be delayed until the Legislature approved funding, thereby delaying the rate implementation for the 1999-2000 rate year until at least February 2000. On November 9, 1999, Health Net filed its third NOD, anticipating DHSs future breach of contract for failure to pay interest and for retaining the prepayment discount for payments that would not be prepaid. In February 2000 DHS implemented new rates, did not pay interest, and again took the prepayment discount.

Under the express terms of the contract, DHS was not obligated to commence paying increased rates until the change orders were approved and the Legislature had appropriated the funding. Health Net, therefore, would not know whether the adjustments provided in paragraph B of section 5.5 of the contract would include payment of interest until DHS was obligated to commence payments. Accordingly, December 1 could not be an automatic trigger for the running of the 15 days during which Health Net was obligated to give notice of a dispute. It was not until DHS notified Health Net each year that it refused to pay interest that the dispute arose or Health Net otherwise became aware of the dispute. Hence, because the NODs were filed within 15 days of the date on which Health Net learned DHS would not pay interest, the NODs were timely.

The Government Claims Act

The claim-filing requirement of the Government Claims Act [Gov. Code, 900 et seq.; Claims Act] serves several purposes: (1) to provide the public entity with sufficient information to allow it to make a thorough investigation of the matter; (2) to facilitate settlement of meritorious claims; (3) to enable the public entity to engage in fiscal planning; and (4) to avoid similar liability in the future. (Westcon Construction Corp. v. County of Sacramento (2007) 152 Cal.App.4th 183, 200 (Westcon).) The purpose of the Claims Act is not to prevent surprise, for even a public entitys actual knowledge of a claim does not satisfy a litigants responsibility to file a timely claim before initiating a lawsuit. (City of Stockton v. Superior Court (2007) 42 Cal.4th 730, 738; Del Real v. City of Riverside (2002) 95 Cal.App.4th 761, 767.) Thus, the failure to present a timely contractual claim with the public entity bars the plaintiff from filing a lawsuit and subjects the complaint to a general demurrer. (State of California v. Superior Court (2004) 32 Cal.4th 1234, 1237, 1240.)

Health Net invokes a Government Code section 930 exemption to the claim-filing requirement.^[1] Section 930 provides, in pertinent part: (a) Any state agency may include in any written agreement to which the agency is a party, provisions governing the . . . [] . . . presentation, by or on behalf of any party thereto, of any or all claims that are required to be presented to the board arising out of or related to the agreement. ( 930, subd. (a)(1), italics added.) In Health Nets view, the alternative claim procedure set forth in detail in the contract was tantamount to the Claims Acts claims-filing requirements. More specifically, Health Net relies on the express language of section 930.4s exception to claims filing requirements.

Section 930.4 provides, in part: A claims procedure established by agreement made pursuant to Section 930 or Section 930.2 exclusively governs the claims to which it relates, except that if the procedure so prescribed requires a claim to be presented within a period of less than one year after the accrual of the cause of action and such claim is not presented within the required time, application may be made to the public entity for leave to present such claim.

DHS asserts that there is nothing in the disputes and appeals section of the contract that states or implies the NOD process was intended to supplant the claims filing requirements. In other words, DHS implies that an alternative claims procedure is ineffective unless there is an express waiver of the Claims Act notice requirements. We disagree. The disputes and appeals section describes a comprehensive mechanism for the presentation of claims and for resolving disputes regarding performance under the contract, including the requirement that Health Net must submit a written NOD describing the conduct (including actions, inactions, and written or oral communications) which it is disputing. Thus, the contract itself accomplishes the same objectives as the Claims Act and assures DHS is provided timely information to facilitate investigation, settlement, fiscal planning, and the implementation of preventative measures. The contract substitutes one kind of notice for another.

DHS fails to cite to any provision of the Claims Act that requires an express waiver. Implicit in sections 930 and 930.2 is the opportunity for parties to an agreement with a state agency to forego the claims procedure prescribed by statute and to provide an alternative procedure for giving the agency notice of a potential claim. We agree with Health Net that section 3.22 of the contract is a provision[] governing the . . . [] . . . presentation . . . of any or all claims that are required to be presented to the board arising out of or related to the agreement. ( 930, subd. (a)(1).) Pursuant to section 930.4, once a state agency exercises its discretion to include an alternative claims procedure as comprehensive as the one before us, the contractual provision exclusively governs the contracting partys claims.

