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Clarian Health West, LLC v. Hargan

United States Court of Appeals, District of Columbia Circuit

December 26, 2017

Clarian Health West, LLC, doing business as Clarian West Medical Center, Appellee
Eric Hargan, Acting Secretary, U.S. Department of Health and Human Services, Appellant

          Argued October 12, 2017

         Appeal from the United States District Court for the District of Columbia (No. 1:14-cv-00339)

          Katherine Twomey Allen, Attorney, U.S. Department of Justice, argued the cause for appellant. With her on the briefs was Michael S. Raab, Attorney.

          Z.W. Julius Chen argued the cause for appellee. With him on the briefs were Christopher L. Keough and Stephanie A. Webster.

          Before: Garland, Chief Judge, Henderson, Circuit Judge, and Edwards, Senior Circuit Judge.



         This case involves a challenge to the legality of a Department of Health and Human Services ("HHS") decision to set forth certain policies regarding the means of calculating reimbursements for Medicare providers in an instruction manual without engaging in notice-and-comment rulemaking. Because we find that nothing required the agency to proceed otherwise, we must respect its selected approach. See Perez v. Mortg. Bankers Ass'n, 135 S.Ct. 1199, 1206 (2015) (emphasizing that courts may not "improperly impose[] on agencies an obligation beyond the 'maximum procedural requirements' specified by [statute or regulation]" (quoting Vermont Yankee Nuclear Power Corp. v. Nat. Res. Def. Council, Inc., 435 U.S. 519, 524 (1978))).

         Under Part A of the Medicare program, hospitals are compensated prospectively based on the estimated likely cost of patient care. Prospective Payment for Medicare Inpatient Hospital Services, 49 Fed. Reg. 234 (Jan. 3, 1984); 42 U.S.C. § 1395ww(d)(2). On some occasions, when the prospective payments appear to have been insufficient, hospitals also receive supplemental or "outlier" payments. 42 U.S.C. § 1395ww(d)(5)(A)(ii); see also Dist. Hosp. Partners, L.P. v. Burwell, 786 F.3d 46, 49 (D.C. Cir. 2015).

         In 2003, the Secretary of HHS promulgated a regulation, through notice-and-comment rule making, that altered the way such "outlier payments" are calculated. Change in Methodology for Determining Payment for Extraordinarily High-Cost Cases (Cost Outliers) Under the Acute Care Hospital Inpatient and Long-Term Care Hospital Prospective Payment Systems, 68 Fed. Reg. 34, 494 (June 9, 2003). As part of the regulation, HHS determined that the payments should be subject to recalculation-or "reconciliation"-after certain hospital cost reports were finalized in order to ensure that the payments corresponded with the hospitals' actual experienced costs. See id. at 34, 501; 42 C.F.R. § 412.84(i)(4). The regulation did not determine how hospitals would be selected for this reconciliation procedure.

         In 2010, HHS established instructions governing the selection process. Set forth in a manual for Medicare payment contractors, the instructions provided two criteria for payments that should be recalculated and reconciled. Medicare Claims Processing Manual, ch. 3, § (Dec. 3, 2010), reprinted in Joint Appendix ("J.A.") 129-30 [hereinafter CMS Manual]. In 2012, HHS and its contractor determined that Appellee Clarian Health West ("Clarian" or "Appellee") met the criteria for outlier payments made to it for services provided in fiscal year 2007. The hospital was subjected to reconciliation, and it was ultimately required to pay back over $2 million in outlier payments.

         Clarian challenged the 2010 Manual instructions before the District Court. It asserted, inter alia, that both the Administrative Procedure Act ("APA"), 5 U.S.C. § 553, and the Medicare Act, 42 U.S.C. §§ 1395hh(a)(1), (b)(1), required HHS to promulgate the criteria for selecting hospitals for reconciliation by regulation after notice-and-comment rule making. And because the Manual instructions were not established in that manner, Clarian claimed that both the instructions and the reconciliation taken pursuant to them were procedurally invalid.

         The District Court found merit in Clarian's procedural challenge and granted its motion for summary judgment. Clarian Health West, LLC v. Burwell, 206 F.Supp.3d 393 (D.D.C. 2016). It concluded that the Medicare statute's procedural requirement was broader than the APA's and determined that, because the instructions did not fall within any of the APA's exceptions to notice-and-comment rule making, they were necessarily procedurally invalid under the Medicare Act. See id. at 420. HHS appealed the District Court's judgment to this court.

