Banner Health v. Thomas Price , 867 F.3d 1323 ( 2017 )

United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued April 13, 2017 Decided August 18, 2017
No. 16-5129
BANNER HEALTH, F/B/O BANNER GOOD SAMARITAN MEDICAL
CENTER, F/B/O NORTH COLORADO MEDICAL CENTER, F/B/O
MCKEE MEDICAL CENTER, F/B/O BANNER THUNDERBIRD
MEDICAL CENTER, F/B/O BANNER MESA MEDICAL CENTER,
F/B/O BANNER DESERT MEDICAL CENTER, F/B/O BANNER
ESTRELLA MEDICAL CENTER, F/B/O BANNER HEART
HOSPITAL, F/B/O BANNER BOSWELL MEDICAL CENTER, F/B/O
BANNER BAYWOOD MEDICAL CENTER, ET AL.,
APPELLANTS
v.
THOMAS E. PRICE, SECRETARY, U.S. DEPARTMENT OF
HEALTH AND HUMAN SERVICES,
APPELLEE
Appeal from the United States District Court
for the District of Columbia
(No. 1:10-cv-01638)
Sven C. Collins argued the cause for appellants. With him
on the briefs was Stephen P. Nash.
Robert L. Roth, James F. Segroves, and John R. Hellow
were on the brief for amici curiae Hospitals in support of
appellants.
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Benjamin M. Shultz, Attorney, U.S. Department of Justice,
argued the cause for appellee. With him on the brief was
Michael S. Raab, Attorney.
Before: ROGERS, GRIFFITH and SRINIVASAN, Circuit
Judges.
PER CURIAM: This appeal challenges the implementation
by the Secretary of Health and Human Services (“HHS”) of the
Medicare outlier-payment program in the late 1990s and early
2000s. The program provides “supplemental” payments to
hospitals to protect them from “bearing a disproportionate share
of the[] atypical costs” associated with caring for “patients
whose hospitalization would be extraordinarily costly or
lengthy.” Cty. of L.A. v. Shalala, 192 F.3d 1005, 1009 (D.C.
Cir. 1999). A group of twenty-nine non-profit hospitals (“the
Hospitals”) principally contend that HHS violated the
Administrative Procedure Act (“APA”), 5 U.S.C. §§ 551 et seq.,
by failing to identify and appropriately respond to flaws in its
methodology that enabled certain “turbo-charging” hospitals to
manipulate the system and receive excessive payments at the
expense of non-turbo-charging hospitals, including appellants.
The court addressed similar challenges in District Hospital
Partners, L.P. v. Burwell, 786 F.3d 46 (D.C. Cir. 2015), and, to
the extent the Hospitals repeat challenges decided in District
Hospital Partners, that decision controls here. See LaShawn A.
v. Barry, 87 F.3d 1389, 1395 (D.C. Cir. 1996). As to the
Hospitals’ other challenges, we affirm the district court’s denials
of their motions to supplement the record and to amend their
complaint, and its decision that HHS acted reasonably in a
manner consistent with the Medicare Act in fiscal years (“FYs”)
1997 through 2003, and 2007. HHS, however, has inadequately
explained aspects of the calculations for FYs 2004 through
2006, and we therefore reverse the grant of summary judgment
3
in that regard and remand the case to the district court to remand
to HHS for further proceedings.
I.
A.
Under the Medicare program, the federal government
reimburses health care providers for medical services provided
to the elderly and disabled. See Social Security Amendments of
1965 (“Medicare Act”), Pub. L. No. 89–97, tit. XVIII, 79 Stat.
286, 291 (1965). Initially, Medicare reimbursed hospitals for
the “reasonable cost” of care provided. See 42 U.S.C.
§ 1395f(b)(1). This system, however, “bred ‘little incentive for
hospitals to keep costs down’ because ‘the more they spent, the
more they were reimbursed.’” Cty. of L.A., 192 F.3d at 1008
(quoting Tucson Med. Ctr. v. Sullivan, 947 F.2d 971, 974 (D.C.
Cir. 1991)) (brackets omitted). “To stem the program’s
escalating costs and perceived inefficiency,” Congress revised
Medicare’s reimbursement system in 1983 to compensate
hospitals prospectively at rates set before the start of each fiscal
year. Id. Because the new system presented its own risk of
under-compensating hospitals for the care of high-cost patients,
Congress “authorized the Secretary [of HHS] to make
supplemental ‘outlier payments.’” Id. at 1009. Day outlier
payments, which have since been phased out, were originally
provided when a patient’s length of stay exceeded a certain
threshold. See 42 U.S.C. § 1395ww(d)(5)(A)(i), (v). Cost
outlier payments are provided when a hospital’s “charges,
adjusted to cost” for a given patient exceed a certain “fixed
dollar amount determined by [HHS],” after discounting any
payments the hospital would normally receive. Id.
§ 1395ww(d)(5)(A)(ii). This appeal addresses cost outlier
payments.
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“[C]alculating [cost] outlier payments is an elaborate
process,” Dist. Hosp. Partners, 786 F.3d at 49, and some
explication is necessary. First, by requiring that charges be
“adjusted to cost” before determining whether a cost outlier
payment is due, 42 U.S.C. § 1395ww(d)(5)(A)(ii), the Medicare
Act “ensures that [HHS] does not simply reimburse a hospital
for the charges reflected on a patient’s invoice.” Dist. Hosp.
Partners, 786 F.3d at 50. HHS applies a “cost-to-charge ratio”
“represent[ing] a hospital’s ‘average markup’” to a hospital’s
charges. Id. (quoting Appalachian Reg’l Healthcare, Inc. v.
Shalala, 131 F.3d 1050, 1052 (D.C. Cir. 1997)). “For example,
if a hospital’s cost-to-charge ratio is 75% (total costs are
approximately 75% of total charges), [HHS] multiplies the
hospital’s charges by 75% to calculate the hospital’s cost.” Id.
Second, the “fixed dollar amount,” 42 U.S.C.
§ 1395ww(d)(5)(A)(ii), commonly known as the “fixed[-]loss
threshold,” “‘acts like an insurance deductible because the
hospital is responsible for that portion of the treatment’s
excessive cost.’” Dist. Hosp. Partners, 786 F.3d at 50 (quoting
Boca Raton Cmty. Hosp. v. Tenet Health Care Corp., 582 F.3d
1227, 1229 (11th Cir. 2009)). The sum of the fixed-loss
threshold and the standard payments a hospital would receive
for a given treatment is known as the “outlier threshold.” Id.
