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Clarian Health West, LLC v. Burwell

United States District Court, District of Columbia

August 26, 2016

CLARIAN HEALTH WEST, LLC, Plaintiff,
v.
SYLVIA MATHEWS BURWELL, Defendant.

          MEMORANDUM OPINION

          KETANJI BROWN JACKSON, United States District Judge.

         The Centers for Medicare and Medicaid Services (“CMS”) is the sub-agency within the Department of Health and Human Services (“HHS”) that administers the federal health insurance program known as Medicare. In 2012, an agent of CMS informed Plaintiff Clarian Health West, LLC (“Clarian”), an Indiana hospital, that it needed to repay more than $2 million in Medicare reimbursement funds that the hospital had received under the Medicare program, due to a reconciliation process that CMS had performed with respect to certain Medicare payments. Clarian objected to CMS's repayment demand, and filed the instant action against Sylvia Mathews Burwell, the Secretary of HHS, to contest the agency's contentions. Clarian's one-count complaint cites the Administrative Procedure Act (“APA”), 5 U.S.C. §§ 701-706, and the Medicare statute's review provisions, 42 U.S.C. § 1395oo(f)(1), and asserts that the agency lacks the statutory and regulatory authority to make Clarian repay the money because the regulation that authorizes the reconciliation process (“the 2003 Rule”) and the guidelines that implement that rule (“the 2010 guidelines” or “the 2010 manual”) were improperly promulgated and are contrary to the terms of the Medicare statute.

         Before this Court at present are the parties' cross-motions for summary judgment. (Pl.'s Mot. for Summ. J. (“Pl.'s Mot.”), ECF No. 13; Def.'s Mot. for Summ. J. (“Def.'s Mot.”), ECF No. 14.) In its motion, Clarian contends, among other things, that CMS's decision to recoup the $2 million was procedurally defective because the agency failed to employ required notice-and-comment procedures prior to adopting the guidelines that establish the criteria for identifying which hospitals should be subjected to the reconciliation process. (See Pl.'s Mem. in Supp. of Pl.'s Mot. (“Pl.'s Mem.”), ECF No. 13-1, at 29-36.)[1] The Secretary's cross-motion argues that there is nothing procedurally or substantively improper about the rule that relates to the reconciliation process or its implementation. (See Def.'s Mem. in Supp. of Def.'s Mot. (“Def.'s Mem.”), ECF No. 14-1, at 24-49.)

         Upon consideration of the parties' arguments, this Court agrees with Clarian that the qualifying criteria contained in the implementing manual were the sort of substantive rule that must go through notice-and-comment rulemaking, and on that ground alone, Clarian's motion for summary judgment will be GRANTED, and the Secretary's motion for summary judgment will be DENIED. A separate order consistent with this opinion will follow.

         I. BACKGROUND

         A. The Applicable Statutory And Regulatory Framework

         The Medicare program “was established in 1965 and provides health care coverage for persons age 65 and older, disabled persons, and persons with end stage renal disease who meet certain eligibility requirements.” Allina Health Servs. v. Burwell, No. 14-cv-1415, 2016 WL 4409181, at *1 (D.D.C. Aug. 17, 2016) (citing 42 U.S.C. §§ 426, 426a). Medicare reimbursements are governed by federal law, and the obtuse text of the Medicare statute has produced much inspired grappling among judges, many of whom have described the legal provisions that govern the Medicare system as a “maze[, ]” Hall v. Sebelius, 667 F.3d 1293, 1301 n.9 (D.C. Cir. 2012) (Henderson, J., dissenting), a “legislative and regulatory thicket[, ]” Adirondack Med. Ctr. v. Sebelius, 29 F.Supp.3d 25, 28 (D.D.C. 2014), aff'd sub nom. Adirondack Med. Ctr. v. Burwell, 782 F.3d 707 (D.C. Cir. 2015), and a “labyrinth[, ]” Biloxi Reg'l Med. Ctr. v. Bowen, 835 F.2d 345, 349 (D.C. Cir. 1987), among other things.[2] The instant lawsuit centers on the government's reimbursement of inpatient hospital care under Medicare Part A, pursuant to which the federal government provides direct reimbursements to healthcare providers to cover the bulk of the expenses that a patient with Medicare insurance (called a “beneficiary”) incurs for inpatient hospital care. See 42 U.S.C. § 1395d; see also Ctrs. for Medicare & Medicaid Servs., Pub. No. 100-01, Medicare General Information, Eligibility, and Entitlement Manual, Ch. 3 §§ 10.2-10.3.