At a minimum, the NODs Health Net filed pursuant to contract constitute substantial compliance with the Claims Act. (City of San Jose v. Superior Court (1974) 12 Cal.3d 447, 456-457.) The NODs provided the same information required by section 910 and provided enough information to allow DHS to investigate the allegations while the witnesses and evidence were still fresh.

DHS, however, insists Health Net did not substantially comply with the Claims Act because the NODs were served on the contracting officer, not the Victim Compensation and Government Claims Board (Claims Board). There is a glaring difference between the facts in Westcon, supra, 152 Cal.App.4th 183 and those before us. In Westcon, a contractor served its claim on a county employee, rather than the county board of supervisors. (Id. at p. 192.) But in Westcon, unlike here, there was no alternative claims procedure set forth in a contract with the public entity. Thus, the court concluded [t]here was a complete failure to serve a responsible officer of the County. (Id. at p. 202.) Here, Health Net served the very officer DHS designated in the contract, the sole administrator of the contract with authority to make all determinations and take all actions as are appropriate . . . . As a result, it can hardly be said there was a complete failure to serve the responsible officer.

Substantive Issues

The Interest Cases

Health Net contends it is entitled to interest on the rate increases DHS failed to pay on time. On the surface, Health Nets position sounds reasonable because we are accustomed to the notion that late payments accrue interest and that compensatory damages for a breach of contract include interest to make the nonbreaching party whole. But we are constrained by the terms of the contract.

To be fair, Health Net urges us to look to the plain meaning of the contract. The contract, as we noted above, states that the change order for each year becomes effective as of October 1, and DHS is compelled to make adjustments for those months a contractor, such as Health Net, is underpaid. Health Net concludes the adjustments do not make the new rates fully effective on October 1 if they do not include the time value of the money that was paid months earlier.

DHS relies on an even plainer reading of the contract. It argues that the contract does not provide for interest when the adjustments are made. DHS points out that the contract provision regarding adjustments is fairly detailed regarding when and how the adjustments will be made, and yet there is no provision for interest for either party. DHS concludes that the exclusion was deliberate.

Health Net directs our attention to two other provisions in which the contract took interest into account for the states benefit.^[2] The examples Health Net provides support DHSs contention, and reaffirm our conclusion, that had the parties intended for interest to be included in the adjustments, they would have addressed it in the contract. Moreover, we find it peculiar that DHS would have failed to specify the amount of interest it would be required to pay had it believed, as Health Net contends, that interest would be part of the adjustments. Because the time value of money fluctuates from year to year, Health Net would have us believe the state agreed to open-ended liability subject to the erratic and unpredictable changes in interest rates. We find that the use of the word adjustment did not include interest and allowed DHS to pay rate increases retroactive to October 1. Health Net assumed the risk of delayed rate increases when it entered an agreement postponing DHSs obligation to pay until the funding was appropriated and the Department of Finance approved the increase.

It is important to emphasize that DHS was not in breach of contract when it failed to pay the increased rates before the Legislature appropriated the funds and the Department of Finance approved the change orders. Consequently, Health Net was not entitled to interest as a component of damages for breach of contract. In a slightly different twist, Health Net argues that the condition precedent focuses on when the duty to perform arises and not on how much DHS was required to pay. Health Net concludes that although DHSs duty to pay was postponed, the amount of the adjustment continued to increase with every month the increased rate was not paid. The argument brings us full circle.

We agree that the condition precedent does not redefine the amount of the obligation, but it does define the date of a breach. Had DHS been in breach of contract, Health Net might have had a claim for interest as a component of its compensatory damages. In the absence of a breach, we must return to the language of the contract, and because we have concluded that adjustments do not include interest even when the effective date of the adjustments is specified as October 1, Health Net is not entitled to interest for the retroactive payments.