“Any cost-adjusted charges imposed above the outlier threshold
are eligible for reimbursement under the outlier payment
provision,” id. (citing 42 U.S.C. § 1395ww(d)(5)(A)(ii)),
although not at full cost, see 42 U.S.C. § 1395ww(d)(5)(A)(iii).
For all years relevant to this appeal, “outlier payments have been
80% of the difference between a hospital’s adjusted charges and
the outlier threshold.” Dist. Hosp. Partners, 786 F.3d at 50; see
42 C.F.R. § 412.84(j) (1997); 42 C.F.R. § 412.84(k) (2003).
Finally, in calculating the fixed-loss threshold, HHS must
ensure that the total amount of outlier payments is not “less than
5
5 percent nor more than 6 percent” of total payments “projected
or estimated to be made” under the inpatient prospective
payment system that year. 42 U.S.C. § 1395ww(d)(5)(A)(iv).
HHS “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 [non-outlier prospective] payments.’”
Dist. Hosp. Partners, 786 F.3d at 51 (quoting Cty. of L.A., 192
F.3d at 1013). For all years relevant to this appeal, HHS has
used 5.1% as its target percentage. See Banner Health v.
Burwell, 126 F. Supp. 3d 28, 43, 50 (D.D.C. 2015) (“Banner
Health 2015”). To account for the costs of the outlier-payment
program, HHS also must reduce the standardized prospective
payment rates for non-outlier payments by the same target
percentage used to establish the fixed-loss threshold. 42 U.S.C.
§ 1395ww(d)(3)(B). In County of Los Angeles, 192 F.3d at
1017–20, the court held that HHS reasonably interpreted the
Medicare Act not to require retroactive adjustments to the
outlier threshold if total actual payments fell above or below the
target percentage given the prospective nature of the system.
B.
Two sets of implementing regulations govern a hospital’s
qualification for outlier payments: (1) payment regulations
determining when individual patient cases qualify for outlier
payments, see 42 C.F.R. §§ 412.80–86; and (2) annual threshold
regulations determining the fixed-loss threshold and other
criteria used to define “outlier cases” for the upcoming fiscal
year, see 42 C.F.R. § 412.80(c). The latter regulation sets the
threshold based on the payment regulations and other factors.
During the early years of the outlier-payment program,
HHS made a number of program-design decisions that are
pertinent to this appeal. In the late 1980s, HHS revised the
payment regulations at 42 C.F.R. § 412.84 to adopt hospital-
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specific cost-to-charge ratios in lieu of a national cost-to-charge
ratio. See FY 1989 Final Rule, 53 Fed. Reg. 38,476, 38,503,
38,507–09, 38,529 (Sept. 30, 1988). The purpose of this change
was to “greatly enhance the accuracy with which outlier cases
are identified and outlier payments are computed, since there is
wide variation among hospitals in these cost-to-charge ratios.”
Id. at 38,503. HHS also provided that a hospital would default
to an average statewide cost-to-charge ratio if its hospital-
specific ratio fell outside reasonable parameters — three
standard deviations above and below the statewide average —
assuming that “ratios falling outside this range are unreasonable
and are probably due to faulty data reporting or entry.” Id. at
38,507–08. Because “Medicare costs are generally overstated
on the filed cost report and are subsequently reduced as a result
of audit,” HHS specified that cost-to-charge ratios were to be
based on the “latest settled cost report” (that is, the latest audited
cost report) and the associated charge data. Id. at 38,507. HHS
acknowledged that this meant the data could be “as much as
three years old,” but nonetheless concluded that it was “the most
accurate available data.” Id.
In 1993, HHS decided to change how it adjusted its data for
inflation in predicting future outlier payments. Until then, HHS
had been inflating the prior year’s charge data and then applying
hospital cost-to-charge ratios to predict cost-adjusted charges for
the upcoming fiscal year. FY 2004 Final Rule, 58 Fed. Reg.
46,270, 46,347 (Sept. 1, 1993). This is referred to as using a
“charge[-]inflation factor.” Id. Recognizing that charges were
consistently increasing at a faster rate than costs and thus cost-
to-charge ratios were declining, HHS switched to a “cost[-
]inflation factor,” which it would apply after adjusting hospital
charges by the cost-to-charge ratios. Id. HHS expected that this
change would address a tendency in the model to
“overestimat[e] outlier payments in setting the thresholds,” that
had been causing actual outlier payments to come in below the
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target percentage of total inpatient prospective payments. Id.
Over the next several years, actual outlier payments began
to grow in relation to total inpatient prospective payments, see
FY 1997 Final Rule, 61 Fed. Reg. 46,166, 46,229 (Aug. 30,
1996); FY 1998 Final Rule, 62 Fed. Reg. 45,966, 46,041 (Aug.
29, 1997), and exceeded the target percentage for the first time
in FY 1997, see FY 1999 Final Rule, 63 Fed. Reg. 40,954,
41,009 (July 31, 1998). Observing that it was now consistently
underestimating the thresholds necessary to hit the 5.1% target
and attributing these miscalculations to the fact that charges
were continuing to increase faster than costs, HHS switched
back to a charge-inflation methodology beginning in FY 2003.
See FY 2003 Final Rule, 67 Fed. Reg. 49,982, 50,123–24 (Aug.
1, 2002). But, unbeknownst to HHS, the outlier-payment system
had, in fact, “beg[u]n to break down in the late 1990s.” Dist.
Hosp. Partners, 786 F.3d at 51. As recounted in District
Hospital Partners,
[o]utlier 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. But hospitals
could manipulate the outlier regulations if their charges
were not sufficiently comparable in magnitude to their
costs. [HHS] issued a notice of proposed rulemaking
(NPRM) [in February 2003] to address these concerns.
In the NPRM, [HHS] 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. A hospital knows
that its cost-to-charge ratio is based on data submitted
in past cost reports. If it dramatically increased
charges between past cost reports and the patient costs
8
for which reimbursement is sought, its cost-to-charge
ratio would be too high and would overestimate the
hospital’s costs. Some hospitals took advantage of this
weakness in the system. [HHS] identified 123
hospitals whose percentage of outlier payments relative
to total [non-outlier prospective] payments increased
by at least 5 percentage points between [FYs] 1999 and
2001. 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. 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. The 123 hospitals are referred to
as turbo-chargers.
[HHS] published the final rule three months after
the NPRM. As relevant here, [HHS] 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. 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.
Second, a hospital’s outlier payments were to be
subject to reconciliation when its cost report coinciding
with the discharge is settled. Outlier payments were
still disbursed based on the best information available
at that time.
