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Regents of University of California Inc. v. Burwell

United States District Court, District of Columbia

February 22, 2016

SYLVIA M. BURWELL, Secretary, Department of Health and Human Services, Defendant.



Under the Medicare program, the government reimburses health care providers for certain expenses incurred in treating Medicare beneficiaries. See Social Security Act of 1965, Pub. L. No. 89-97, tit. XVIII, 79 Stat. 286, 291 (codified as amended at 42 U.S.C. § 1395 et seq.) (“Medicare Act”). The Medicare wage index reflects regional variations in hospital wage costs and is one factor used to determine the amount of a provider’s reimbursement. In 2005, the Department of Health and Human Services adopted a rule that purported to clarify the accounting method used to calculate the wage index. In this action, numerous hospitals and related entities challenge the application of the 2005 Rule to the wage indices for federal fiscal years (“FFYs”) 2007 and 2008.

The matter is presently before the Court on the parties’ cross-motions for summary judgment. Dkts. 21, 23. The Court held oral argument on the motions on February 16, 2016. Plaintiffs contend that application of the 2005 Rule to the FFYs 2007 and 2008 wage indices constitutes impermissible, retroactive rulemaking because the wage index for a given fiscal year is based on cost data submitted by providers three or four years earlier, and Plaintiffs submitted their cost data in accordance with the accounting rules then in effect. Plaintiffs further argue that the 2005 Rule “is inconsistent with the overall purpose and objective of the wage index statute;” that the Secretary of Health and Human Services (“Secretary”) and her intermediaries have inconsistently applied the rule without an adequate explanation; and that “the Secretary erred in applying it to the . . . plaintiffs in this case.” Dkt. 21-1 at 21. The Secretary responds that the 2005 Rule is a valid exercise of the discretion delegated to her pursuant to the wage-index provision of the Medicare Act. Dkt. 23 at 13-21. She also contends that Plaintiffs waived any retroactivity claim by failing to raise it in the notice-and-comment process preceding adoption of the rule, id. at 21-22; that, in any event, the rule does not operate retroactively, id. at 22-26; and that, even if it did, the statute authorizes retroactive regulation in these circumstances, id. at 26- 28. Finally, she contends that any alleged inconsistency in the application of the 2005 Rule is merely a byproduct of the agency’s discretion whether to initiate an audit, id. at 30-32, and that Plaintiffs are not entitled to a special exemption from the rule, id. at 33-36. For the following reasons, the Court DENIES Plaintiffs’ motion, Dkt. 21, and GRANTS the Secretary’s motion, Dkt. 23.


A. Statutory and Regulatory Background

Prior to 1983, Medicare providers “were reimbursed for the actual costs that they incurred, provided they fell within certain cost limits, ” including the requirement that they be reasonable. Methodist Hosp. of Sacramento v. Shalala, 38 F.3d 1225, 1227 (D.C. Cir. 1994). As a result, when “hospital costs increased, so too did Medicare reimbursements.” Id. In 1983, however, “Congress . . . completely revised the scheme for reimbursing Medicare hospitals” and adopted the Prospective Payment System (“PPS”) in order “to encourage health care providers to improve efficiency and reduce operating costs.” Id. Under the PPS, qualifying hospitals are reimbursed using fixed, prospective rates for a specified category of treatment. Id. In the typical case, the reimbursement rate does not vary from patient to patient or provider to provider. Id. Cf. Cnty. of L.A. v. Shalala, 192 F.3d 1005, 1009 (D.C. Cir. 1999) (explaining supplemental “outlier payments”). “By establishing predetermined reimbursement rates that remain static regardless of the costs [actually] incurred by a hospital [in an individual case], Congress sought ‘to reform the financial incentives hospitals face, promoting efficiency in the provision of services by rewarding cost[-]effective hospital practices.’” Cnty. of L.A., 192 F.3d at 1008 (quoting H.R. Rep. No. 98-25, at 132 (1983), as reprinted in 1983 U.S.C.C.A.N. 219, 351).

Under the PPS, wages and wage-related costs are a “significant component of the Medicare payment” that qualifying hospitals receive. Anna Jaques Hosp. v. Sebelius, 583 F.3d 1, 2 (D.C. Cir. 2009) (“Anna Jaques I”). “Because these costs vary widely across the country, Congress requires the Secretary to adjust Medicare reimbursements according to ‘area differences in hospital wage[s].’” Id. (quoting 42 U.S.C. § 1395ww(d)(3)(E)(i) (alteration in original)); see also 42 U.S.C. § 1395ww(d)(2)(H). The wage index is the mechanism by which the Secretary does so. It is “a factor (established by the Secretary) reflecting the relative hospital wage level in the geographic area of the hospital compared to the national average hospital wage level.” 42 U.S.C. § 1395ww(d)(3)(E)(i). As the D.C. Circuit has explained:

The wage index reflects a requirement in the 1983 Amendments that the federal rate be adjusted to reflect geographic variations in labor costs. See 42 U.S.C. § 1395ww(d)(2)(H). The area wage indexes for each region are based on wage-cost data periodically submitted by Medicare hospitals across the country. The indexes are used at two points in the prospective payment rate calculation. First, regional wage indexes are used (along with other factors, such as inflation and hospital case-mix ratios) to modify and standardize the data used to establish the nationwide “federal rate.” See 42 U.S.C. § 1395ww(d)(2)(C)(ii). Second, once the federal rate has been set, the wage indexes are used to make regional adjustments to the labor-related portion of the federal rate. See 42 U.S.C. § 1395ww(d)(2)(H). Because each wage index is used to develop the base national rate as well as to adjust that rate by region, a change in any single wage index can affect the reimbursement rate of each hospital in the country.