Prepayment Discount

Under the contract, Health Net has the option to be paid at the beginning of each month in advance of providing services to beneficiaries, in which case the state is entitled to a 5.6 percent prepayment discount, or at the end of the month at the full rate established for a particular rate year. Health Net elected to be paid at the beginning of each month. DHS, however, continued to deduct the prepayment discount on payments that were delayed as much as 15 months. Health Net objects to the deduction for prepayment discounts that were not prepaid.

DHS asserts a very technical argument to dispel the counterintuitive notion that it is entitled to a discount for late payments. DHS contends that once Health Net opted for prepayments, the discounted rate became a term of the contract and its prepayment election controlled, not the timing of the payments. Moreover, DHS complains that Health Net failed to mitigate its damages by changing the election and requesting payment at the end of the month. When it became clear that DHS did not, and would not, forego the discount on its late payments, Health Net did ultimately forego its right to prepayment and elected to be paid at the end of the month in order to avoid DHSs continued application of the prepayment discount.

Health Net insists that the rate manual, not the contract, describes the prepayment discount. The rate manual refers to the discount as an interest adjustment. The manual provides: The interest adjustment is only made for plans that receive capitation at the beginning of the month. It is the one month discount factor at an annual rate of 5.6 percent (based on what the State would be expected to earn in the Pooled Money Investment Fund.) The discount (interest adjustment) on its face only applies to plans that receive payments at the beginning of the month. We agree with Health Net there was no legitimate basis for DHS to retain interest on payments that were not receive[d] . . . at the beginning of the month. We simply cannot accept DHSs rigid enforcement of a so-called election that contravenes any reasonable interpretation of the terms of the contract calling for a prepayment discount.

In an argument merely floated in a footnote in the opening brief but expanded in the reply brief, Health Net now asserts it is entitled to an amount equal to the entire prepayment discount and not just the portion attributable to the difference between the old and new rates. We are not disposed to consider arguments set forth in footnotes. (See Unilogic, Inc. v. Burroughs Corp. (1992) 10 Cal.App.4th 612, 624, fn. 2.) In any event, the argument is without merit. Health Net overreaches and, like DHS, attempts to substitute a highly technical argument for common sense and basic fairness.

During each of the rate years in which the increased rates were delayed, the contract required DHS to continue to pay the old rates during the interim. Health Net does not suggest DHS failed to pay the old rates, presumably at the beginning of each month. As to the old rates paid on time, DHS is entitled to the prepayment discount as those payments continue to be prepaid. We concluded above that the state was not entitled to discount the differential, that is, the retroactive adjustment to the new rates, because that differential had not been prepaid.

But Health Net now attempts to recover the entire discount, assertedly because (1) the prepayment discount is part of the rate methodology, (2) the rate methodology is supposed to produce sound rates, (3) early payment was impossible because of the budget process, and therefore (4) the entire rate must be deemed unsound insofar as the prepayment discount was applied. We reject this convoluted logic for the same reason we reject DHSs strained construction of the contract -- not only does the logic defy common sense and a reasonable construction of the agreement between the parties, but it requires the court to play with the words of the agreement to create an unjust result.

Neither party has directed us to specific contract language that would require us to pillage the ordinary meaning of a prepayment discount. DHS is entitled to a discount to the extent it prepaid the capitation rates at the beginning of each month. For those rates that were not prepaid, that is, the new rates, it was not entitled to the discount. Anything more or less distorts the plain meaning of the language and imposes an unfair windfall on one party or the other.

PART II: THE RATE CASES

Facts

Under the contract, DHS is obligated to make an annual redetermination of rates either unilaterally on an actuarial basis or through negotiation. Capitation rates for each rate period, as calculated by DHS, are prospective rates and constitute payment in full . . . on behalf of a Member for all Covered Services required by such Member and for all Administrative Costs incurred by Contractor in providing or arranging for such services . . . . All rate adjustments after September 1997 are subject to future appropriations of funds by the Legislature and the Department of Finance approval. Further, all payments are subject to Title 42, CFR 447.361 and the availability of Federal congressional appropriation of funds. Rate adjustments are effective as of October 1 of each year. Health Net assumed the total risk of providing the covered services in return for the capitated rates.