Id. (citing 2003 Outlier NPRM, 68 Fed. Reg. 10,420 (Mar. 5,
2003) and 2003 Outlier Final Rule, 68 Fed. Reg. 34,494 (June
9, 2003)) (internal quotation marks and alterations omitted).
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HHS opted not to change the then-in-effect FY 2003
threshold to reflect the new methodology. 2003 Outlier Final
Rule, 68 Fed. Reg. at 34,506. In rejecting this option in the
NPRM, HHS cited the “extreme uncertainty regarding the
effects of aggressive hospital charging practices on FY 2003
outlier payments to date.” 2003 Outlier NPRM, 68 Fed. Reg. at
10,427. Noting, however, that outlier payment data “for the first
quarter of FY 2003” would “be available soon,” the NPRM
allowed that HHS might adjust the fixed-loss threshold at some
point in the future. Id. In the Final Rule, however, HHS
estimated an immediate adjustment would increase the FY 2003
threshold “by approximately $600,” 2003 Outlier Final Rule, 68
Fed. Reg. at 34,505, and determined that any benefits in
accuracy were outweighed by the potential that “ for disruption
and the fact that there was only a “limited amount of time
remaining in the fiscal year,” id. at 34,506. Although unknown
to the public at the time, the decision not to adjust the FY 2003
threshold represented a departure from HHS’s initial thinking as
documented in a draft interim final rule (“draft IFR”) submitted
to the Office of Management and Budget (“OMB”) about month
before the NPRM was issued. The draft IFR, which otherwise
was largely consistent with the changes ultimately adopted but
would have been implemented earlier in the fiscal year, would
have also immediately lowered the FY 2003 outlier threshold
from $33,560 to $20,760.
HHS subsequently calculated annual fixed-loss thresholds
in accordance with the new methodology, making only minor
modifications to this approach along the way. See FY 2004
Final Rule, 68 Fed. Reg. 45,346, 45,476–77 (Aug. 1, 2003); FY
2005 Final Rule, 69 Fed. Reg. 48,916, 49,276–78 (Aug. 11,
2004); FY 2006 Final Rule, 70 Fed. Reg. 47,278, 47,493–94
(Aug. 12, 2005); FY 2007 Final Rule, 71 Fed. Reg. 47,870,
48,148–51 (Aug. 18, 2006). For FY 2004, HHS attempted to
predict which hospitals would be subject to reconciliation and
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project their cost-to-charge ratios accordingly. See FY 2004
Final Rule, 68 Fed. Reg. at 45,477. HHS subsequently
abandoned this approach, however, concluding that the majority
of hospitals would not be subject to reconciliation and it was
difficult to predict which would be in any given year. See FY
2005 Final Rule, 69 Fed. Reg. at 49,278. For FY 2007, HHS
announced that it applied an adjustment factor to cost-to-charge
ratios to account for the fact that hospitals’ charges had
consistently been growing faster than their costs, causing cost-
to-charge ratios to consistently decline between when the
threshold was estimated and when payments would actually be
made. See FY 2007 Final Rule, 71 Fed. Reg. at 48,150. For
further elaboration on the details of these rules, see Parts VI
through IX.
C.
The Hospitals appealed their final outlier payment
determinations between 1997 and 2007. See 42 U.S.C.
§ 1395oo(a). Challenging the validity of the governing
regulations, they were granted expedited judicial review and
filed a complaint in district court. See Banner Health, 797 F.
Supp. 2d 97, 103–04 (D.D.C. 2011) (“Banner Health 2011”); 42
U.S.C. § 1395oo(f)(1). HHS moved to dismiss the complaint for
lack of subject matter jurisdiction and for failure to state a claim
for which relief can be granted. The district court ruled that the
Hospitals “stated sufficient facts . . . to support their standing”
at that time to pursue claims under the Medicare Act, but
dismissed claims brought under the Mandamus Act. Banner
Health 2011, 797 F. Supp. 2d at 107. The district court
otherwise declined to reach the merits of the Hospitals’
remaining challenges in the absence of an administrative record
and ordered the Hospitals to file a “notice of claims” identifying
each “discrete agency action” being challenged. Id. at 118.
 11
Over the next several years the district court pared down the
Hospitals’ claims, see Banner Health v. Sebelius, 905 F. Supp.
2d 174, 182–87, 188 (D.D.C. 2012), and the parties engaged in
discovery, see Banner Health v. Sebelius, 945 F. Supp. 2d 1,
13–15, 17–39 (D.D.C. 2013). During this process, HHS advised
the court that it had lost and was unable to recover multiple
boxes of public comments submitted in connection with the FY
2004 rulemaking. Id. at 19. The district court concluded this
loss was insufficient to defeat the “presumption of regularity” to
be afforded to HHS’s action, id. at 20, but granted the Hospitals’
motion to supplement the record with certain materials,
including the draft IFR that HHS prepared but abandoned in
2003, see id. at 27; see also id. at 33, 34, 36, 38. The Hospitals
sought leave to amend and supplement their complaint to add
claims under 5 U.S.C. § 553 regarding HHS’s failure to disclose
the draft IFR and its contents during the 2003 outlier
rulemaking, but the district court denied this motion as futile.
Banner Health v. Burwell, 55 F. Supp. 3d 1, 7, 12 (D.D.C. 2014)
(“Banner Health 2014”).
In September 2014, the parties filed cross-motions for
summary judgment. The Hospitals also filed a motion for
judicial notice or, in the alternative, for extra record
consideration of documents and other related relief. Banner
Health 2015, 126 F. Supp. 3d at 36–37. The district court
granted the latter motion insofar as the court would “take
judicial notice of the publicly available materials subject to the
motion, as relevant” id. at 37; see id. at 62, but otherwise denied
the Hospitals’ record-related requests, id. at 37; see id. at 60–64.
On the merits, the district court remanded the FY 2004 fixed-
loss threshold rule for HHS “to explain its decision regarding its
treatment of certain data — or to recalculate the fixed[-]loss
threshold if necessary[.]” Id. at 37; see id. at 96–99. The
district court explained that it was bound to do so by this court’s
remand in District Hospital Partners. Id. at 98 (citing Dist.
12
Hosp. Partners, 786 F.3d at 60). Otherwise, it rejected the
Hospitals’ challenges to the FY 2004 fixed-loss threshold. Id.
at 99. The district court denied their challenges to the
regulations in all other respects. See id. at 37, 67–96.