         We conclude that the Manual instructions embody a general statement of policy, not a legislative rule, setting forth HHS's enforcement priorities. Policy statements do not establish binding norms. Pac. Gas & Elec. Co. v. Fed. Power Comm'n, 506 F.2d 33, 38 (D.C. Cir. 1974). And they are not "rules" that must be issued through notice-and-comment rule making. Perez, 135 S.Ct. at 1203. Nor are the instructions subject to the Medicare Act's independent notice-and-comment requirement because they do not establish or change a substantive legal standard. Because neither the APA nor the Medicare Act required that the Manual instructions be established by regulation, we reverse the decision of the District Court.

         I. Background

         A. Statutory and Regulatory Background

         Congress established the Medicare program in 1965 to "provide[] federally funded health insurance for the elderly and disabled." Methodist Hosp. of Sacramento v. Shalala, 38 F.3d 1225, 1226-27 (D.C. Cir. 1994); 42 U.S.C. § 1395 et seq. HHS administers the program through the Centers for Medicare and Medicaid Services ("CMS"). It originally reimbursed hospitals based on the "reasonable costs they incurred in providing services to Medicare patients." Cape Cod Hosp. v. Sebelius, 630 F.3d 203, 205 (D.C. Cir. 2011). Members of Congress became concerned that this system failed to effectively incentivize hospitals to control their costs. To address this issue, in 1983 Congress adopted a "prospective payment system" under which hospitals receive a fixed payment for inpatient services. Id. "Congress believed that [this system] would encourage efficiency 'by rewarding cost-effective hospital practices.'" Id. (quoting Methodist Hosp. of Sacramento, 38 F.3d at 1227).

         Under the prospective payment system, CMS pays hospitals a set amount per patient which is adjusted to roughly reflect the average cost incurred by hospitals nationwide for treating patients with the same diagnosis. 42 U.S.C. § 1395ww(d)(2), (4); see also Cape Cod Hosp., 630 F.3d at 205-06 (explaining the payment-calculation process). These payments are calculated by private healthcare insurers, known as Medicare Administrative Contractors ("MACs"), under contract with CMS. See 42 U.S.C. § 1395h(a).

         Congress recognized, however, that in some circumstances, treatment for patients would be extraordinarily costly. See Cty. of Los Angeles v. Shalala, 192 F.3d 1005, 1009 (D.C. Cir. 1999). Congress thus authorized HHS to make supplemental "outlier payments" to hospitals to account for these disparate costs. 42 U.S.C. § 1395ww(d)(5)(A). Under the statute, a hospital is eligible for an outlier payment "in any case where charges, adjusted to cost, exceed . . . the sum of the applicable [adjusted standardized prospective rate] plus a fixed dollar amount determined by the Secretary." Id. § 1395ww(d)(5)(A)(ii). This case deals with the manner in which CMS calculates such payments.

         1. Outlier Payment Formula

         The Medicare Act and HHS's implementing regulations establish the general formula for outlier payment calculations. First, CMS instructs MACs to calculate the hospital's "cost-to-charge ratio, " which represents the amount the hospital on average incurs in costs for every dollar that it bills. 42 C.F.R. § 412.84(i)(2). The MAC then multiplies the total amount billed by the cost-to-charge ratio to determine the hospital's actual costs. Id. § 412.84(g). If the difference between this number and the amount that the hospital received as a prospective payment exceeds the "fixed-loss threshold" set by the Secretary, the hospital can request an outlier payment. Id. § 412.84(k). The amount of the payment is calculated using the amount by which the actual costs exceed the prospective payment plus the fixed-loss threshold. That number is multiplied by the "marginal cost factor, " which is set by regulation at 80%. Id. Under this process, a hospital may ultimately recover 80% of the difference between its cost-adjusted charges and the outlier threshold. Id.; see also Dist. Hosp. Partners, 786 F.3d at 49-51 (providing an example calculation).

         In the 2000s, HHS determined that hospitals were manipulating their charges in order to inflate their cost-to-charge ratios. See Proposed Change in Methodology for Determining Payment for Extraordinarily High-Cost Cases (Cost Outliers) Under the Acute Care Hospital Inpatient Prospective Payment System, 68 Fed. Reg. 10, 420, 10, 423 (Mar. 5, 2003). This process of "turbocharging" was made possible by the temporal disconnect between the time when the costs were incurred and the time period used to determine the hospital's cost-to-charge ratio. See id. For many years, MACs calculated the cost-to-charge ratio using the hospital's most recently settled cost report, which was typically three years old. Id. By rapidly increasing the amount it charged for services, a hospital could take advantage of the higher out-of-date cost-to-charge ratio which, when multiplied by the inflated charges, would result in a higher outlier payment divorced from any increase in actual cost of care. See id.

         2. ...

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