United States District Court, District of Columbia
For ADIRONDACK MEDICAL CENTER, AGNESIAN HEALTHCARE, INC., doing business as ST AGNES HOSPITAL, ALBEMARLE HOSPITAL AUTHORITY, doing business as ALBEMARLE HOSPITAL, AUGUSTA HEALTH CARE, INC., T/A doing business as AUGUSTA HEALTH, BATES COUNTY MEMORIAL HOSPITAL, BENEFIS HOSPITALS, INC., BLESSING HOSPITAL, BOTHWELL REGIONAL HEALTH CENTER, CAPE COD HEALTHCARE INC., doing business as CAPE COD HOSPITAL, CAROLINAEAST MEDICAL CENTER, doing business as CAROLINAEAST HEALTH SYSTEM, CARSON TAHOE REGIONAL HEALTHCARE, CGH MEDICAL CENTER, CHAMPLAIN VALLEY PHYSICIANS HOSPITAL, CHESAPEAKE HOSPITAL CORPORATION, doing business as RAPPAHANNOCK GENERAL HOSPITAL, CLALLAM COUNTY PUBLIC HOSPITAL DISTRICT 2, doing business as OLYMPIC MEDICAL CENTER, CLEARFIELD HOSPITAL, COMMUNITY MEMORIAL HEALTHCENTER, CORTLAND REGIONAL MEDICAL CENTER, INC., GOLDEN VALLEY MEMORIAL HOSPITAL DISTRICT, GRAHAM HOSPITAL ASSOCIATION, GRENADA LAKE MEDICAL CENTER, HOLY ROSARY HEALTHCARE, IHC HEALTH SERVICES INC., doing business as DIXIE REGIONAL MEDICAL CENTER, JOINT TOWNSHIP DISTRICT MEMORIAL HOSPITAL, LAKE REGIONAL HEALTH SYSTEM, LAWRENCE MEMORIAL HOSPITAL, LRGHEALTHCARE, doing business as LAKES REGION GENERAL HOSPITAL, MARY LANNING MEMORIAL HOSPITAL, MCALESTER REGIONAL HEALTH CENTER AUTHORITY, doing business as MCALESTER REGIONAL HEALTH CENTER, MCDONOUGH COUNTY HOSPITAL DISTRICT, doing business as MCDONOUGH DISTRICT HOSPITAL, MEMORIAL HOSPITAL OF SHERIDAN COUNTY, MEMORIAL MEDICAL CENTER OF WEST MICHIGAN, MUNSON MEDICAL CENTER, OTERO COUNTY HOSPITAL ASSOCIATION, doing business as GERALD CHAMPION REGIONAL MEDICAL CENTER, OTSEGO MEMORIAL HOSPITAL, PASSAVANT MEMORIAL AREA HOSPITAL ASSOCIATION, doing business as PASSAVANT AREA HOSPITAL, PHELPS COUNTY REGIONAL MEDICAL CENTER, PROMISE REGIONAL MEDICAL CENTER-HUTCHINSON, INC., RAPID CITY REGIONAL HOSPITAL INC., REGIONAL WEST MEDICAL CENTER, REID HOSPITAL & HEALTH CARE SERVICES INC., doing business as REID HOSPITAL, RICE MEMORIAL HOSPITAL, SALINA REGIONAL HEALTH CENTER, INC., SARAH BUSH LINCOLN HEALTH CENTER, SKY LAKES MEDICAL CENTER INC., SOUTHEASTERN REGIONAL MEDICAL CENTER, SOUTHERN ILLINOIS HOSPITAL SERVICES, doing business as HERRIN HOSPITAL, SOUTHWEST MEDICAL CENTER, SOUTHWESTERN VERMONT MEDICAL CENTER INC., SSM REGIONAL HEALTH SERVICES, doing business as FRANCIS HOSPITAL & HEALTH SERVICES, ST. JAMES HEALTHCARE INC., ST. JOSEPH REGIONAL MEDICAL CENTER, ST. JOSEPH'S MEDICAL CENTER, ST. LUKE'S MAGIC VALLEY REGIONAL, ST. MARY'S HOSPITAL & MEDICAL CENTER, INC., STILL WATER MEDICAL CENTER AUTHORITY, doing business as STILLWATER MEDICAL CENTER, RUTLAND HOSPITAL, INC., VALLEY VIEW HOSPITAL ASSOCIATION, WAYNE MEMORIAL HOSPITAL INC., WAYNESBORO HOSPITAL, WESTERN MISSOURI MEDICAL CENTER, ALL PLAINTIFFS, Plaintiffs: Ankur Jayant Goel, MCDERMOTT, WILL & EMERY, Washington, DC; Johnny H. Walker, III, MCDERMOTT WILL & EMERY LLP, Washington, DC.