On remand, HHS elaborated the rationale for calculating the
threshold in FY 2004 but made no substantive changes to the
regulations. See Remand Explanation, 81 Fed. Reg. 3,727,
3,728–29 (Jan. 22, 2016); see also Part VI, infra. The district
court subsequently granted summary judgment to HHS,
concluding that it had provided an adequate explanation for the
decision not to exclude the 123 turbo-charging hospitals from
the calculations used to set the FY 2004 fixed-loss threshold,
and that the Hospitals had failed to identify any flaws in the
Remand Explanation that undermined that conclusion or raised
issues outside those remaining in the case. Banner Health v.
Burwell, 174 F. Supp. 3d 206, 208–09 (D.D.C. 2016) (“Banner
Health 2016”). The Hospitals appeal. The 186 hospitals in
District Hospital Partners have filed an amicus brief, as the
district court there failed to retain jurisdiction upon remand,
urging that the Remand Explanation was inadequate and the
HHS’s failure to correct for all known turbo-chargers when
setting the 2004 threshold resulted in the outlier payments to the
186 hospitals being too low.
II.
As a threshold matter, HHS contends that the Hospitals lack
standing under Article III of the U.S. Constitution to challenge
its failure between 1997 and 2003 to amend the outlier-payment
regulations and threshold determinations in response to the
turbo-charging phenomenon because any injury they may have
suffered would not be redressed by their requested relief.
Although questioning the Hospitals’ standing on other grounds
in the district court, see Banner Health 2015, 126 F. Supp. 3d at
13
64–67, HHS did not make this specific argument. Nonetheless,
“because [it] goes to our jurisdiction, we must consider it.”
Shays v. FEC, 528 F.3d 914, 922–23 (D.C. Cir. 2008); see
Cierco v. Mnuchin, 857 F.3d 407, 2017 WL 2231107 at *6 (D.C.
Cir. 2017). We hold that the Hospitals have Article III standing
to pursue their challenges.
To establish Article III standing, the plaintiff must have
“suffered an injury in fact” that “is fairly traceable to the
challenged action of the defendant” and it must be “likely, as
opposed to merely speculative, that the injury will be redressed
by a favorable decision.” Friends of the Earth v. Laidlaw Envtl.
Servs., 528 U.S. 167, 180–81 (2002) (citing Lujan v. Defs. of
Wildlife, 504 U.S. 555, 560–61 (1992)) (internal quotation
marks omitted). For purposes of standing, this court is to
“assume” that a plaintiff is “correct on the merits,” Sierra Club
v. EPA, 699 F.3d 530, 533 (D.C. Cir. 2012), and that the court
will grant the relief sought, West v. Lynch, 845 F.3d 1228, 1235
(D.C. Cir. 2017) (citing Fla. Audobon Soc’y v. Bentsen, 94 F.3d
658, 663–64 (D.C. Cir. 1996) (en banc)). A plaintiff lacks
standing, however, if they fail to show that they would benefit
under their alternate methodology. See, e.g., Franklin v.
Massachusetts, 505 U.S. 788, 802 (1992); Nat’l Law Ctr. on
Homelessness & Poverty v. Kantor, 91 F.3d 178, 183 (D.C. Cir.
1996).
HHS maintains that any injury suffered by the Hospitals is
not redressable because they would have received the same
amount or less in outlier payments had HHS taken the action
they propose. HHS has misconstrued the Hospitals’ challenge,
suggesting that they only seek changes to the cost-to-charge
ratios and not to the thresholds, and that even if it were to revise
the thresholds, they would have gone up rather than down.
Under the Hospitals’ theory, however, HHS violated the APA by
failing to recognize and respond to turbo-charging in a timely
14
manner. Were HHS to revise the outlier payment and threshold
regulations to avoid making “unlawful turbo-charged
payments,” the Hospitals maintain, such payments could no
longer factor into the threshold calculations and the thresholds
would be lower. Reply Br. 3 (emphasis added). That the
Medicare Act does not require HHS to recalculate thresholds
retroactively when actual outlier payments fall above or below
the targeted percentage, see Cty. of L.A., 192 F.3d at 1017–20,
does not also mean HHS would not reevaluate its threshold
when the premises underlying his or her predictions have been
successfully challenged.
III.
The Hospitals challenge a number of the district court’s
procedural rulings. We conclude that none of these challenges
have merit for the following reasons.
A.
The Hospitals first contend the court abused its discretion
in refusing to consider as evidence, or, in the alternative, as
adjudicatory facts, materials referenced in their summary
judgment motion, and in denying their motion to supplement the
record of the FY 2004 rulemaking. The court reviews such
evidentiary and docket management decisions for abuse of
discretion, see Am. Wildlands v. Kempthorne, 530 F.3d 991,
1002 (D.C. Cir. 2008); Jackson v. Finnegan, Henderson,
Farabow, Garrett & Dunner, 101 F.3d 145, 150, 151 (D.C. Cir.
1996), and finds none.
The district court struck three tables depicting data from
the administrative record appended to the hospitals’ motion for
summary judgment. The court had set a “generous” seventy-
page limit for motions, and “caution[ed] the parties that any
attempt to subvert the[] page limits by including additional
15
briefing in appendices will be rejected, and such appendices will
be stricken from the record.” Sched. & Proc. Order at 4, No.
10-1638 (July 17, 2014). The Hospitals contend that the tables
should not count towards the page limits because they
“faithfully reproduced record data.” Appellants’ Br. 92. The
tables, however, compile data from various disparate sources
and present it in a simplified manner meant to persuade. In
enforcing its warning against briefing through appendices, “the
district court exercised its prerogative to manage its docket, and
its discretion to determine how best to accomplish this goal.”
Jackson, 101 F.3d at 151.
The district court also refused to consider certain items as
extra-record evidence: (1) congressional testimony by an HHS
official, Thomas Scully (“Scully Testimony”); and (2) two briefs
submitted by the government in another outlier-related case
(“Boca Briefs”). “It is well understood in administrative law
that the ‘focal point for judicial review should be the
administrative record already in existence, not some new record
completed initially in the reviewing court.’” Tripoli Rocketry
Ass’n v. Bureau of Alcohol, Tobacco, Firearms, & Explosives,
437 F.3d 75, 83 (D.C. Cir. 2006) (quoting Envtl. Def. Fund v.
Costle, 657 F.2d 275, 284 (D.C. Cir. 1981)). “Exceptions to that
rule are quite narrow and rarely invoked[,] . . . primarily limited
to cases where the procedural validity of the agency’s action
remains in serious question, or the agency affirmatively
excluded relevant evidence.” CTS Corp. v. EPA, 759 F.3d 52,
64 (D.C. Cir. 2014) (internal quotation marks and citations
omitted); see Am. Wildlands, 530 F.3d at 1002.
