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District Hospital Partners, L.P. v. Burwell

United States Court of Appeals, District of Columbia Circuit

May 19, 2015


Argued February 12, 2015

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Appeal from the United States District Court for the District of Columbia. (No. 1:11-cv-00116).

Robert L. Roth argued the cause for the appellants. James F. Segroves and John R. Hellow were with him on brief.

John L. Oberdorfer, Pierre H. Bergeron, Stephen P. Nash and Sven C. Collins were on brief for the amici curiae Non-Profit Hospitals in support of the appellants.

James C. Luh, Trial Attorney, United States Department of Justice, argued the cause for the appellee. Stuart F. Delery, Assistant Attorney General, Ronald C. Machen, Jr., U.S. Attorney, and H. Thomas Byron III, Attorney, were with him on brief.

Before: HENDERSON, ROGERS and BROWN, Circuit Judges.


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Karen LeCraft Henderson, Circuit Judge

This case requires us to slough through the " labyrinthine world" of Medicare reimbursements. Adirondack Med. Ctr. v. Sebelius, 740 F.3d 692, 694, 408 U.S. App.D.C. 161 (D.C. Cir. 2014). Under the current system, hospitals are reimbursed for treating a Medicare patient based on the average treatment cost for that patient's ailment/condition. Some patients, however, require protracted care that far outpaces an illness's average cost of treatment. To account for this, hospitals can request " additional payments," known as outlier payments, if the cost of treating a particular patient is sufficiently high. 42 U.S.C. § 1395ww(d)(5)(A). Every year, the Secretary of Health and Human Services (HHS) sets a monetary threshold above which outlier payments may be recovered.

A group of 186 hospitals that participates in Medicare believes that the HHS Secretary set the monetary threshold for outlier payments too high in 2004, 2005 and 2006. Led by District Hospital Partners (DHP), the hospitals sued the Secretary in federal district court, claiming that she violated the Administrative Procedure Act (APA), 5 U.S.C. § § 551 et seq., by engaging in arbitrary and capricious decision-making. They also moved to supplement the administrative record. The district court denied the motion to supplement in part and rejected DHP's

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APA challenges to each outlier threshold. We affirm the district court's partial denial of the motion to supplement and its rejection of the APA challenges to the 2005 and 2006 outlier thresholds. Its conclusion that the 2004 threshold is adequately explained, however, is erroneous and we therefore reverse its summary judgment grant to the Secretary on this claim and remand to the district court with instructions to remand to the Secretary for further proceedings. See Miller v. Dep't of Navy, 476 F.3d 936, 939-40, 375 U.S. App.D.C. 3 (D.C. Cir. 2007).


A. The Outlier Payment System

Medicare was " [e]stablished in 1965 as part of the Social Security Act." Fischer v. United States, 529 U.S. 667, 671, 120 S.Ct. 1780, 146 L.Ed.2d 707 (2000). It operates as a " federally funded medical insurance program for the elderly and disabled," id., and is managed by the HHS Secretary, 42 U.S.C. § 1395kk(a). The program originally reimbursed hospitals for the " reasonable costs" of services provided to Medicare patients. Cnty. of L.A. v. Shalala, 192 F.3d 1005, 1008, 338 U.S. App.D.C. 168 (D.C. Cir. 1999). That system deteriorated over time, however, because it provided " little incentive for hospitals to keep costs down," as " [t]he more they spent, the more they were reimbursed." Id. In 1983, the Congress became particularly concerned " that hospitals reimbursed on a reasonable cost basis lacked incentives to operate efficiently." Transitional Hosps. Corp. of La., Inc. v. Shalala, 222 F.3d 1019, 1021, 343 U.S. App.D.C. 82 (D.C. Cir. 2000).

To rectify the problem, the Congress shifted to a prospective payment system that reimburses hospitals based on the average rate of " operating costs [for] inpatient hospital services." Cnty. of L.A., 192 F.3d at 1008. Because different illnesses entail varying costs of treatment, the Secretary uses diagnosis-related groups (DRGs) to " modif[y]" the average rate. Cape Cod Hosp. v. Sebelius, 630 F.3d 203, 205, 394 U.S. App.D.C. 59 (D.C. Cir. 2011). A DRG is a group of related illnesses to which the Secretary assigns a weight representing " the relationship between the cost of treating patients within that group and the average cost of treating all Medicare patients." Id. at 205-06. To calculate a specific reimbursement, the Secretary " takes the [average] rate, adjusts it [to account for regional labor costs], and then multiplies it by the weight assigned to the patient's DRG." Cnty. of L.A., 192 F.3d at 1009.

The major innovation of the prospective payment system is that hospitals are " reimbursed at a fixed amount per patient, regardless of the actual operating costs they incur in rendering [those] services." Sebelius v. Auburn Reg'l Med. Ctr., 133 S.Ct. 817, 822, 184 L.Ed.2d 627 (2013) (emphasis added). The new system incentivizes hospitals to keep costs as low as possible. But the " Congress recognized that health-care providers would inevitably care for some patients whose hospitalization would be extraordinarily costly or lengthy." Cnty. of L.A., 192 F.3d at 1009. To account for costly patients, the Congress allows hospitals to request outlier payments. See 42 U.S.C. § 1395ww(d)(5)(A)(ii). 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." Id.