Attachment 1 of the contract, as amended, presents the methodology and calculation of the capitation rates to be used by actuaries employed by DHS. Under the capitated contract, the state pays Health Net a monthly fee for each Medi-Cal beneficiary enrolled in the plan and Health Net is then responsible for providing all medically necessary health care services to the beneficiary . . . . The precise methodology set forth in the contract is as follows: The rate development process for this Contract consists of two separate calculations. First, a Fee-For-Service equivalent (FFSE) is determined for the entire group of Medi-Cal eligibles. Second, rates are calculated for each Contract by beneficiary aid code using historical Medi-Cal managed care data. The name given this latter method is an experienced [sic] based methodology. Both the FFSE and experience based methodologies use factors which directly influence the cost of providing health care to Medi-Cal beneficiaries. These factors are age, sex, geographic area with price indices, Medi-Cal aid code, and eligibility for Medicare. The rate methodologies also employ adjustments for changes that are likely to occur during the term of the Contract. These adjustments include fee, benefit, or policy changes to reflect changes to the Medi-Cal program that are mandated each year by the State Legislature and the use of a trend factor to project costs to the term of the Contract.

In the administrative hearing, the DHS actuary testified to his understanding of the scope of this authority and discretion, his fiduciary responsibilities, his lack of familiarity with the contract, the budget constraints, the horse trading that became part of the actuarial process, and the variety of factors that influenced his redetermination of the rates. Despite the fact he had not seen the rate determination methodology set forth in the contract before the administrative hearing and had read only parts of the contract, he was confident that he alone was responsible for setting the rates and, as an actuary, he had the discretion to do so. He had never grappled with any limits on his discretion in setting rates as such a consideration was not important to him.

The actuary expressed no obligation to adhere to the terms of the contract, but believed he had a fiduciary responsibility to the people of California. And I want to spend their money as best as possible to get quality medical care. So, Im looking to spend as little as possible. In fact, he never gave any consideration whether his approach was consistent with the terms of the contract.

The actuary was forthright about the predominant role of the budget in rate setting. He candidly stated, And if I know that the government has less funds, then yeah, Im going to try and spend less. In fact, he testified that the budget set the pool for the 2001-2002 rate year. He was given a mandate to freeze the rates to the level set for the prior 2000-2001 rate year. On cross-examination, the actuary admitted he could not be certain that he would have set the same rate without considering the budget. Rather, the budget made it easier for me to do my work.

His work was not always transparent. At the administrative hearing, he revealed for the first time the factors he had utilized and admitted they were not set forth in the rate manual provided to the plans. He believed that an actuary retained the freedom to consider a multitude of economic, geographic, and political factors. Indeed, at one point he testified that the profitability of Health Nets parent company gave him comfort that the rates would be sufficient and the plan would not go out of business. There was even horse trading that went on between the actuary and his supervisors to make the rates more palatable to the plans.

Based on the actuarys forthright testimony, the trial court found he had deviated from the actuarial methodology set forth in attachment 1 of the contract. The court explained: Petitioner is correct that the amount of money available in the state budget for capitation rate payments is not a factor that may properly be considered in the actuarial determination of capitation rates under Attachment 1 to the contract. [Citation.] Thus, in its final decision, respondent incorrectly determined that the Departments actuaries acted within the terms of the contract and properly looked at the Budget element. [Citation.] Under the contract, available legislative appropriations may be considered only in the context of capitation rate payments, which are conditioned on approval by the Department of Finance and appropriations by the Legislature. [Citation.] Neither Attachment 1 to the contract nor acceptable actuarial practice provides a basis for considering budgetary constraints in the actuarial calculation of the rates.

[] . . . []

With respect to the 2001/2002 rate year, however, substantial evidence in the administrative record does establish that respondents actuaries were required to set capitation rates within the constraints of available budgeted funds. [Citation.] Clearly deviating from the actuarial methodology set forth in Attachment 1, the actuaries set the rates within the pool of budgeted funds instead of the FFSE/UPL [upper payment limit].