Methodist Hosp., 38 F.3d at 1227-28 (internal footnote omitted).

The Medicare Act requires the Secretary to update the wage index “at least every 12 months . . . on the basis of a survey conducted by the Secretary (and updated as appropriate) of the wages and wage-related costs of subsection (d) hospitals in the United States.” 42 U.S.C. § 1395ww(d)(3)(E)(i). The statute also requires that the Secretary ensure that the aggregate, adjusted payments do not exceed the aggregate payments “that would have been made in the year without such adjustment.” Id. “On all other aspects of the wage-index calculation, ” however, “the statute is silent.” Anna Jacques Hosp. v. Burwell, 797 F.3d 1155, 1163 (D.C. Cir. 2015) (“Anna Jacques II”).

To calculate the wage index, the Secretary uses data from cost reports that hospitals file annually with fiscal intermediaries, which act as the Secretary’s agents in administering the PPS.[1] 42 U.S.C. § 1395h. Historically, the wage index was calculated using data collected in Worksheet S-3, Part II, of providers’ cost reports. See Dkt. 21-1 at 12; Dkt. 23 at 9; 42 C.F.R. § 413.20(b). “For each fiscal year, the wage index is based on data reported by hospitals 3 or 4 years earlier in annual cost reports.” Dkt. 23 at 9; accord Dkt. 21-1 at 11; see also Anna Jaques I, 583 F.3d at 3. For example, the wage index for FFY 2007 (which began October 1, 2006) was based on data from hospitals’ cost reports for the hospitals’ fiscal years that began during FFY 2003. Dkt. 14-5 at 114.

The present case concerns regulations governing the accounting method used to calculate the wage index. In particular, the Plaintiffs challenge the application of a rule adopted in August 2005 to pension costs reported in June 30, 2004 and June 30, 2005 cost reports and used to calculate the wage indices for FFYs 2007 and 2008, respectively. The following is an overview of the evolution of the relevant rules.

On September 1, 1994, the Secretary promulgated a final rule making changes to, inter alia, the methodology for calculating the wage index. See Medicare Program; Changes to the Hospital Inpatient Prospective Payment Systems and Fiscal Year 1995 Rates, 59 Fed. Reg. 45, 330 (Sept. 1, 1994) (“1994 Rule”). As relevant here, the Preamble to the 1994 Rule stated that hospitals should “follow Generally Accepted Accounting Principles (GAAP) in developing the wage-related costs contained in the Worksheet S-3, Part II, for purposes of the hospital wage index.” Id. at 45, 357. The Secretary explained:

We believe it is appropriate to apply GAAP for these purposes because the function of the wage index is to measure relative hospital labor costs across areas. This function is distinct from that of cost reimbursement, in which applicable Medicare principles (which may differ from GAAP) measure the actual costs incurred by individual hospitals. We believe the application of GAAP for purposes of compiling data on wage-related costs used to construct the wage index will more accurately reflect relative labor costs, because certain wage-related costs (such as pension costs) as recorded under GAAP tend to be more static from year to year. Application of Medicare principles, on the other hand, could create large swings in these costs from year to year, particularly in years when there are large over- or under-funded pension estimates; such application might lead to a wage index that does not accurately reflect relative labor costs.

Id. (emphasis in original). The regulation was made “effective for cost reporting periods beginning on or after October 1, 1994. . . . The changes [did] not affect the [F]FY 1995 wage index.” Id. at 45, 354; see also Id. at 45, 357. In support of her decision not to include past cost reporting periods, the Secretary explained that “it has always been [the Department’s] policy not to apply policy changes retroactively, ” “it would not be fair to hospitals to require that they retroactively revise their recordkeeping systems to accommodate these changes, ” and, although the adjustments to the wage index would not take effect until FFY 1999, that delay would give hospitals time “to adjust their fiscal plan[s].” Id. at 45, 359.