Although calculating outlier payments is an elaborate process, three particular numbers are important: (1) the cost-to-charge ratio, (2) the fixed loss threshold, and (3) the outlier threshold. A hospital's cost-to-charge ratio is calculated from data

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in its most recent cost report. See 42 C.F.R. § 412.84(i)(2). The ratio represents a hospital's " average markup." Appalachian Reg'l Healthcare, Inc. v. Shalala, 131 F.3d 1050, 1052, 327 U.S. App.D.C. 396 (D.C. Cir. 1997). Markup is key because outlier payments are available only " where charges, adjusted to cost, exceed" the applicable DRG rate by a fixed amount. 42 U.S.C. § 1395ww(d)(5)(A)(ii) (emphasis added). The ratio ensures that the Secretary does not simply reimburse a hospital for the charges reflected on a patient's invoice but instead only for charges that are " adjusted to cost." Id. Applying the cost-to-charge ratio in practice is straightforward. For example, if a hospital's cost-to-charge ratio is 75% (total costs are approximately 75% of total charges), the Secretary multiplies the hospital's charges by 75% to calculate the hospital's cost. See Boca Raton Cmty. Hosp., Inc. v. Tenet Health Care Corp., 582 F.3d 1227, 1229 n.3 (11th Cir. 2009).

The second important number is the fixed loss threshold. A hospital can request an outlier payment if its charges exceed the " DRG prospective payment rate . . . plus a fixed dollar amount determined by the Secretary." 42 U.S.C. § 1395ww(d)(5)(A)(ii) (emphasis added). The italicized portion--" a fixed dollar amount" --is known as the fixed loss threshold. In effect, this threshold " acts like an insurance deductible because the hospital is responsible for that portion of the treatment's excessive cost" above the applicable DRG rate. Boca Raton Cmty. Hosp., 582 F.3d at 1229. The Secretary calculates a new fixed loss threshold for each fiscal year. See 42 U.S.C. § 1395ww(d)(6).

The third number is the outlier threshold. The Secretary calculates it by adding the DRG rate for a certain illness or condition to the fixed loss threshold.[1] See Cnty. of L.A., 192 F.3d at 1009. Any cost-adjusted charges imposed above the outlier threshold are eligible for reimbursement under the outlier payment provision. See 42 U.S.C. § 1395ww(d)(5)(A)(ii). Since 2003, outlier payments have been 80% of the difference between a hospital's adjusted charges and the outlier threshold. See 68 Fed. Reg. at 45,476; 42 C.F.R. § 412.84(k).

We can tie this all together with an example. 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, see supra n.1, the hospital is eligible for an outlier payment of $8,000, which is 80% of the difference between its

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cost-adjusted charges ($23,000) and the outlier threshold ($13,000). See generally 62 Fed. Reg. 45,966, 45,997 (Aug. 29, 1997) (explaining similar example).

Apart from calculating individual reimbursements, the Secretary must also ensure that total outlier payments are neither " less than 5 percent nor more than 6 percent" of the total DRG-related payments in a given year. 42 U.S.C. § 1395ww(d)(5)(A)(iv). The Secretary complies with this provision by selecting outlier thresholds that, " when tested against historical data, will likely produce aggregate outlier payments totaling between five and six percent of projected . . . DRG-related payments." Cnty. of L.A., 192 F.3d at 1013. Nevertheless, testing against historical data is only a predictive exercise. Id. at 1009. Accordingly, the Secretary does not take corrective action once the fiscal year ends even if outlier payments fall outside the five-to-six per cent range. Id. We have upheld this practice. Id. at 1020.

B. The Outlier Correction Rule

The outlier payment system began to break down in the late 1990s. Outlier payments were supposed to be made " only in situations where the cost of care is extraordinarily high in relation to the average cost of treating comparable conditions or illnesses." 68 Fed. Reg. 10,420, 10,423 (Mar. 5, 2003). But hospitals could manipulate the outlier regulations if their charges were " not sufficiently comparable in magnitude to their costs." Id. The Secretary issued a notice of proposed rulemaking (NPRM) to address these concerns. Id. at 10,420.

In the NPRM, the Secretary described how a hospital could use " 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." Id. at 10,423. A hospital knows that its cost-to-charge ratio is based on data submitted in past cost reports. Id. If it dramatically increased charges between past cost reports and the patient costs for which reimbursement is sought, its cost-to-charge ratio would " be too high" and would " overestimate the hospital's costs." Id. Some hospitals took advantage of this weakness in the system. The Secretary identified " 123 hospitals whose percentage of outlier payments relative to total DRG payments increased by at least 5 percentage points" between fiscal years 1999 and 2001. Id. The adjusted charges at those 123 hospitals " increased at a rate at or above the 95th percentile rate of charge increase for all hospitals . . . over the same period." Id. And during that time, the 123 hospitals had a " mean rate of increase in charges [of] 70 percent" alongside a decrease of " only 2 percent" in their cost-to-charge ratios. Id. at 10,424. The 123 hospitals are referred to as turbo-chargers.

The Secretary published the final rule three months after the NPRM. See 68 Fed. Reg. 34,494 (June 9, 2003) (outlier correction rule). As relevant here, the Secretary adopted two new provisions to close the gaps in the outlier payment system. First, a hospital's cost-to-charge ratio was to be calculated using more recent cost reports. Id. at 34,497-99 (codified at 42 C.F.R. § 412.84(i)(1)-(2)). This change reduced " the time lag for updating cost-to-charge ratios by a year or more" and ensured that those ratios accurately reflected a hospital's costs. Id. at 34,497. Second, a hospital's outlier payments were to be subject to reconciliation when its " cost report[] coinciding with the discharge is settled." Id. at 34,504 (codified at 42 ...

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