         1. Medicare's Prospective Payment System

         The complexity of the Medicare scheme is partly due to the intricacies of the prospective payment system that Congress has adopted with respect to Part A reimbursements-a payment system that Congress developed in reaction to the failures of the cost-based payment system that was used when Medicare was first enacted. See Dist. Hosp. Partners, L.P. v. Burwell, 786 F.3d 46, 49 (D.C. Cir. 2015). Under the prior regime, hospitals and other health care providers were reimbursed for all “reasonable costs” that the provider incurred in treating beneficiaries, Good Samaritan Hosp. v. Shalala, 508 U.S. 402, 405 (1993), but that cost-based system “deteriorated over time . . . because it provided little incentive for hospitals to keep costs down, as the more they spent, the more they were reimbursed[, ]” Dist. Hosp. Partners, 786 F.3d at 49 (internal quotation marks and citation omitted); see also H.R. Rep. No. 98-25, at 132 (1983), reprinted in 1983 U.S.C.C.A.N. 219, 351 (asserting that the cost-based payment system “lack[ed] incentives for efficiency” because the federal government would “simply respond[] to hospital cost increases by providing increased reimbursement”). In 1983, Congress replaced Medicare's cost-based payment system with the prospective payment scheme that has given rise to many legal disputes and that is at the heart of the present action. See Social Security Amendments of 1983, Pub. L. No. 98-21, § 601, 97 Stat. 65, 149-63.

         Under the prospective payment system, in contrast to the cost-based system, the federal government pays the hospital a set reimbursement amount that is established in advance of the hospital's expenditures and that is generally based upon the government's ex ante assessment of what it costs to care for an individual with the Medicare beneficiary's specific diagnosis, regardless of how much the hospital actually spends to care for a beneficiary. See Cape Cod Hosp. v. Sebelius, 630 F.3d 203, 205 (D.C. Cir. 2011); see also Dist. Hosp. Partners, 786 F.3d at 49 (explaining that prospective payments incentivize hospitals to reduce the cost of inpatient care because any reduction in cost directly profits the hospitals, while increases in the cost of care beyond the predetermined amount are borne by the hospitals rather than the federal government). The prospective payments that hospitals receive for treating Medicare patients are calculated by private health care insurers known as Medicare Administrative Contractors (“MACs”) pursuant to a multifactor formula that begins with a “standardized amount, ” which generally “reflects the average cost incurred by hospitals nationwide for each patient they treat and then discharge.” Cape Cod Hosp., 630 F.3d at 205.[3]

         In order to ensure that the prospective payment system fairly approximates the actual cost of the care provided, the MACs adjust the standardized amount to account for various factors, including the relative cost of the care associated with different patient diagnoses. See Dist. Hosp. Partners, 786 F.3d at 49; Cape Cod Hosp., 630 F.3d at 205. Per the Medicare statute, HHS has classified the care that can be afforded to every type of hospital patient into Diagnosis Related Groups (“DRGs”), see 42 U.S.C. § 1395ww(d)(4)(A), and each DRG is weighted in accordance with “the estimated relative cost of hospital resources used with respect to discharges classified within that group compared to discharges classified within other groups[, ]” 42 C.F.R. § 412.60(b).[4]This means, for example, that the DRG classification that includes a heart transplant will be weighted more heavily than one for a non-invasive procedure-i.e., the “DRG weight” will be greater-because heart surgery uses more resources and imposes higher costs on the hospital. Cty. of Los Angeles v. Shalala, 192 F.3d 1005, 1008 (D.C. Cir. 1999). And the greater the DRG weight, the higher the rate of reimbursement; indeed, the DRG weight adjustment is such an important factor in determining the rate of reimbursement under the prospective payment system that the Medicare statute itself refers to reimbursements as the “DRG prospective payment rate.” See, e.g., 42 U.S.C. § 1395ww(d)(5)(A)(ii).