For MID-COLUMBIA MEDICAL CENTER, Plaintiff: Johnny H. Walker, III, MCDERMOTT WILL & EMERY LLP, Washington, DC.
For KATHLEEN G. SEBELIUS, in her official capacity as Secretary of the United States Department of Health and Human Services, Defendant: Kathryn L. Wyer, LEAD ATTORNEY, U.S. DEPARTMENT OF JUSTICE, Civil Division, Washington, DC.
For KNOX COMMUNITY HOSPITAL, EDWARD JOHN NOBLE HOSPITAL OF GOUVERNEUR, NEW YORK (INC), HANOVER HOSPITAL, INC., HAYS MEDICAL CENTER, INC., LABETTE COUNTY MEDICAL CENTER, MEMORIAL HOSPITAL OF SWEETWATER COUNTY, MERCY HOSPITAL LEBANON, MERCY MEMORIAL HEALTH CENTER, INC., NEWMAN MEMORIAL COUNTY HOSPITAL, NORTH PLATTE NEBRASKA HOSPITAL CORPORATION, NORTHWESTERN MEDICAL CENTER INC., POCATELLO HOSPITAL, LLC, RICHMOND MEMORIAL HOSPITAL, Amicus: Dennis M. Barry, LEAD ATTORNEY, KING & SPALDING, Healthcare Group, Washington, DC.
ROSEMARY M. COLLYER, United States District Judge.
Plaintiff Hospitals  sue Kathleen Sebelius, Secretary of Health and Human Services, challenging her application of certain adjustments to Medicare reimbursement rates for sole community hospitals and Medicare-dependent, small rural hospitals. The Hospitals assert that the Secretary's
actions are both ultra vires and arbitrary and capricious in violation of the Administrative Procedure Act, 5 U.S.C. § 706. The parties also litigate whether the Secretary violated the APA by failing to comply with notice and comment rulemaking procedures when she issued payment instructions affecting sole community hospitals for fiscal year (" FY" ) 2009 and FY2010. The Secretary counters that her actions are within her authority and consistent with the APA. Before the Court are the parties' cross-motions for summary judgment. The Court will grant in part and deny in part the Secretary's motion for summary judgment. The Court will grant the Secretary's motion for summary judgment on the issue of whether the Secretary was required to engage in rulemaking when issuing the second 2008 rebasing instruction for sole community hospitals and deny Plaintiffs' motion for summary judgment on this issue. The Court will deny both the Secretary's and Plaintiffs' motions for summary judgment without prejudice on the issue of whether the Secretary's application of a cumulative budget neutrality adjustment for sole community hospitals in FY2009 and FY2010, and for Medicare-dependent, small rural hospitals in FY2010, violates the APA and order further briefing.
1. Inpatient Prospective Payment System
Medicare is a federal health insurance program for the elderly and the disabled. See 42 U.S.C. § 1395 et seq. It is administered by the Centers for Medicare and Medicaid Services (" CMS" ), a division of the Department of Health and Human Services (" HHS" ), under the executive management of Defendant Kathleen Sebelius, Secretary of HHS, who is sued in her official capacity.
Plaintiff Hospitals provide acute inpatient medical care to residents of small or rural communities. Each Hospital has been designated a " sole community hospital" (" SCH" ) or a " medicare-dependent, small rural hospital" (" MDH" ) under Medicare. See 42 U.S.C. § 1395ww(d)(5)(D)(iii) (defining sole community hospital); id. § 1395ww(d)(5)(G)(iv) (defining Medicare-dependent, small rural hospital). Because they are critical to providing hospital services in remote and rural areas and to the uninsured poor, the Hospitals are covered by special cost reimbursement protections for services under Medicare. Id. § § 1395ww(d)(5)(D) & 1395ww(d)(5)(G).