Yet the actuary believed that despite the budget concern, the rates were actuarially sound. He, and other administrators at DHS and the Department of Finance, testified they would not have approved rates that were not actuarially sound. He described at some length how he first calculated the FFSE/UPL and then set the rate by using the available experience data. He made necessary adjustments as he obtained better data over time.

This testimony led the superior court to conclude: Nonetheless, this deviation from the Attachment 1 methodology did not produce capitation rates for 2001/2002 that were actuarially unacceptable. When setting the rates within the pool of budgeted funds, the actuaries also followed the actuarial methodology in Attachment 1 to calculate the FFSE/UPL and found that it was less than the pool of budgeted funds. Accordingly, the budgetary constraints imposed on the rate-setting process did not reduce the 2001/2002 capitation rates below an acceptable actuarial level. [Citation.]

Thus, although respondent clearly breached the rate-setting methodology in Attachment 1 to the contract when it imposed budgetary constraints on the rate-setting in 2001/2002, no corrective action or damages is necessary or appropriate. A writ of mandate requiring respondent to recalculate the 2001/2002 rates without regard to any budget constraints would only require respondents actuaries to do what they have already done and would not uncover any additional amount of capitation rates to which petitioner would be entitled as damages.

The actuary, however, did not testify that the FFSE/UPL was less than the pool of budgeted funds as the court reported. As a result, the linchpin of the trial courts analysis is flawed. Although the actuary testified he calculated the FFSE/UPL in an orthodox manner, he clearly stated that the budget set the pool and contrary to the courts finding, he never opined that the budget allotment was greater than the FFSE/UPL.

Discussion

A. Administrative Costs

We do not disagree with Health Nets basic assertion that it was entitled to recover its administrative expenses as part of its costs of providing services to Medi-Cal beneficiaries. The capitation rates set forth in the contract, as Health Net points out, are to include the costs of providing the covered services and the administrative costs. Nor do we read the actuarys testimony to be at odds with this basic principle. As Health Net emphasizes, he too explained that an administrative adjustment is part of a rate calculation.

Yet Health Net objects to the actuarys failure to identify its compensation for administrative costs as a separate component of the rate calculation in the rate manual. Having evaluated Health Nets argument in the context of a voluminous administrative record on actuarial practices, discretion, and methodology, we conclude the issue is not whether Health Net should be compensated for its administrative costs, for everyone agrees it should be, but whether the contract required the actuary to account for those costs separately and to identify how and where they were calculated into the rates for 1998-1999, 1999-2000, and 2001-2002. This issue presents a mixed question of law and fact.

We interpret the terms of the contract de novo. (E.M.M.I.Inc. v. Zurich American Ins. Co. (2004) 32 Cal.4th 465, 470.) We pointed out above those provisions that support Health Nets position the capitated rates are to include administrative costs. But it is attachment 1 to the amended contract that sets forth the specific methodology for calculating the rates. That methodology, as quoted in full in our statement of facts, ante, at pages 17 and 18, describes the two-step process the actuary must follow and expressly identifies a variety of factors that influence the calculation of costs. These factors are age, sex, geographic area with price indices, Medi-Cal aid code, and eligibility for Medicare. The rate methodologies also employ adjustments for changes that are likely to occur during the term of the Contract. These adjustments include fee, benefit, or policy changes to reflect changes to the Medi-Cal program that are mandated each year by the State Legislature and the use of a trend factor to project costs to the term of the Contract. Conspicuously missing from the list of factors or adjustments are administrative costs. We therefore conclude that although administrative costs are to be included in the capitation rates, the terms of the contract do not compel the actuary to separately identify those costs in his rate calculations.

Yet this issue also presents a question of fact as to whether the actuary did include administrative costs in the rates. Thus, we must comb the actuarys testimony to determine whether there is substantial evidence to support the administrative tribunals and superior courts findings that his rate calculations included administrative costs. The record supports the findings.

It is important to distinguish the states administrative costs from the administrative costs incurred by Health Net. The actuary testified that the state accrued savings from delegating to the plans the management costs associated with health care. Yet at the same time, the state incurred a number of expenses associated with running a managed care program. The actuary explained that the expenses incurred by the state were to be paid from the savings. To understand how the actuary treated the states administrative costs, we turn to the two-step methodology required by the contract and the actuarys testimony as to where these costs influenced the process.