In District Hospital Partners, 786 F.3d at 56, the court
affirmed the exclusion of the Scully Testimony, concluding that
it did not fall within any of the established exceptions to the rule
limiting review to the existing administrative record. To the
extent that the Hospitals present a different challenge here, it is
16
no more persuasive. They contend that the testimony would
show that HHS changed its approach to turbo-charging in 2003
due to opposition from OMB, and that HHS, in Scully’s view,
“‘did not understand why’ it ‘kept missing and missing’ its
targets and ‘really never understood the dynamics’ of its model.”
Appellants’ Br. 94 (citing Scully Testimony at 4). The already-
voluminous record, however, does not “say so little” as to
“‘frustrate judicial review,’” Dist. Hosp. Partners, 786 F.3d at
56 (quoting Am. Wildlands, 530 F.3d at 1002), and the testimony
does not constitute “background information” necessary “to
determine whether the agency considered all of the relevant
factors,” Am. Wildlands, 530 F.3d at 1002 (quoting James
Madison Ltd. by Hecht v. Ludwig, 82 F.3d 1085, 1095 (D.C. Cir.
1996)). The Hospitals offer no reason why OMB’s involvement
in the decision to use traditional notice-and-comment
rulemaking is pertinent to any of their challenges, and HHS
acknowledges that it found it “surprising” that hospitals were
able to manipulate the outlier payment regulations through
turbo-charging. Appellee’s Br. 12.
The Hospitals’ position regarding the Boca Briefs is not
any more compelling. The government’s position in that
litigation as to the proper construction of the outlier provisions
in the Medicare Act neither directly contradicts, nor sheds light
on, the challenged actions. Cf. Nat’l Res. Def. Council v. EPA,
755 F.3d 1010, 1020–21 (D.C. Cir. 2014). That one of the briefs
identified more than one hundred turbo-charging hospitals by
name is also irrelevant for effective judicial review. To the
extent the Hospitals contend, in the alternative, that these
materials are appropriate for judicial notice as publicly available
materials, the district court did “take judicial notice of these
documents as necessary in resolving this matter[.]” Banner
Health 2015, 126 F. Supp. 3d at 62.
17
The district court also denied the hospitals’ motion to
supplement the record with a comment letter from the
Federation of American Hospitals responding to the FY 2004
rulemaking. The letter was made part of the record in the
District Hospital Partners litigation. See Dist. Hosp. Partners,
LP v. Sebelius, 971 F. Supp. 2d 15, 26–28 (D.D.C. 2013) aff’d
in part and rev’d in part sub nom. Dist. Hosp. Partners, 786
F.3d 56. Here, the district court concluded that the letter was
too prejudicial given the late hour at which the Hospitals sought
its admission. The record shows that the Hospitals had ample
time to act before the day briefs were to be filed and that their
delay denied HHS the opportunity to treat the comment as part
of the administrative record in preparing its motion for summary
judgment. The district court “acted within the range of
permissible alternatives that were available to it” in denying the
motion. Jackson, 101 F.3d at 150.
B.
The Hospitals further contend that the district court erred in
denying their motion for leave to amend their complaint to
allege that HHS had violated 5 U.S.C. § 553 by failing to
disclose data, analysis, and conclusions in the 2003 draft IFR
that were adverse to the determinations made in subsequent
rulemakings. The district court ruled that the proposed
amendment was futile because the Hospitals had failed to show
that HHS relied on the draft IFR and its supporting materials in
the challenged regulations. Banner Health 2014, 55 F. Supp. 3d
at 11–12. Our review is de novo. See In re APA Assessment Fee
Litigation, 766 F.3d 39, 55 (D.C. Cir. 2014).
“Under APA notice and comment requirements, ‘among the
information that must be revealed for public evaluation are the
technical studies and data upon which the agency relies in its
rulemaking.’” Am. Radio Relay League v. FCC, 524 F.3d 227,
236 (D.C. Cir. 2008) (citing Chambers of Commerce v. SEC,
18
443 F.3d 890, 899 (D.C. Cir. 2006)) (internal quotation marks
and alterations omitted); see Portland Cement Ass’n v.
Ruckelshaus, 486 F.2d 375, 393–94 (D.C. Cir. 1973). This
“allow[s] for useful criticism,” including by enabling
commenters “to point out where . . . information is erroneous or
where the agency may be drawing improper conclusions[.]” Am.
Radio Relay League, 524 F.3d at 236 (internal quotation mark
omitted); see Chambers of Commerce, 443 F.3d at 900; Sierra
Club v. Costle, 657 F.2d 298, 398 n.484 (D.C. Cir. 1981).
HHS maintains that the Hospitals’ motion to amend is
futile, citing National Mining Association v. Mine Safety and
Health Administration, 599 F.3d 662, 671 (D.C. Cir. 2010),
because the new allegation challenges HHS’s decision not to
make a midyear adjustment to the FY 2003 threshold. HHS
failed to make this argument in the district court, and it is forfeit.
See Am. Wildlands, 530 F.3d at 1001. To the extent HHS
maintains that a Section 553 claim based on American Radio
Relay League conflicts with the APA and Vermont Yankee
Nuclear Power Corp. v. Natural Resources Defense Council,
435 U.S. 519 (1978), the court rejected this argument in
American Radio Relay League, 524 F.3d at 239–40, stating that
it “is not imposing new procedures but enforcing the agency’s
procedural choice by ensuring that it conforms to APA
requirements,” id. at 239. The availability of a Section 553
claim remains the law of the circuit. See Allina Health Servs. v.
Sebelius, 746 F.3d 1102, 1110 (D.C. Cir. 2014); LaShawn A., 87
F.3d at 1395.
The Hospitals’ nonetheless falter in their attempt to bring
their challenge under the ambit of American Radio Relay
League. There, this court held that the Federal Communications
Commission must release unredacted versions of the technical
studies and data on which it relied in promulgating a rule. Am.
Radio Relay League, 524 F.3d at 240. The court explained the
19
redactions “may contain contrary evidence, inconvenient
qualifications, or relevant explanations of the methodology
employed” that speak to the weight that should be given the
unredacted portions of a study. Id. at 239. The Hospitals seek
to equate HHS’s “cherry-pick[ing]” portions of the draft IFR
with the redaction of a technical study. Appellants’ Br. 97. But
the court has never suggested that an unpublished draft rule
constitutes a “study” for purposes of this doctrine, see Am.
