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Lee Memorial Health System v. Burwell

United States District Court, District of Columbia

September 7, 2016

SYLVIA M. BURWELL, Secretary of the U.S. Department of Health & Human Services Defendant.


          ROSEMARY M. COLLYER United States District Judge

         In these consolidated cases, Plaintiff hospitals challenge the methods used by the Department of Health & Human Services to calculate the “fixed-loss threshold, ” a term integral to reimbursement under the Medicare program. Because the Center for Medicare and Medicaid Services, a constituent agency of HHS, followed the notice and comment rulemaking process and is entitled to a highly deferential standard of review, the Court cannot say that it has acted arbitrarily or capriciously. The regulations will stand.

         I. FACTS

         Plaintiffs, a group of non-profit organizations that own and operate acute care hospitals participating in the Medicare program (Hospitals), [1] contend that the Center for Medicare and Medicaid Services (CMS), led by Secretary Sylvia Burwell (the Secretary), has underpaid them for Medicare services provided during the fiscal years ending in 2008, 2009, 2010, and 2011. Plaintiffs challenge CMS's administration of the outlier payment system, which pays eligible hospitals a percentage of their costs above the typical threshold for treating a Medicare patient. Plaintiffs challenge the “fixed loss threshold” rulemakings promulgated in fiscal years 2008 through 2011, as well as the 2003 amendment to the outlier payment regulations.

         Presently before the Court are Defendant's Motion to Dismiss or, in the alternative, for Summary Judgment, Dkt. 73, and Plaintiffs' Motion for Summary Judgment, Dkt. 74.

         A. Statutory Background

         Medicare is a federal program that provides health insurance to the elderly and the disabled. See generally 42 U.S.C. §§ 1395 et seq. Generally speaking, hospitals provide care to Medicare beneficiaries and then seek reimbursement from CMS.

         Reimbursement is not a precise exercise. Instead of reimbursing the providers dollar for dollar, CMS pays fixed rates through the Inpatient Prospective Payment System (IPPS).[2] Under IPPS, inpatient services are divided into categories called “diagnosis related groups” or “DRGs.” See 42 U.S.C. § 1395ww(d). Each DRG merits a standard payment rate, intended to reflect the estimated average cost of treating the service(s) provided. See id. Because these DRGs correspond to the given patient's diagnosis upon discharge, the rates may vary from the costs actually incurred by the provider.

         In some cases, the rates may drastically understate a hospital's costs. To compensate providers for exceptionally costly cases, Congress established the “outlier” payment system. See generally 42 U.S.C. § 1395ww(d)(5)(A). If the cost of health care in a given case exceeds the DRG payment “plus a fixed dollar amount determined by the Secretary, ” then the hospital is eligible for an outlier payment. Id. § 1395ww(d)(5)(A)(ii).[3] Taken together, the DRG plus the “fixed dollar amount determined by the Secretary” represents the “outlier threshold.” 42 U.S.C. § 1395ww(d)(5)(A)(ii); see also Cnty. of L.A., 192 F.3d at 1010. If a case qualifies, the provider receives 80% of the costs that exceed the outlier threshold. 42 C.F.R. § 412.84(k). This 80% is called the “additional payment” or “outlier payment.” E.g., Id. §§ 412.80(a)(3), (c).[4]

         The key phrase for present purposes is the “fixed dollar amount, ” which is to be “determined by the Secretary” and “specified by CMS.” 42 U.S.C. § 1395ww(d)(5)(A)(ii); 42 C.F.R. § 412.80(a)(3). The parties refer to this as the “fixed-loss threshold” or “FLT.” The Fixed Loss Threshold functions as an “insurance deductible” of sorts. Boca Raton Cmty. Hosp., Inc. v. Tenet Health Care Corp., 582 F.3d 1227, 1229 (11th Cir. 2009). When the cost of care exceeds the predetermined DRG payment, the provider must absorb the entire Fixed Loss Threshold amount before it can recoup any outlier payments from CMS. The parties' interests are thus diametrically opposed: CMS benefits from a higher Fixed Loss Threshold and the Hospitals benefit from a lower Fixed Loss Threshold.