         Significantly for present purposes, Medicare's prospective payment system not only seems to provide incentives for hospitals to control costs while accounting for the variable care costs that are associated with different patient diagnoses, it also recognizes that the costs of healthcare can sometimes be unpredictable, and that a purely prospective system would unfairly omit reimbursements for the high costs a hospital can incur when a particular beneficiary's care ends up being unduly expensive through no fault of the hospital, as sometimes happens. See Cty. of Los Angeles, 192 F.3d at 1009 (“Despite the anticipated virtues of [the prospective payment system], Congress recognized that health-care providers would inevitably care for some patients whose hospitalization would be extraordinarily costly or lengthy.”). To prevent hospitals from facing significant losses for providing care to patients in such “outlier” cases-i.e., situations in which the cost of the care provided to a Medicare beneficiary far exceeds the prospective reimbursement rate for a particular diagnosis-Congress authorized HHS to reimburse hospitals for these costs through a system of “outlier payments.” See 42 U.S.C. § 1395ww(d)(5)(A); H.R. Rep. No. 98-25, at 154, reprinted in 1983 U.S.C.C.A.N. 219, 373. It is the manner in which CMS calculates, assesses, and retroactively reconciles such outlier payments that is at issue in this case.

         2. Outlier-Payment Calculations

         Section 1395ww(d)(5)(A)(ii) of Title 42 of the U.S. Code permits a hospital to “request additional payments” (above and beyond the standardized payments that are provided pursuant to the prospective payment system) in certain instances, and the statute identifies the particular circumstances under which such a request is warranted. Specifically, per the statute, “[a] hospital is eligible for an outlier payment ‘in any case where charges, adjusted to cost, exceed . . . the sum of the applicable DRG prospective payment rate . . . plus a fixed dollar amount determined by the Secretary.'” Dist. Hosp. Partners, 786 F.3d at 49 (alterations in original) (quoting 42 U.S.C. § 1395ww(d)(5)(A)(ii)); see also 42 U.S.C. § 1395ww(d)(5)(A)(iii) (stating that the amount of the outlier payment “shall be determined by the Secretary and shall . . . approximate the marginal cost of care beyond” the otherwise applicable “cutoff point”). In practice, this statutory command has spawned an “elaborate process” for calculating outlier payments, which involves the intersection of three distinct concepts: (1) charges, adjusted to cost, (2) the outlier threshold, and (3) the marginal cost factor. Dist. Hosp. Partners, 786 F.3d at 49.

         The “charges, adjusted to cost” figure ensures that the outlier payment reflects the actual cost of the care provided to a beneficiary, and that the government “does not simply reimburse a hospital for the charges reflected on a patient's invoice[.]” Dist. Hosp. Partners, 786 F.3d at 50. It is calculated by multiplying two different numbers: the first is the amount that the hospital charged for the service provided to the beneficiary, and the second is the “cost-to-charge ratio, ” which is “a fraction that represents the estimated amount that [a hospital] incurs in costs for every dollar that it bills in charges.” (Def.'s Mem. at 13.) In other words, the cost-to-charge ratio is “a number representing a hospital's average markup[.]” Appalachian Reg'l Healthcare, Inc. v. Shalala, 131 F.3d 1050, 1052 (D.C. Cir. 1997).

         The outlier threshold is also a combination of numbers, but the numbers are added rather than multiplied.[5] The first figure is “the applicable DRG prospective payment rate[, ]” 42 U.S.C. § 1395ww(d)(5)(A)(ii), which is the payment that the hospital would ordinarily receive under Medicare's reimbursement process for a non-outlier case. The second number is the “fixed loss threshold, ” which is a fixed amount that the Secretary sets anew each year. Dist. Hosp. Partners, 786 F.3d at 50.[6] The fixed loss threshold essentially “acts like an insurance deductible[, ]” id. (quoting Boca Raton Cmty. Hosp., Inc. v. Tenet Health Care Corp., 582 F.3d 1227, 1229 (11th Cir. 2009)) (internal quotation mark omitted), in that it reflects an amount that the hospital simply has to bear in order to receive any outlier payments.

         The final component that factors into the calculation of an outlier payment is the marginal cost factor. This factor represents the “marginal cost” of offering extra care to outlier patients, 42 U.S.C. § 1395ww(d)(5)(A)(iii), and by regulation, this factor is set at 80%, see 42 C.F.R. § 412.84(k).