Radio Relay League, 524 F.3d at 239, nor does there appear to
be reason to do so here. The packaging of facts and conclusions
in the draft IFR did not “inextricably b[i]nd” them together in
the same manner as a study, which is to be considered as a
whole. Id. The draft IFR merely represented one way for HHS
to respond to available information. That the published rules
referenced some of the same information and analysis as the
draft IFR does not mean that HHS relied on the draft IFR, but
rather on some of the same underlying material, such as analyses
indicating vulnerabilities in the original outlier methodology and
findings regarding the 123 hospitals that had been receiving
disproportionately high outlier payments. Although HHS’s
decision to disregard certain information may be challenged as
arbitrary and capricious, Section 553 does not require disclosure
of materials that were considered and rejected in the course of
a rulemaking. See id. at 240 (quoting 1 RICHARD J. PIERCE, JR.,
ADMINISTRATIVE LAW TREATISE 437 (4th ed. 2002)).
IV.
Having rejected the Hospitals’ procedural challenges, we
now turn to their challenges to various aspects of the outlier
rules for every fiscal year between 1997 and 2007, as well as a
midyear rule promulgated during FY 2003. The district court
rejected each of those challenges. We address the Hospitals’
challenges in chronological order, affirming the district court’s
grant of summary judgment except with regard to aspects of the
20
FY 2004, 2005, and 2006 rules. We begin here with the
challenges to the rules governing FYs 1997 through 2003.
The Hospitals acknowledge that HHS was not aware of
turbo-charging before October 2002, when a stock-market
analyst wrote an editorial exposing turbo-charging. Their
primary challenge to the fixed-loss thresholds for FYs 1997
through 2003 is that the failure to discover and stop turbo-
charging was arbitrary and capricious. At the very least, the
Hospitals argue, HHS committed an error when calculating the
fixed-loss threshold for each of those fiscal years. We reject
both claims.
A.
As a preliminary matter, HHS argues that the Supreme
Court’s decision in Auer v. Robbins, 519 U.S. 452 (1997), bars
the Hospitals’ claim that HHS’s failure to uncover turbo-
charging was arbitrary and capricious. In Auer, the Secretary of
Labor declined to consider whether the agency should amend
one of its regulations in response to a Supreme Court decision.
The Auer Court held that the agency could not have acted
arbitrarily and capriciously in failing to amend its regulation,
because nobody had asked the agency to do so. See id. at 459.
The Court thus found that it had “no basis” on which to question
the Secretary’s failure to act. Id. HHS argues that because the
Hospitals never asked it to amend its regulations to address
turbo-charging, we similarly have no basis to question its failure
to do so.
HHS is mistaken. The petitioners in Auer believed a public
and well-known Supreme Court decision should have led the
agency, on its own, to change one of its regulations. By
contrast, the Hospitals here argue that HHS was in possession of
non-public information that — in combination with public data
— uniquely positioned it to uncover turbo-charging, such that its
21
failure to do so prior to October 2002 was arbitrary and
capricious. If the Hospitals are correct, we cannot fault them for
failing to petition HHS to address a problem that only it could
have known about. We do not read Auer, which says nothing
about an agency’s obligations when it has access to important
information that commenters do not, to foreclose such a claim.
B.
The Hospitals look first to the information that was publicly
available, suggesting that the rapid rise of the fixed-loss
threshold, coupled with steadily decreasing hospital-level cost-
to-charge ratios, should have tipped HHS off to turbo-charging’s
existence. It is true that those developments show that hospital
charges were rising more rapidly than were costs. But
intentional charge manipulation is neither the most obvious, nor
necessarily the most probable, explanation for what hindsight
reveals was actually widespread turbo-charging. The healthcare
market is notoriously complex, and a host of other factors —
e.g., the changing demographics of the Medicare-insured
population, or the introduction of new medical technology and
medications — could, as the Hospitals acknowledge, see Reply
Br. 37–39, have been responsible for the phenomenon.
But the Hospitals urge that various comments made during
past rulemakings also should have tipped HHS off that there was
a distinct possibility that turbo-charging was the real culprit. In
1988, for example, HHS adopted a number of the features of the
outlier-payment system that enabled turbo-charging. One
commenter warned that the rule created “an incentive for
hospitals to increase their charges and to manipulate their charge
structures” in order to receive lower cost-to-charge ratios. FY
1989 Final Rule, 53 Fed. Reg. at 38,509. And in 1994, another
commenter “expressed concern over the use of statewide
averages” for hospitals with cost-to-charge ratios three standard
deviations below the statewide mean, because that practice
22
“created a clear incentive for hospitals to artificially inflate their
gross charges, and circumvent the intent that hospitals only be
paid marginal costs for outliers.” FY 1995 Final Rule, 59 Fed.
Reg. 45,330, 45,407–08 (Sept. 1, 1994). These comments may
have put HHS on notice that the outlier-payment system created
incentives, in theory, for hospitals to manipulate their charges,
but both comments predated the era of widespread turbo-
charging, and neither suggested the practice was anything other
than a mere possibility.
In our view, those comments fall far short of demonstrating
that HHS should have discovered that the skyrocketing
fixed-loss thresholds in subsequent years were actually caused
by turbo-charging. Critically, even though the annual increases
in the fixed-loss threshold and declines in hospital-specific cost-
to-charge ratios were publicly available, the Hospitals can point
to no contemporaneous comment that even hinted the underlying
cause of those trends was willful charge manipulation. In fact,
no commenter asked HHS to investigate whether willful charge
manipulation might be to blame. Not until FY 2003 did a
commenter even urge HHS to “[r]eevaluate assumptions about
cost and charge increases and other factors that influence the
outlier projections,” noting in particular the lack of up-to-date
cost information. Comment Responding to FY 2003 NPRM, 67
Fed. Reg. 31,404 (May 9, 2002) (available at J.A. 638). But
although in retrospect HHS realized that the data lag helped to
enable turbo-charging, this type of generalized comment was
insufficient to put HHS on notice of that specific problem.
The success of the Hospitals’ claim thus turns on whether
the combination of public and non-public information in HHS’s
possession put it in a position to discover an illegal practice that
had evaded detection by the rest of the industry. The Hospitals
point to non-public data showing that, in some fiscal years, a
select few hospitals received up to twice as much in outlier
23
payments as they did in non-outlier inpatient payments. No
doubt, those figures raise red flags with regard to those
particular hospitals. Under the Medicare Act, outlier payments
should account only for 5–6% of the average hospital’s
M e d i c a r e - r e l a t e d p a y me n t s . S e e 42 U.S.C.
§ 1395ww(d)(5)(A)(iv). Had HHS adequately overseen the
outlier-payment system, the Hospitals argue, it would have
known to attribute those aberrational outlier payments to turbo-
charging.