         Finally, the Medicare Act requires that in any fiscal year “[t]he total amount of the [outlier] payments . . . may not be less than 5 percent nor more than 6 percent of the total payments projected or estimated to be made based on DRG prospective payment rates for discharges in that year.” 42 U.S.C. § 1395ww(d)(5)(A)(iv). Thus, although the Fixed Loss Threshold is “determined by the Secretary, ” she must set a Fixed Loss Threshold high enough to ensure that projected outlier payments do not exceed 6% of the projected DRG payments, but not so high that projected outlier payments are less than 5% of the projected DRG.[5] Although the statute's command is unequivocal, Fixed Loss Threshold rulemakings are predictive. Id. (requiring outlier payments to be within 5-6 “percent of the total payments projected or estimated to be made based on DRG prospective payment rates for discharges”) (emphasis added); 42 C.F.R. § 412.80(c) (“CMS will issue threshold criteria for determining outlier payment in the annual notice of the prospective payment rates published in accordance with § 412.8(b).”). As a result, there is no obvious way for CMS to guarantee that annually prescribed rates and thresholds will yield outlier payments that are between 5% and 6% of total DRG payments in the next federal fiscal year. Nor must it take corrective action if its predictions fall short. See Cnty. of L.A., 192 F.3d at 1020. The D.C. Circuit has upheld this practice. See Dist. Hosp. Partners, 786 F.3d at 51.

         B. Regulatory Background

         2003 was a watershed year for the outlier-payment system. The system had been manipulated in the late 1990s by some hospitals which exploited certain regulatory vulnerabilities, arising from “the time lag between the current charges on a submitted bill and the cost-to-charge ratio taken from the most recent settled cost report, ” which predated current charges. Notice of Proposed Rulemaking, 68 Fed. Reg. 10, 420, 10, 423 (Mar. 5, 2003) (3/5/03 NPRM). The outlier payment system depends on calculating “charges, adjusted to cost, ” including overhead and capital costs. 42 U.S.C. § 1395ww(d)(5)(A)(ii) (emphasis added). That adjustment is made using the “cost-to-charge ratio” (CCR) mentioned in the Notice of Proposed Rulemaking. Because hospitals knew that CCRs were based on past cost reports, some hospitals increased their charges for patient care between past cost reports and current reimbursement requests, yielding a CCR that would “be too high” and thus “overestimate the hospital's costs.” 3/5/2003 NPRM at 10, 423. Some 123 hospitals were found to have increased their charges by 70 percent, while only decreasing their CCRs by two percent. Id. at 10, 424. This became known as “turbo-charging.” Dist. Hosp. Partners, 786 F.3d at 51 (describing turbochargers).

         1. The February 2003 Draft Interim Final Rule

         The Hospitals rely heavily on a Draft Interim Final Rule proposed in February 2003-before the Notice of Proposed Rulemaking cited above-and obtained by them through a Freedom of Information Act (FOIA) request. Hosp. Mot. [Dkt. 74] at 11 (citing AR S3595-S3659) (Draft); see also Joint Appendix, Ex. 4 [Dkt. 81-4] at 97-161 (same). The 63-page Draft included a number of findings and proposed various solutions.[6] The Draft found that turbocharging caused “nearly all of the increase in the FY 2003 threshold from FY 2002 ($21, 025 to $33, 560).” AR S3610. It also described the effect of turbocharging on the Fixed Loss Threshold: “Because the fixed-loss threshold is determined based on hospitals' historical charge data, hospitals that have been inappropriately maximizing their outlier payments have caused the threshold to increase dramatically for FY 2003.” AR S3610.