         Putting these all together, the amount of an outlier payment is determined by taking the cost-adjusted charges (which are determined by multiplying the charge for the outlier treatment by the hospital's cost-to-charge ratio), subtracting the outlier threshold (which is determined by adding the standard reimbursement payment for the services provided and the fixed loss threshold), and multiplying that number by the marginal cost factor (which is always 80%).[7] In a recent opinion, the D.C. Circuit provided a helpful example that explains how this formula works in practice, and also illustrates the fact that outlier payments cover some, but not all, of the costs associated with treating outlier cases:

Assume that the Secretary sets the fixed loss threshold at $10, 000. Assume also that a hospital treats a Medicare patient for a broken bone and that the DRG rate for the treatment is $3, 000. The Medicare patient required unusually extensive treatment which caused the hospital to impose $23, 000 in cost-adjusted charges. If no other statutory factor is triggered, . . . the hospital is eligible for an outlier payment of $8, 000, which is 80% of the difference between its cost-adjusted charges ($23, 000) and the outlier threshold ($13, 000).

Dist. Hosp. Partners, 786 F.3d at 50-51.

         B. The 2003 Rule And The 2010 Implementation

         1. The Road To Reconciliation Of Past Outlier Payments

         In the early 2000s, many hospitals were attempting to game the outlier-payment process through a sophisticated form of overbilling known as “turbocharging.” See Banner Health v. Burwell, 126 F.Supp.3d 28, 48 (D.D.C. 2015). Through the practice of turbocharging, which exploits a tension that arises when the cost-adjusted charges are calculated, a hospital can generate outlier payments that are significantly greater than would otherwise be expected under the formula discussed above. This can happen because, as explained, the cost-adjusted charges are determined by multiplying the amount the hospital actually charged for a particular type of care by the hospital's cost-to-charge ratio. However, there can be a temporal disconnect between these two numbers, given that the amount charged for a type of care is determined as of the time that the care is provided, while the cost-to-charge ratio is based on the most recently settled cost report, and cost reports can take several years to settle. See Dist. Hosp. Partners, L.P. v. Sebelius, 973 F.Supp.2d 1, 14 (D.D.C. 2014), aff'd in part, rev'd in part sub nom. Dist. Hosp. Partners, 786 F.3d 46. Thus, the cost-to-charge ratio that is used for purposes of calculating outlier payments in any given year is based on data that lags behind the hospital's actual cost-to-charge ratio for that year, see id., and a hospital can manipulate the cost-adjusted charge factor in the outlier-payment calculation by drastically increasing the amount that it charges for inpatient care, out of all proportion to the actual increase in costs associated with that care. In other words, when current (heavily inflated) charges are multiplied by an out-of-date (relatively deflated) cost-to-charge ratio, the hospital's cost-adjusted charges figure increases, and the hospital ends up being reimbursed for outlier payments at ever higher rates despite no obvious increase in the quality or cost of care. (See Pl.'s Mem. at 15-17.) See also Elizabeth A. Weeks, Gauging the Cost of Loopholes: Health Care Pricing and Medicare Regulation in the Post-Enron Era, 40 Wake Forest L. Rev. 1215, 1248-50 (2005) (describing this process).[8]

         By 2003, HHS had discovered that turbocharging practices were widespread among hospitals, and issued a proposed rule regarding a change in the methodology for determining outlier payments partly to address the turbocharging problem. See Medicare Program; Proposed Change in Methodology for Determining Payment for Extraordinarily High-Cost Cases (Cost Outlier) Under the Acute Care Hospital Inpatient Prospective Payment System, 68 Fed. Reg. 10, 420 (March 5, 2003). The agency received notice and comment, and promulgated the final rule-referred to herein as the “2003 Rule”-on June 9, 2003. See Medicare Program; 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).

         The 2003 Rule revised “the methodology for determining payments for extraordinarily high-cost cases (cost outliers) . . . under the . . . prospective payment system[.]” Id. at 34, 494. Notably, the 2003 Rule did not alter the underlying formula for calculating outlier payments, but it did include a host of measures designed to combat turbocharging. For example, instead of relying on the most recent settled cost report, the rule provided that a MAC can consider “the most recent tentative settled cost report” when determining the applicable cost-to-charge ratio for the following year. See Id. at 34, 499 (emphasis added); see also 42 C.F.R. § 412.84.[9] Furthermore, and most relevant to the present case, the 2003 Rule provided for the “reconciliation” of outlier payments after the cost report for the relevant period has been finalized. See Change in Methodology, 68 Fed. Reg. at 34, 501 (“[W]e proposed to add a provision to our regulations to provide that outlier payments would become subject to reconciliation when hospitals' cost reports are settled.”); 42 C.F.R. § 412.84(i)(4) (“[A]ny reconciliation of outlier payments will be based on operating and capital cost-to-charge ratios calculated based on a ratio of costs to charges computed from the relevant cost report and charge data determined at the time the cost report coinciding with the discharge is settled.”). Pursuant to this new reconciliation process, MACs were authorized to revisit outlier payments once a hospital's actual cost-to-charge ratio for a particular year had been determined-despite the fact that the necessary data for making that determination is ordinarily not available until years after the pertinent outlier payments have been disbursed-and to revise outlier payments retroactively.