To provide an incentive for all hospitals serving Medicare patients to control costs, Congress directed the Secretary in 1983 to create an " inpatient prospective payment system" (IPPS), whereby CMS pays prospectively a fixed payment for each anticipated patient discharge, depending on anticipated diagnosis, necessary treatment, and the like, as described at 42 U.S.C. § 1395ww(d). See Methodist Hosp. of Sacramento v. Shalala, 38 F.3d 1225, 1226-27, 309 U.S. App. D.C. 37 (D.C. Cir. 1994) (describing the transition in 1983 to a prospective payment system for hospitals reimbursed under Medicare). The payment rates are set before the fiscal year begins and control reimbursements for specified services without regard to the actual cost of providing that medical care to hospitalized Medicare patients. Id. " Congress designed this system to encourage health care providers to improve efficiency and reduce operating costs." Id.
IPPS depends, in part, on patient diagnoses. Diagnoses are assigned to a " diagnosis-related group" (" DRG" ), and each DRG is assigned a weight that is multiplied
by a base dollar amount to determine actual payment. 42 C.F.R. § 412.60(b); id. § 412.64(g). CMS annually identifies hundreds of different DRGs, assigning each " a numeric weight reflecting the amount of resources needed, on average, to treat a patient with the corresponding diagnosis," relative to other diagnoses. Florida v. Tenet Healthcare Corp., 420 F.Supp.2d 1288, 1293 (S.D. Fla. 2005); see 42 U.S.C. § 1395ww(d)(4)(A)-(B); 42 C.F.R. § 412.60. The Amici  advised that DRG weights range from less than 1 up to 7. Transcript of Feb. 25, 2013 Hearing [Dkt. 38], 8:1-3. Starting in fiscal year (" FY" ) 1988, Congress required the Secretary to adjust DRG weighting factors every year " to reflect changes in treatment patterns, technology . .., and other factors which may change the relative use of hospital resources." 42 U.S.C. § 1395ww(d)(4)(C)(i). Starting in FY1991, Congress also required the Secretary to ensure that annual adjustments to DRG weighting factors not result in an overall increase to Medicare spending. Id. § 1395ww(d)(4)(C)(iii). The law specifies:
Any such adjustment [to diagnosis-related groups] . . . for discharges in a fiscal year . . . shall be made in a manner that assures that the aggregate payments under this subsection for discharges in the fiscal year are not greater or less than those that would have been made for discharges in the year without such adjustment.
Id. The parties agree that this subsection of Medicare stands for the proposition that other factors might increase the cost of Medicare coverage but the Secretary must ensure that annual changes to DRG weights have a budget-neutral effect.
Consequently, in addition to adjusting DRG weights to reflect changes in treatment patterns and technology each year, the Secretary also adjusts new DRG weights so that the average case after the annual adjustment has the same DRG weighting factor as the average case before adjustment. This normalization, however, does not achieve full budget neutrality in overall payments because the " average" cannot capture the full range of diagnoses and treatments. See FY1991 Proposed Rule, 55 Fed. Reg. 19,426, 19,466 (May 9, 1990) (" While [normalization] is intended to ensure that recalibration does not affect total payments to hospitals, our analysis indicates that the normalization adjustment does not achieve budget neutrality with respect to aggregate payments to hospitals." ). As a result, the Secretary calculates an additional adjustment--a so-called DRG budget neutrality adjustment--to satisfy the congressional directive that changes to DRG weighting factors not be a cause of increases in Medicare costs. Id. The Secretary insists that she has implemented the budget neutrality adjustment in a cumulative manner since 1994, i.e., the Secretary does not remove the effects of prior years' budget neutrality adjustments when adding the current year's budget neutrality adjustment. See FY1994 Final Rule, 58 Fed. Reg. 46,270, 46,346 (Sept. 1, 1993) (" Th[e] budget neutrality adjustment factor is applied to the standardized amounts without removing the effects of the [prior year's] budget neutrality adjustment. We do not
remove the prior budget neutrality adjustment because the statute requires that aggregate payments after the changes in the DRG relative weights and wage index equal estimated payments prior to the changes. If we removed the prior year adjustment, we would not be able to satisfy this condition." ). Notably, however, the budget neutrality adjustment--although called a DRG budget neutrality adjustment by the parties--is actually applied by the Secretary to the payment rate applicable to the Hospitals and not to the DRG weights themselves. See, e.g., FY1994 Proposed Rule, 58 Fed. Reg. 30,222, 30,269 (May 26, 1993) (" In addition, we are proposing to continue to apply the same FY1994 [budget neutrality] adjustment factor to the hospital-specific rates . . . to ensure that we meet the statutory requirement that aggregate payments neither increase nor decrease as a result of the implementation of the DRG weights and updated wage index." ).