         To prevent future turbocharging, the Draft said that CMS “need[ed] to make revisions to [its] outlier payment methodology, ” primarily by “updating cost-to-charge ratios [CCRs].” 3/5/2003 NPRM at 10, 421, 10, 423. See also generally AR S3612-15. More specifically, the Draft proposed to amend CMS's payment regulations so that “fiscal intermediaries”-insurance companies who examine Medicare payment claims under contract with CMS-could “use either the most recent settled or the most recent tentative settled cost report, whichever is from the latest cost reporting period.” AR S3614. But reducing the lag time alone would not be enough, because some hospitals could still “increase charges much faster than costs during the time between the tentative settled cost report period and the time when the claim is processed. . . . [T]here will still be a lag of 1 to 2 years.” AR S3614-15. To counter this possibility, the Draft proposed a new regulatory provision that would allow CMS to increase a hospital's CCR if “more recent charge data indicate that a hospital's charges have been increasing at an excessive rate (relative to the rate of increase among other hospitals).” AR S3615. The hospitals could also have requested a modified CCR if they presented substantial evidence that the ratios were inaccurate. AR S3615.

         Further, the Draft reconsidered CMS's previous policy “that payment determinations [were] made on the basis of the best information available at the time a claim is processed and [were] not revised, upward or downward, based upon updated data.” AR S3620. Acknowledging that “some hospitals have taken advantage of the current outlier policy, ” AR S3620, the Draft resolved to reconcile processed payments with hospital cost reports once they were ultimately settled. AR S3621; see also AR 3626 (“[W]e believe the only way to eliminate the potential for such overpayments is to provide a mechanism for final settlement of outlier payments using actual cost-to-charge ratios from final, settled cost reports.”). That proposal would trigger another problem, however: “in the event of a decline in the [CCR], some cases would no longer qualify for any outlier payments while other cases would qualify for lower outlier payments.” AR S3622 (emphasis added). In other words, the reconciliation might show that an instance of patient treatment was never eligible for an outlier payment to begin with. And because CMS must predict the “total amount” of outlier payments before the fiscal year begins to comply with the 5-6% requirement, “the only way to accurately determine the net effect of a decrease in [CCRs] on a hospital's total outlier payments is to assess the impact on a claim-by- claim basis.” Id. The Draft admitted candidly that CMS was “still assessing the procedural changes necessary to implement this change.” Id.

         The proposed amendments to the outlier payment scheme would have also made it “necessary, ” according to the Draft, to lower the Fixed Loss Threshold. AR S3629. After excluding the 123 offending turbochargers from the CCR pool; applying actual CCRs (from settled cost reports) to the hospitals that were previously assigned statewide averages; extrapolating future CCRs from the national progression over the previous three years; and reestimating charge inflation without the 123 turbochargers, the Draft recommended reducing the Fixed Loss Threshold from $33, 560 to $20, 760. See AR S3629-33.

         2. FY 2003 Proposed and Final Rules Amending Payment Regulation

         The Draft was never published. Although the Hospitals suggest that CMS “bow[ed] to pressure from [the Office of Management and Budget], ” Hosp. Mot. at 11, that proposition finds no support in the record and may be inconsequential since both agencies are in the Executive Branch and headed by presidential appointees exercising their discretion. Whatever the reason, the Draft was abandoned.

         Instead, CMS on March 5, 2003 published a Notice of Proposed Rulemaking, 3/5/03 NPRM, 68 Fed. Reg. 10, 420-29. The NPRM contained the same modifications listed above to the outlier payment scheme, but did not propose a corresponding reduction in Fixed Loss Threshold.

         After comments, the Final Rule was largely unchanged. See Final Rule, 68 Fed. Reg. 34, 494 (June 9, 2003) (Final Rule). “Many commenters recommended that [CMS] lower the outlier threshold.” Final Rule at 34, 505. CMS acknowledged having “reestimated the fixed-loss threshold reflecting the changes implemented in this final rule that will be in effect during a portion of FY 2003.” Id. Specifically, CMS inflated charges in the FY 2002 Medical Provider Analysis and Review (MedPAR) file[7] by the two-year average annual rate of change in charges. Id. Had its analysis stopped there, the Fixed Loss Threshold would have been $42, 300. Id. “However, after accounting for the changes implemented in this final rule, we estimate the threshold would be only slightly higher than the current threshold (by approximately $600).” Id. (emphasis added). Nonetheless, despite concluding that the Fixed Loss Threshold should be higher, CMS found it “appropriate not to change the FY 2003 outlier threshold at this time” because “[c]hanging the threshold for the remaining few months of the fiscal year could disrupt the hospitals' budgeting plans and would be contrary to the overall prospectivity of the [inpatient prospective payment system].” Id. at 34, 506. The Fixed Loss Threshold stayed at $33, 560 for the remainder of FY 2003. Id.