Again, we disagree. It is far from obvious that this sporadic
and anomalous data should have put HHS on the lookout for a
widespread and systematic scheme to defraud Medicare through
turbo-charging. Indeed, we fail to see how the mere presence of
such aberrational data in HHS’s possession should have alerted
it to turbo-charging. The charge figures for an individual
hospital are but a speck in the vast reams of data that HHS
maintains — the offending hospitals constituted only around 2%
of all hospitals participating in the Medicare program. Not to
mention, despite seeing the same trend in terms of rising
thresholds, it did not occur to any regulated party to ask HHS to
pore over hospital-level data in search of evidence of willful
charge manipulation, as the Hospitals now claim HHS should
have done.
With the benefit of 20/20 hindsight, the Hospitals have been
able to identify suspicious charge data for individual healthcare
providers. But they have failed to convince us that it was
arbitrary and capricious for HHS not to have found the cause, in
real time, before turbo-charging was brought to its attention in
October 2002.
C.
The Hospitals raise another challenge to HHS’s fixed-loss
thresholds for FYs 1997 through 2003. When the projected
24
cost-to-charge ratio for a hospital in a given year was three
standard deviations above or below the statewide average, HHS
used that statewide-average figure in its calculations. See Part
I.B, supra. The Hospitals argue that the statewide-averages
HHS used were outdated and, in fact, higher than the correct
averages. If the Hospitals are right, that means HHS was
overestimating the outlier payments it would make to those
hospitals, which in turn would have led it to set the fixed-loss
threshold too high.
However, the Hospitals fail to show that HHS actually made
this mistake. Their claim relies solely on the inclusion of
year-old statewide averages in certain data files, known as
“impact files,” containing records of hospital costs and charges
that HHS uses when calculating the annual threshold. Because
some outdated data was discovered in select impact files
included in the administrative record, the Hospitals insist that
HHS in fact calculated the annual thresholds based on the wrong
statewide averages for every fiscal year between 1997 and 2003.
HHS does not deny that at least some of the impact files in
its possession contain outdated data. Rather, HHS argues that
although there may have been some out-of-date data in some of
the impact files it kept, that data was not used in calculating the
fixed-loss threshold. HHS claims that it used files containing
the correct, up-to-date statewide averages and backs up this
assertion by noting that it reported the up-to-date statewide
averages in the same annual rulemakings in which it set the
fixed-loss threshold for every fiscal year between 1997 and
2003. There is no dispute that HHS had the correct data in its
possession, and we believe the most sensible inference is that
HHS used that data. Indeed, for the Hospitals to be correct, it
would have to be the case that for seven consecutive years, HHS
publicly announced the current (correct) statewide averages, but
nonetheless employed outdated statewide averages in its
25
calculations. That strikes us as unlikely, to say the least. It is
true that in the many intervening years, HHS has either lost or
misplaced the relevant records that could definitively settle
which figures it actually employed. But the Hospitals have not
provided an adequate basis to overcome the “presumption of
regularity” that agency proceedings enjoy. San Miguel Hosp.
Corp. v. NLRB, 697 F.3d 1181, 1186–87 (D.C. Cir. 2012).
V.
The Hospitals next argue that HHS’s decision not to lower
the FY 2003 fixed-loss threshold midyear violated the agency’s
obligations under both the Medicare Act and the APA. We
disagree.
A.
Recall that at the beginning of each fiscal year, HHS sets a
fixed-loss threshold that it believes will lead outlier payments to
equal 5.1% of non-outlier inpatient payments for that year. See
Part I.A, supra. According to the Hospitals, in calculating what
threshold will allow HHS to hit its target, HHS must count only
the outlier payments it expects to make to non-turbo-charging
hospitals. Because HHS made its calculations for FY 2003
using payments it expected to make to all hospitals that year, it
necessarily set a threshold that was higher than it would have
had it excluded from its model the payments it expected to make
to turbo-charging hospitals. Of course, HHS was unaware of
turbo-charging at the time it set the FY 2003 threshold. But in
the Hospitals’ view, as soon as HHS became aware that some of
the payments it had been making were going to turbo-chargers,
it was statutorily obligated to go back and lower the threshold —
in the middle of the fiscal year. Only by lowering the threshold
midyear, the Hospitals argue, could HHS actually hit its target.
26
The Hospitals’ argument fails. Most fundamentally, the
court held in County of Los Angeles, 192 F.3d at 1019, that HHS
is not obligated to make later adjustments in order to hit its
target percentage so long as it acts reasonably in setting the
fixed-loss threshold at the beginning of each fiscal year. The
court explained that this holding stems from the prospective
nature of the outlier-payment program, which allows for
efficient administration. Indeed, it would be unduly burdensome
for HHS to “establish outlier thresholds in advance of each fiscal
year, and process millions of bills based on those figures,” only
to require it to later “recalibrate those calculations, reevaluate
anew each of the millions of inpatient discharges under the
revised figures, and disburse a second round of payments.” Id.
(citation omitted). In addition, the prospective nature of the
system allows for “certainty and predictability of payment for
not only hospitals but the federal government.” Id. That
certainty and predictability would disappear if the fixed-loss
threshold were subject to midyear, or end-of-year, course
correction.
The Hospitals also argue that, regardless of County of Los
Angeles, HHS opened the door to a challenge simply by
responding to comments that asked it to lower the threshold and
explaining its decision not to make a midyear change. Not so.
As here, when an “agency merely responds to . . . unsolicited
comment[s] by reaffirming its prior position, that response does
not” open the agency’s position up to a challenge. Kennecott
Utah Copper Corp. v. U.S. Dep’t of Interior, 88 F.3d 1191, 1213
(D.C. Cir. 1996). Moreover, an agency does not “reopen an
issue by responding to a comment that addresses a settled aspect
of some matter, even if the agency had solicited comments on
unsettled aspects of the same matter.” Id. The FY 2003
threshold was a “settled aspect” of the matter at the time HHS
issued the 2003 Outlier NPRM, meaning that there was no
“reopening” here. In any event, HHS’s explanation was well-
27
reasoned, resting in significant part on its assessment that
“[c]hanging the threshold for the remaining few months of the
fiscal year could disrupt hospitals’ budgeting plans and would
be contrary to the overall prospectivity” of the outlier-payment
program. 2003 Outlier Final Rule, 68 Fed. Reg. at 34,506.
Those were the very concerns that drove our decision in County
of Los Angeles.
Moreover, the Hospitals are mistaken that HHS could not
lawfully factor in outlier payments to turbo-charging hospitals
when determining whether it was likely to hit its 5.1% target. It
is true that the Medicare Act provides that a hospital may
request outlier payments only when its “charges, adjusted to
cost,” exceed the outlier threshold. 42 U.S.C.