2. Methodology for Calculating Payment Rates for SCHs and MDHs
Most hospitals are paid according to what the regulations call the " federal rate" for each Medicare beneficiary.  See 42 C.F.R. § 412.64. The starting point in calculating the federal rate in a given year is the " average standardized amount," essentially the average operating cost per patient discharge for all IPPS hospitals  in a given time period, irrespective of diagnosis. See 42 U.S.C. § 1395ww(d)(3)(A). The average standardized amount is case-mix adjusted, which means that the average cost is divided by the average DRG weight for all IPPS hospitals in the relevant year. Id. ; see also id. § 1395ww(d)(2)(C). For a new year, the average standardized rate of the previous year is updated for inflation, 42 U.S.C. § 1395ww(b)(3)(B), and multiplied by a budget neutrality adjustment for the new year. See, e.g., 58 Fed. Reg. 30,269. To calculate the reimbursement rate for a specific discharged beneficiary, this product is multiplied by the DRG weighting factor that applies to the diagnosis of the discharged patient. See 42 U.S.C. § 1395ww(d)(3)(D). The result is the federal rate payment for that diagnosis as of discharge. However, in light of the financial burden of addressing the needs of their small-community or rural-patient populations, the Medicare Act provides a special method for calculating reimbursement rates for SCHs and MDHs.
SCHs and MDHs are paid according to the federal rate or according to each hospital's distinct " hospital-specific rate," depending on which rate will result in a higher payment.  An MDH is paid the federal rate plus 75% of the difference, if any, between its federal rate payment and its hospital-specific rate payment. 42 U.S.C. § 1395ww(d)(5)(G)(ii)(II); 42 C.F.R. § 412.108. An SCH receives either the federal rate or its hospital-specific rate, whichever is higher. 42 U.S.C. § 1395ww(d)(5)(D)(i); 42 C.F.R. § 412.92. The starting point for calculating a hospital-specific rate is the historic average per-patient cost at the specific hospital in a particular base year, as identified by Congress.  See 42 C.F.R. § 412.2(c). The
average cost is then case-mix adjusted, which means that the average cost per discharged patient is divided by the average DRG weight for the base year at that particular hospital. See, e.g., 42 C.F.R. § 412.73(b). These costs are then updated by a rate-of-increase percentage.  See, e.g., id. § 412.73(c). The result of this formula is the hospital-specific rate. The hospital-specific rate is further multiplied by the budget neutrality adjustment. See id. § 412.73(d). To determine payment for a specific patient, this product is multiplied by the DRG weight relevant to that patient's diagnosis. See, e.g., id. § 412.73(e).
3. The Secretary's Rebasing Instructions
In 2006, Congress added FY2002 as a base year for calculating hospital-specific rates for MDHs, effective for cost reporting periods beginning on or after October 1, 2006. See Deficit Reduction Act of 2005, Pub. L. No. 109-171, § 5003(b), 120 Stat. 4 (2006). In 2008, Congress added FY2006 as a new base year for SCHs, effective for cost reporting periods beginning on or after January 1, 2009. See Medicare Improvements for Patients and Providers Act of 2008, Pub. L. No. 110-275, § 122, 122 Stat. 2494.
When Congress adds a new base year, the Secretary provides technical instructions to fiscal intermediaries  on how to calculate new hospital-specific rates. These are called " rebasing" instructions. For example, in 1999, Congress added FY1996 as a new base year for cost-reporting periods beginning on or after October 1, 2000 for SCHs. See Medicare, Medicaid, and State Children's Health Insurance Program Balanced Budget Refinement Act of 1999, Pub. L. No. 106-113, § 405, 113 Stat. 1501. In the summer of 2000, the Secretary issued rebasing instructions under that law and directed fiscal intermediaries for SCHs to apply cumulative ...