Pivotal to the entire rate setting methodology is the determination of the FFSE under the traditional fee-for-service program managed by the state. Under federal law the state was prohibited from paying the plans under the managed care program more than the state would have paid cumulatively under the fee for service program. Thus, step one, referred to by the actuary as step A, of the calculation required the actuary to calculate the total fees for equivalent services; that figure became the UPL. This figure was characterized as the pool or the pie.

The actuary explained that the savings the state accrued as a result of delegating its administrative responsibilities to the plans was added to the UPL, thus enlarging the pie for the plans benefit. Consequently, the administrative costs, while not transparent, appear to have been included in the calculation of the FFSE and to have been used to enlarge the UPL. Furthermore, as the trial court pointed out, The actuary testified that the rates were intended to provide enough money overall for the operations of a managed care plan like petitioner, overpaying for some services and underpaying for others. [Citation.] In particular, the managed care plan was expected to have large savings in hospital inpatient services that would cover its administrative costs.

The actuary testified to the actuarial soundness of his rate calculations. Given his inflated sense of actuarial discretion and his abiding conviction that his allegiance was to the taxpayers of the State of California rather than the parties to the contract, it is not surprising that Health Net would have little confidence in his inclusion of its administrative costs in a manner that was at best camouflaged. But, as we pointed out above, the contract itself did not require the transparency Health Net now expects. Circumscribed by the limited scope of appellate review of administrative proceedings, we conclude the actuarys testimony constitutes substantial evidence to support his calculations, and in the absence of a contractual provision requiring him to separately identify administrative costs as a factor or an adjustment, he was not obligated to provide any greater specificity than he did.

Our task is to interpret the meaning of the terms of the contract, including the technical meaning of the actuarial methodology set forth in attachment 1 of the contract. In short, both parties are bound to the plain meaning of the terms set forth in the contract. Where, as we explain below, those terms required the actuary to employ a specific methodology, we will enforce the terms of the agreement. But where, as here, the contract does not require the actuary to include a separate component for administrative costs, we must also adhere to the terms of the agreement. We agree with Health Net that the contract envisions administrative costs will be included in the capitation rates, but we disagree that the language required a specific calculation.

B. The Rate Freeze

Let us begin with the elephant in the room. That beast is the state budget or, more accurately in the lean years at issue here, the looming state deficit. The question is what role the deficit should have played and what role it did play in the calculation of the capitated rates for the rate year 2001-2002.

The administrative tribunal was very blunt in its finding that [t]he State Budget always plays a role in monetary issues and with an expenditure of public monies. To argue otherwise is naive. The Contract is very clear about that. Section 5.5 states that any rates are subject to the allocation of funds by the Legislature and [Department of Finance] approval. The Contract also sets forth maximum amounts a provider will be paid in a given year.

While Health Nets position is that consideration of the Budget goes outside the scope of the rate redetermination methodology, this tribunal finds that the Departments actuaries acted within the terms of the Contract and properly looked at the Budget element.

As already mentioned, the superior court disagreed. Unlike the administrative tribunal, the court found that the actuary did not follow the contractual methodology required for redetermining the rates and consequently breached the contract. Nevertheless, the court found the breach caused no damages because the frozen rates were higher than the UPL, and consequently, the rates the actuary calculated were not only actuarially sound, they were not affected by the freeze.

DHSs position appears to be much more nuanced than the administrative tribunals and definitely at odds with the superior courts finding that the actuarys methodology breached the contract. DHS does not contend that the actuary was at liberty to set the UPL based on the budget alone. Indeed, as Health Net points out, in 2001 DHS admitted a freeze would violate the contract. Rather, DHS emphasizes the wide discretion accorded actuaries, the range of rates allowed under the contract methodology, the possibility of diverse but acceptable actuarial opinions, and the soundness of the actuarially derived rates. DHS, in essence, would have us broadly construe the terms of the contract to accord the actuary considerable discretion to employ sound actuarial methods and find substantial evidence that the rates fell within an acceptable range.