         2. The 2010 CMS Manual And The Qualifying Criteria For Being Subjected To The Outlier Payment Reconciliation Process

         The core of Clarian's complaint revolves around the fact that the 2003 Rule only generally authorized the reconciliation process and specified that any reconciliation would be based on the cost and charge data contained in the hospital's final settled cost report, and did not proceed to detail how the reconciliation process would operate in practice. See 42 C.F.R. § 412.84(i)(4). In fact, in response to a number of comments that asked the agency to set certain “parameters” in order to guide the implementation of the newly authorized reconciliation process, the Secretary expressly acknowledged that the agency would not be addressing the specific circumstances under which reconciliation would be appropriate at the time the rule was promulgated. See Change in Methodology, 68 Fed. Reg. at 34, 503. The Secretary made crystal clear that the agency's plan was to issue implementation guidelines at some later point in time, id. (stating that HHS “intend[s] to issue a program instruction in the near future . . . [containing] thresholds for fiscal intermediates to reconcile outlier payments for other hospitals during FY 2003”) and, in the context of the 2003 Rule, the Secretary's preamble merely mentioned that the agency was “considering” certain thresholds for “cost reporting periods beginning during FY 2004[, ]” id.

         In December of 2010-more than seven years after the 2003 Rule took effect- the HHS finally provided specific standards for MACs to use when administering the reconciliation process: it published instructions for reconciliation in a CMS manual governing Medicare claims processing. See Ctrs. for Medicare & Medicaid Servs., Pub. No. 100-04, Medicare Claims Processing Manual, Ch. 3 § 20.1.2.5. Importantly, according to this 2010 manual, a hospital's outlier payments are potentially subject to reconciliation if two criteria are met:

(1) the provider's “actual operating [cost-to-charge ratio] is found to be plus or minus 10 percentage points from the [cost-to-charge ratio] used [to calculate a provider's] outlier payments, ” and
(2) the provider's “[t]otal outlier payments in that cost reporting period exceed $500, 000.”

Id. § 20.1.2.5(A). The manual instructs that a MAC must follow a step-by-step procedure for initiating reconciliation if these two criteria are satisfied. See Id. (“If the criteria for reconciliation are met, Medicare contractors shall follow the instructions below in § 20.1.2.7.”); see also Id. § 20.1.2.7 (detailing the 14-step reconciliation process). And as part of that process, the MAC must alert the CMS Central Office that the offending hospital has met the reconciliation criteria and provide a bevy of information about the hospital. See Id. § 20.1.2.7. If CMS gives the go-ahead, the MAC must then calculate the difference between the original and revised outlier payments, finalize the hospital's cost report, issue a Notice of Program Reimbursement, and “make the necessary adjustment from or to the provider.” Id. The manual is less clear about what happens if a hospital does not meet the reconciliation criteria after the cost report for a given year settles: on the one hand, it suggests that no reconciliation will occur because “the cost report shall be finalized[;]” on the other hand, it notes that “[e]ven if a hospital does not meet the criteria for reconciliation . . . the Medicare contractor has the discretion to request that a hospital's outlier payments . . . be reconciled if the hospital's most recent cost and charge data indicate that the outlier payments to the hospital were significantly inaccurate.” Id. § 20.1.2.5(A).

         Notably, as mentioned, the Secretary's statement in the preamble to the 2003 Rule hinted at the possibility that the agency might eventually adopt these two qualifying criteria for initiating reconciliation, see Change in Methodology, 68 Fed. Reg. at 34, 503, but these reconciliation standards did not become official agency policy until the 2010 claims processing manual was published. It is undisputed that the 2010 manual was produced without notice or an opportunity for the public to comment on the selected standards, and the manual contains no statement from the agency that sets forth any justification for these particular criteria. The only record evidence regarding the agency's reasoning appears in the preamble to the 2003 Rule, which notes the agency's general view that these thresholds ...


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