         3. The FY 2004 Regulations

         By the time CMS set the Fixed Loss Threshold for FY 2004, the changes to the outlier payment regulations were fully in effect. See generally Final Rule, 68 Fed. Reg. 45, 346 (Aug. 1, 2003) (FY 2004 FLT Reg.). Extrapolating from 2002 MedPAR data, CMS applied “the 2-year average annual rate of change in charges per case, ” as opposed to costs per case, “to establish the FY 2004 threshold.” Id. at 45, 476. CMS then took three steps to update the CCR:

[1] for each hospital, we matched charges-per-case to costs-per-case from the most recent cost reporting year; [2] we then divided each hospital's costs by its charges to calculate the cost-to-charge ratio for each hospital; and [3] we multiplied charges from each case in the FY 2002 MedPAR (inflated to FY 2004) by this cost-to-charge ratio to calculate the cost per case.


         The FY 2004 Fixed Loss Threshold regulation also reviewed and evaluated the reconciliation process established by the 2003 amendment to the outlier payment threshold.[8] 68 Fed. Reg. at 45, 476-77. The novel reconciliation process had presented a roadblock. See Id. (“Without actual experience with the reconciliation process, it is difficult to predict the number of hospitals that will be reconciled.”). CMS resolved to “assess the appropriate number of hospitals to be reconciled” once “later data bec[a]me available.” Id. CMS did identify, however, 50 of the turbocharging hospitals as likely subjects of reconciliation. Id. at 45, 476-77.

         Based on all of this, CMS set an FY 2004 Fixed Loss Threshold of $31, 000. Id. at 45, 477.

         4. The FY 2005-2007 Fixed Loss Threshold Regulations

         This pattern largely repeated itself until the years challenged in this case. See generally 69 Fed. Reg. 48, 916, 49, 276, 49, 278 (Aug. 11, 2004) (FY 2005 FLT Reg.) (lowering the Fixed Loss Threshold to $25, 800, after initially proposing $35, 085, in response to comments suggesting that CMS revise its methodology); 70 Fed. Reg. 47, 278, 47, 493-94 (Aug. 12, 2005) (FY 2006 FLT Reg.) (lowering the Fixed Loss Threshold to $23, 600, after initially proposing $26, 675, by using the same methodology but updated data); 71 Fed. Reg. 47, 870, 48, 151 (Aug. 18, 2006) (FY 2007 FLT Reg.) (raising the Fixed Loss Threshold to $24, 475, after initially proposing $25, 530). To sum up: the Fixed Loss Threshold was set at $25, 800 in FY 2005; $23, 600 in FY 2006; and $24, 475 in FY 2007.

         Throughout these rulemakings, commenters continually complained that the Fixed Loss Thresholds were too high, both out of self-interest and a concern over statutory compliance by CMS. E.g., FY 2005 FLT Reg. at 49, 276 (“Some commenters explained that this increase to the threshold would make it more difficult for hospitals to qualify for outlier payments and put them at greater risk when treating high cost cases. . . . The commenters further noted that, in the proposed rule, [CMS] estimated total outlier payments for FY 2004 to be 4.4 percent of all inpatient payments.”); FY 2006 FLT Reg. at 47, 974; FY 2007 FLT Reg. at 48, 149.

         Commenters cited previous years' outlier payments, which had not fallen within the 5-6% statutory window. E.g., FY 2007 FLT Reg. at 48, 149 (“The commenters noted that total estimated outlier payments in FY 2004 and FY 2005 were well under the 5.1 percent target.”). CMS conceded this as a factual matter. Id. at 48, 150 (“As the commenters noted, the outlier thresholds we have projected in the last several years have resulted in payments below the 5.1 percent target.”). CMS also noted that in earlier years, payments had been significantly higher than 5.1% because of turbocharging. Id. (“[I]n the early years of th[e] decade, outlier payments were significantly higher than the 5.1 percent target we projected.”).