Health Net, on the other hand, insists that the contract prescribes the specific methodology to be used by the state actuaries when DHS elects to unilaterally, but actuarially, redetermine rates. According to Health Net, that methodology, set forth in attachment 1 to the contract as revised by amendment 7, dictates the exclusive factors the actuaries are allowed to use in calculating the rates and circumscribes their actuarial discretion. Simply put, since the budget is not enumerated in the factors identified in the contract methodology, Health Net concludes the actuary erred when he succumbed to a mandated freeze and allowed the budget [to] set the pool. The contract language subjecting rate redeterminations to future legislative appropriations, in Health Nets view, has no bearing on rate setting; rather, it applies only to the ability of the state to pay the rates its actuaries have determined.

Health Net argues that its interpretation of the contract is consistent with federal and state law. DHS does not challenge the federal holdings that budgetary considerations cannot be the conclusive factor in rate setting. (See, e.g., Clayworth v. Bonta (E.D.Cal. 2003) 295 F.Supp.2d 1110, 1129, reversed on other grounds in Clayworth v. Bonta (9th Cir. 2005) 140 Fed. Appx. 677 [2005 U.S. App. LEXIS 16093].) DHS concedes the budget was a factor in the actuarys rate setting, but it was not the conclusive factor. Thus, the simplistic proposition that the budget cannot exclusively dictate rates does not answer the much thornier question whether the rate freeze was dictated by the budget or a mere footnote in the actuarys rate redetermination.

Section 14301, subdivision (a) of the Welfare and Institutions Code, also cited by Health Net, is more instructive. This section requires that a detailed description of the specific actuarial method to be used by the state actuary in determining prospective per capita rates should be included in the contract. Subdivision (a) states, in part: The contract shall provide the specific per capita rates, to be determined by sound actuarial methods on the basis of age, sex, and aid categories, which the state shall pay the prepaid health plan each month for each beneficiary enrolled in the prepaid health plan, a detailed description of the specific actuarial method or methods and assumptions used in determining per capita rates, and a summary of the data base, including costs and inflation assumptions and utilization rates, which was used to determine per capita rates. Nowhere in section 14301 does the Legislature direct the actuary to use the budget as a factor in rate setting, let alone allow legislative appropriations to determine the rates.

Health Nets contract with the state follows the guidelines set forth in Welfare and Institutions Code section 14301. The revised attachment 1 to the contract provides a detailed description of the specific actuarial method or methods and assumptions used in determining per capita rates. Given the specificity of the methodology set forth in the contract and the legislative directive to include this type of detailed description within the contract, we agree with Health Net that the contract does circumscribe the state actuarys discretion and does not allow the budget to determine the rates. The administrative tribunal erred as a matter of law in deciding that the contract clearly provided for the state budget to play a role and that the actuaries worked within the terms of the Contract by incorporating the Budget element.

Although DHS gives lip service to the contract methodology and suggests the actuary followed the essential steps in the prescribed methodology, the main thrust of DHSs argument is that the freeze had no meaningful impact on the rate setting because the actuary would have proposed the same rates whether or not a freeze was in effect. Despite the freeze, in other words, the rate setting was actuarially sound. The actuarys testimony belies DHSs position in several material respects.

First and foremost, the actuary testified that [t]he budget set the pool, a freeze had been mandated, and he [was] not certain that the rates would have been the same without considering the budget. Since pool was synonymous with the UPL, the freeze defined the total amount of money available to pay the plans. And since the actuary himself could not say that the rates would have been the same in the absence of the mandated freeze, we cannot accept DHSs argument that they would have been.

Second, we are troubled by the actuarys testimony in several other respects. He candidly admitted he had not seen the contract before the administrative hearing and his allegiance was not to following the methodology prescribed in the contract but to the taxpayers of the state. He believed he had a fiduciary obligation to those taxpayers to maximize savings and, impliedly therefore, to minimize rates to the plans. As a result, we agree with the trial court that by failing to follow the prescribed methodology, DHS breached the contract.

We reject DHSs proposition that the rates should not be disturbed because they are actuarially sound. If we were asked solely to determine whether there was substantial evidence to support a finding that the rates were actuarially sound, we would have to conclude the actuary and supervisor in the Department of Finance provided testimony that they were confident of the integrity of the rate setting and that testimony would be sufficient. But this is a contract case and we must give effect to the plain terms of the parties agreement.

