United States Court of Appeals, District of Columbia Circuit
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
October 12, 2017
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.
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.
EDWARDS, SENIOR CIRCUIT JUDGE.
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
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.
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
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, § 220.127.116.11(A) (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.
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.
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
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.
Statutory and Regulatory Background
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).
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. §
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
Outlier Payment Formula
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).
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.