         More specifically, commenters decried CMS's failure to (1) apply an adjustment factor to the CCRs; or (2) account for the effect of reconciliation. E.g., FY 2006 FLT Reg. at 47, 494 (“Several commenters suggested an alternative to the methodology we proposed”: CMS “should adjust cost-to-charge ratios that will be used to calculate the FY 2006 outlier threshold.”); FY 2005 FLT Reg. at 49, 277 (“One of the commenters also noted that none of the calculations above factored in the impact of reconciliation that would result in an even lower outlier threshold.”).

         On the first point, CMS eventually relented. See FY 2007 FLT Reg. at 48, 150 (“[W]e now agree with the commenters that it is appropriate to apply an adjustment factor to the CCRs so that the CCRs we are using in our simulation more closely reflect the CCRs that will be used in FY 2007.”). CMS agreed to “apply only a one year adjustment factor” of 99.73%. Id. The Hospitals refer to this as a “negative 0.27%.” Hosp. Mot. at 14.

         On the second point, CMS held firm and did not account for the potential effect of reconciliation when setting the outlier threshold. FY 2007 FLT Reg. at 48, 149 (“As we did in establishing the FY 2006 outlier threshold, in our projection of FY 2007 outlier payments, we proposed not to make an adjustment for the possibility that hospitals' CCRs and outlier payments may be reconciled upon cost report settlement.”) (citation omitted).

         5. The FY 2008-2011 Fixed Loss Threshold Regulations

         We come now to the Fixed Loss Threshold regulations at issue in this case. Cf. Hosp. Mot. at 15 (“In Each of FYs 2008-2011 Here at Issue . . . .”). The Hospitals allege generally that CMS “continued to use the flawed FLT model that had resulted in substantial underpayment in FY 2007.” Id. With the benefit of hindsight, CMS has reported that the total outlier payments (as a percentage of total DRG payments) were 4.8% for FY 2008, see 74 Fed. Reg. at 44, 012 (AR 7084); 5.3% for FY 2009, see 75 Fed. Reg. 50, 042, 50, 431 (Aug. 16, 2010) (AR 10187)[9]; 4.7% for FY 2010, see 76 Fed. Reg. 51, 476, 51, 795-96 (Aug. 18, 2011); and 4.8% for FY 2011, see 77 Fed. Reg. 53, 258, 53, 697 (Aug. 31, 2012).

         a. FY 2008

         For FY 2008, CMS used the same methodology as it had used for FY 2007 to calculate the outlier threshold. See 72 Fed. Reg. 47, 130, 47, 417 (Aug. 22, 2007) (FY 2008 FLT Reg.). The agency applied a one-year CCR adjustment factor (99.12%) to the CCRs in the October 2006 update to the hospitals' Provider Specific File, which is a file for each provider that contains the unique information relevant to that provider that is used by CMS to compute payments and repayments for services provided. CMS also artificially inflated (by 15.04%) the 2006 MedPAR claims by two years. Id. The result was a proposed Fixed Loss Threshold of $23, 015. Id. Several commenters thought that amount was too high. See generally Id. at 47, 417-18. These commenters noted that outlier payments had been only 4.63% of overall FY 2007 payments; faulted CMS for not using more recent CCR data; and suggested applying the CCR adjustment factor over different periods of time (longer or shorter than one year). Id.

         CMS did not budge. See Id. at 47, 418 (“Because we are not making any changes to our methodology for this final rule with comment period, for FY 2008, we are using the same methodology we proposed to calculate the outlier threshold.”). It did use more recent data, however, which resulted in a lower final Fixed Loss Threshold of $22, 635. Id. at 47, 419.[10] One commenter implored CMS to use even more recent data. Id. at 47, 418 (“The commenter urged CMS to use the June 2007 update [to the hospital CCRs] instead of the March 2007 update for the final rule.”). CMS declined because the June CCR update would not be ready until the end of July, “which is beyond the timetable necessary for us to compute the outlier threshold and publish this final rule with comment period by August 1st.” Id.

         b. FY 2009

         The process was the same for FY 2009. See 73 Fed. Reg. 48, 434, 48, 763 (Aug. 19, 2008) (FY 2009 FLT Reg.) (“For FY 2009, we proposed to continue to use the same methodology used for FY 2008 to calculate the outlier threshold.”) (citation omitted). CMS again proposed a one-year CCR adjustment factor (99.2%) to CCRs calculated from the previous December's Provider Specific File update. Id. Once again, the previous year's MedPAR data were extrapolated out by two years. Id. The result was a proposed Fixed Loss Threshold of $21, 025. Id.