Health Net bargained for much more than the vaporous notion that the rates would be actuarially sound. Either it had the opportunity to negotiate a redetermination of rates or, under the terms of the contract, the state actuaries were required to follow a prospective assessment of costs as embodied in the detailed methodology set forth in amendment 7 to attachment 1 to the contract. Although the contractual methodology itself allowed for the exercise of some degree of actuarial discretion in calculating future rates based on insufficient data, that discretion certainly was not left unfettered. The failure to implement the contractual methodology constituted, as the trial court found, a breach of contract.

But the record does not support the trial courts finding that the breach caused no damages, or at a minimum, the testimony is simply too ambiguous to conclude that the rates would not have been higher in the absence of the freeze. If, as the trial court found, the actuary had testified that the UPL was smaller than the frozen rates, then we would agree the freeze did not impact the actuarys rate setting because the frozen rates would have been higher than the pool of funds available to distribute to the plans. But the trial court erred -- the actuary did not testify the UPL was less than the frozen rates. Quite to the contrary, he testified the budget set the pool and he was uncertain whether the rates would have been higher had there been no mandated freeze.

There is one final ingredient. Health Net complains that because of the freeze, the actuary failed to take four out of six trend factors into account. The contract does dictate that the rate methodologies must employ adjustments, including a trend factor to project costs to the term of the Contract. DHS complains that Health Net failed to raise the issue in the trial court. Since we must remand the 2001-2002 rate year to DHS for a redetermination of the rates independent of the freeze, the actuary should make any necessary contractual adjustments based on the appropriate trend factors.

DHS urges us to remand this matter to the administrative tribunal for a determination whether there was a breach of contract and only then for a calculation of damages, if necessary. We will remand the matter, but for the limited purpose of calculating the capitation rates for the 2001-2002 rate year. We explain.

The trial court found DHS breached the contract when its actuary failed to apply the contractual methodology for the 2001-2002 rate year. For all the reasons discussed in part II of this opinion, there is substantial evidence to support the trial courts finding. Moreover, the analysis of breach hinged on the proper interpretation of the contract. Because we interpret the meaning of the contract de novo, there is no reason to begin anew.

Rate determination, however, presents an entirely different challenge. Neither the administrative tribunal nor the trial court reached the issue of the amount of damages, either because, in the case of the administrative tribunal, it found no breach or, in the case of the trial court, it found there were no damages. Actuarial science far exceeds our capabilities.

We therefore remand the matter to DHS for an actuarial determination of the rates for 2001-2002 without considering a rate freeze or the state budget. The actuary is not contractually obligated, as we found above, to provide a separate component for Health Nets administrative costs. Nor is DHS required, under the terms of the contract, to pay interest. DHS is required, however, to refund the prepayment discount it took for the months the adjustments were made after the Legislature appropriated the funding.

DISPOSITION

We affirm the superior courts 2004 denial of the petition for a writ of administrative mandamus insofar as it denies Health Nets claim for interest, and reverse it insofar as it denies Health Nets claim for a refund of the prepayment discounts deducted from retroactive adjustments.

We affirm the superior courts 2006 denial of the petition for a writ of administrative mandamus insofar as it denies Health Nets claim for additional compensation for its administrative costs, and reverse it insofar as it erroneously concludes the breach of contract was inconsequential.

We remand to DHS to calculate the rates for rate year 2001-2002 without imposing a mandated freeze and by applying the trend factors required by the contract.

Health Net shall recover costs on appeal.

RAYE , J.

We concur:

DAVIS , Acting P. J.

BUTZ , J.

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^[1] All further statutory references are to the Government Code unless otherwise indicated.

^[2] The contract recognizes there is an interest loss to the State when the State pays contractors in advance of the time they would be required to pay claims and therefore DHS includes an interest adjustment . . . to recognize this payment lag. The contract also provides for the prepayment discount discussed post, at pages 13 through 16, and that discount, according to Health Net, recognizes the time value of money.