On June 27, 1995, the Secretary promulgated a final rule “to clarify the concept of ‘accrual basis of accounting.’” Medicare Program; Clarification of Medicare’s Accrual Basis of Accounting Policy, 60 Fed. Reg. 33, 126, 33, 126 (June 27, 1995) (“1995 Rule”). In so doing, she observed that “some providers . . . believe that, for Medicare purposes, they [can] . . . rely solely upon the generic definition of the accrual basis of accounting, whereby . . . expenses are reported in the period in which they are incurred, regardless of when they are paid.” Id. If that interpretation were credited, Medicare “would be forced to pay currently for accrued liabilities that either may not be liquidated timely or may never be liquidated.” Id. As the Secretary further explained, although “Medicare recognizes only costs associated with a liability that is timely liquidated through an actual expenditure of funds[, ] GAAP does not offer this assurance for Medicare.” Id. at 33, 131. In short, “Medicare payment policy and GAAP have different objectives. Medicare’s objective for cost payment . . . is to pay providers . . . the reasonable and proper cost of furnishing services . . . in a specific fiscal period. . . . [T]he primary goal of GAAP is the full and proper presentation of accounting data through statements and reports.” Id. at 33, 127.

The 1995 Rule, codified at 42 C.F.R. § 413.100, accordingly adopted an express requirement that “[f]or accrued costs to be recognized for Medicare payment in the year of the accrual, ” the liability must be liquidated within a specified timeframe. 60 Fed. Reg. at 33, 136. That rule, however, applied only to reimbursements made under traditional Medicare reasonable-cost principles, and not to in-patient hospitals subject to the PPS. See Dkt. 7-1 at 15 (PRRB decision in this case concluding that “when § 413.100 was promulgated in the June 1995 Final Rule, CMS did not intend for it to encompass the reporting of wage-related costs for purposes of the wage index” (emphasis in original)); 60 Fed. Reg. at 33, 126 (“This policy pertains to all services furnished by providers other than inpatient hospital services . . . and certain inpatient routine services furnished by skilled nursing facilities choosing to be paid on a prospective payment basis . . . .”). The 1995 Rule was intended to “codif[y] in the regulations Medicare’s longstanding policy regarding the timing of payment for accrued costs by requiring timely liquidation of liabilities in order to receive Medicare payment.” 60 Fed. Reg. at 33, 129. That policy was designed “to prevent the outlay of Federal trust funds before they are needed to pay the costs of providers’ actual expenditures.” Id.

In June 2003, the Secretary attempted to clarify the 1995 Rule’s application to PPS providers by including a note in the Medicare Provider Reimbursement Manual stating that “[a]lthough hospitals should use GAAP in developing wage related costs, the amount reported for wage index purposes must meet the reasonable costs provisions of Medicare.” Dkt. 14-5 at 38; see also Medicare Program; Changes to the Hospital Inpatient Prospective Payment Systems and Fiscal Year 2006 Rates, 70 Fed. Reg. 47, 278, 47369 (Aug. 12, 2005). As the Secretary later explained, “[t]he clarification was to ensure that a hospital includes in the wage index only those pension and other deferred compensation plan costs that meet the timely liquidation requirements for Medicare reasonable cost principles.” 70 Fed. Reg. at 47, 369.

In May 2005, the Office of Inspector General of the Department of Health and Human Services (“OIG”) “alerted [the Centers for Medicare & Medicaid Services (“CMS”)] to . . . preliminary findings regarding hospitals’ inconsistent reporting of pension and other postretirement benefit costs as wage data in their cost reports.” Dkt. 14-5 at 115. The OIG explained that “[w]hile some hospitals included millions of dollars in unfunded pension and other postretirement benefit costs in their annual wage data, others included only funded amounts.” Id. In its final report, issued in February 2007, the OIG found that hospitals “overstated their wage data by a total of $326.4 million by reporting unliquidated and/or other postretirement benefit costs, ” id. at 118, and recommended, among other things, that CMS ensure “that its [F]FY 2007 wage indexes were adjusted, and its [F]FY 2008 wage indexes will be adjusted, as appropriate, to account for the inaccurate wage data identified.” Id. at 111, 122.

On August 12, 2005, the Secretary promulgated a final rule making a variety of revisions to the wage index. Medicare Program; Changes to the Hospital Inpatient Prospective Payment Systems and Fiscal Year 2006 Rates, 70 Fed. Reg. at 47, 278 (Aug. 12, 2005) (“2005 Rule”). As relevant here, the Secretary “clarifi[ed]” that pension and other deferred compensation plan costs used to calculate the wage index must comply with the timely liquidation of liability rule, 42 C.F.R. § 413.100. Id. at 47, 369. The Secretary explained:

Since publication of the September 1, 1994 rule, we have periodically received inquiries for more specific guidance on developing wage-related costs for the wage index. . . . Due to recent questions and concerns we received regarding inconsistent reporting and overreporting of pension and other deferred compensation plan costs, as a result of an ongoing Office of Inspector General review, we are clarifying in this final rule that hospitals must comply with the requirements in 42 CFR 413.100, the [Provider Reimbursement Manual], Part I, sections 2140, 2141, and 2142, and related Medicare program instructions for developing pension and other deferred compensation plan costs as wage-related costs for the wage index. The Medicare instructions for pension costs and other deferred compensation costs combine GAAPs, Medicare payment principles, and Department of Labor and Internal ...

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