         This proposal found a slightly more welcoming reception than its predecessors. Id. at 48, 764 (“The commenters commended CMS for making refinements such as applying an adjustment factor to CCRs when computing the outlier threshold but noted that, because CMS is still not reaching the 5.1 percent target, there is still room for improvement.”). Commenters again called the CCR adjustment calculation “unnecessarily complicated”; again urged CMS to use more recent, historical, and industry-wide rates of change; again asked CMS to vary the CCR adjustment factor to more or less than one year; and again asked CMS to apply the June Provider Specific File update instead of the March version. Id.

         Once again, CMS was implacable. See generally Id. (providing largely the same reasons as in FY 2008). Applying the same methodology as in the proposed rule-but with more recent data-CMS settled on a Fixed Loss Threshold of $20, 185. Id.[11] As it had done previously, CMS refused to make “any adjustments for the possibility that hospitals' CCRs and outlier payments may be reconciled upon cost report settlement.” Id. at 48, 765.

         c. FY 2010

         “For FY 2010, [CMS] proposed to continue to use the same methodology used for FY 2009 to calculate the outlier threshold.” 74 Fed. Reg. 43, 754, 44, 007 (Aug. 27, 2009) (FY 2010 FLT Reg.) (citation omitted). The previous year's MedPAR files were used, and a one-year CCR adjustment factor (98.4%) was applied to the CCRs as contained in the previous December's Provider Specific File update. See generally Id. at 44, 007-08. CMS proposed a Fixed Loss Threshold of $24, 240, which represented a 21% increase from the previous fiscal year. Id. at 44, 008.

         The FY 2010 proposed increase spurred further protest. See generally Id. Commenters could not understand why-when CMS had met its target in FY 2009-there should be any change. Id. at 44, 009. Others accused CMS of purposefully erring on the low end of the 5-6% target or below it altogether. Id. Another asked CMS to make a mid-year change to the Fixed Loss Threshold if it appeared that the 5-6% target would not be met. Id. Still others repeated the requests to use June data instead of March data in the Final Rule, to account for reconciliation. Id. at 44, 009-10.

         CMS insisted in its response that it had “use[d] the most recent data available to set the outlier threshold.” Id. at 44, 009. A mid-year course correction was rejected. Id. (citing 70 Fed. Reg. at 47, 495). All other suggestions were denied for the same reasons as in previous years. See generally FY 2010 FLT Reg. at 44, 010.

         d. FY 2011

         Fiscal year 2011-the last at issue in this case-proved to be no different. See 75 Fed. Reg. 50, 042, 50, 427 (FY 2011 FLT Reg.) (Aug. 16, 2010) (“For FY 2011, [CMS] proposed to continue to use the same methodology used for FY 2009 to calculate the outlier threshold.”) (citation omitted). CMS proposed a one-year CCR adjustment factor of 98.9% with a resulting Fixed Loss Threshold of $24, 165, a 4.5% increase from the previous year. Id. at 50, 428.

         Commenters again pointed out that the previous year had missed the mark (outlier payments were merely 4.7% of total payments) and reiterated the previous years' suggestions about how to fix that. See generally Id. at 50, 428-29. Commenters also made several discrete suggestions, addressed in the analysis below. See infra at 38-39.

         CMS rejected each of the suggestions. FY 2011 FLT Reg. at 50, 429 (“Because we are not making any changes to our methodology for this final rule, for FY 2011, we are using the same methodology we proposed to calculate the outlier threshold.”). Applying that methodology to the ...

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