§ 1395ww(d)(5)(A)(ii). It is also the case that hospitals’ outlier
payments are supposed to “approximate the marginal cost of
care beyond the [outlier threshold].” Id.
§ 1395ww(d)(5)(A)(iii).
Although HHS has argued in other litigation that turbo-
charging hospitals acted improperly in manipulating their
charging practices in order to receive extensive outlier
payments, see Boca Raton Cmty. Hosp. v. Tenet Healthcare
Corp., 9:05-cv80183- PAS, ECF No. 49 (S.D. Fla. May 17,
2005), it does not follow that HHS unlawfully issued outlier
payments to turbo-chargers. HHS cannot ascertain a hospital’s
true costs in treating an outlier case until long after it makes the
outlier payment. HHS estimates a hospital’s charges, adjusted
to cost, and marginal cost of care beyond the threshold, using
cost-to-charge ration data in its possession at the time of
payment. It would be inconsistent with the prospectivity of the
outlier-payment program to require HHS to “reevaluate anew
each of the millions of” outlier payments it made during a fiscal
year because the cost-to-charge ratios it had been employing
turned out, due to no fault of its own, to have been too high.
28
Cty. of L.A., 192 F.3d at 1019. That is the case even if those
cost-to-charge ratios were too high as a result of the unlawful
efforts of the turbo-charging hospitals. We therefore reject the
Hospitals’ argument that HHS acted contrary to the Medicare
Act by declining to alter the FY 2003 fixed-loss threshold.
B.
In the alternative, the Hospitals argue that HHS’s decision
not to lower the threshold midyear was nonetheless arbitrary and
capricious. The Hospitals advance three distinct concerns with
the HHS’s course of action. None is persuasive.
First, they complain that HHS should have explained why
it did not exclude the 123 turbo-charging hospitals that year
from its target calculations. This challenge merely recasts the
Hospitals’ argument that HHS violated the Medicare Act as a
challenge under the APA. Suffice it to say, there was nothing
amiss in accounting for outlier payments the Medicare Act
permitted it to consider.
The Hospitals also claim that HHS erred in not explaining
why it rejected the draft IFR’s conclusion that an immediate
reduction in the FY 2003 threshold was warranted. But to the
extent the Hospitals argue that HHS departed from its prior
policy, that claim is squarely foreclosed by our decision in
District Hospital Partners. As we explained in that case, the
draft IFR “was never ‘on the books’ in the first place.” Dist.
Hosp. Partners, 786 F.3d at 58 (quoting FCC v. Fox Television
Stations, 556 U.S. 502, 515 (2009)). HHS therefore need not
explain any departure from what it said in the draft IFR. See id.
And to the extent the Hospitals argue that the draft IFR
contained obvious alternatives to what HHS did in its final rule,
they ignore that HHS issued its final rule in June, four months
after the IFR. As HHS explained, circumstances in June
differed markedly from those in February: the end of the fiscal
29
year was fast approaching and changing the fixed-loss threshold
at that time could have resulted in considerable disruption to
hospitals’ budgets. 2003 Outlier Final Rule, 68 Fed. Reg. at
34,505. Whatever HHS’s obligation was to explain its decision
to “depart” from the draft IFR, it met that obligation here.
Finally, the Hospitals take issue with a sentence in the final
rule that states that HHS “inflated charges from the FY 2002
Medicare Provider Analysis and Review (MedPAR) file by the
2-year average annual rate of change in charges per case to
predict charges for FY 2004.” Id. (MedPAR is a database that
aggregates the claims submitted by hospitals to HHS.) Both
parties agree that HHS should have instead been predicting
charges for FY 2003. HHS, noting that this sentence appeared
in a section of the rule concerned exclusively with the 2003
fiscal year, assures us that it in fact predicted charges for FY
2003 and that the reference to FY 2004 was, as the district court
found, “self-evidently” a typo. Banner Health 2015, 126 F.
Supp. 3d at 95; see also Appellee’s Br. 56–57. Upon reviewing
the context in which the statement was made, and considering
that the Hospitals provide no reason to doubt HHS’s assurances,
we accept this explanation.
VI.
The Hospitals next take issue with several aspects of the FY
2004 Final Rule. We first describe the details of this Rule, as
well as the 2016 Remand Explanation issued by HHS to
elaborate on its decision-making, and then turn to the merits of
the Hospitals’ challenges to the adequacy of both documents.
We agree with the district court that HHS sufficiently justified
its decision to anticipate reconciling only 50 turbo-charging
hospitals, and therefore to utilize projection cost-to-charge ratios
for only that smaller subset of turbo-chargers. See Banner
Health 2015, 126 F. Supp. 3d at 99; Banner Health 2016, 174 F.
30
Supp. 3d at 208. But we hold that it inadequately explained its
failure to exclude turbo-chargers from its calculation of the
annual rate of charge inflation.
A.
As previously explained, HHS’s June 2003 rulemaking was
designed to cure most of the ills that had plagued the
outlier-payment system during the turbo-charging era. HHS
expected that its three key reforms would substantially diminish,
if not wholly eradicate, the practice of turbo-charging. See Part
I.B, supra. But that set of reforms introduced a fresh problem:
when it came time to set the FY 2004 threshold in August 2003,
no outlier payments had been made under the new system. HHS
would therefore have to estimate the outlier payments to be
made under a framework it had never actually implemented.
For FY 2004, as for all other relevant years, HHS sought a
formula that would generate a fixed-loss threshold under which
outlier payments would amount to 5.1% of non-outlier inpatient
payments. See 42 U.S.C. § 1395ww(d)(5)(A)(iv); FY 2004
Final Rule, 68 Fed. Reg. at 45,478. Its chosen methodology
ultimately yielded a FY 2004 fixed-loss threshold of $31,000, a
modest decrease from the previous year’s threshold of $33,560.
See id. at 45,477.
HHS’s FY 2004 rule divided hospitals into two groups:
those it expected would ultimately be subjected to
reconciliation, and those it expected would not. See id. at
45,476–77. HHS estimated its anticipated outlier payments to
the latter group of hospitals using a multi-step formula. It first
identified the charges billed by each hospital in the FY 2002
MedPAR files. To predict each hospital’s charges during the
2004 fiscal year, HHS multiplied the 2002 MedPAR data by
1.268, the two-year average annual rate of change in charges per
case from FY 2000 to FY 2002. Lastly, HHS multiplied the
31
product of that calculation by each hospital’s cost-to-charge
ratio from “the most recent cost reporting year.” Id. at 45,476.
HHS also identified “approximately 50” hospitals that it
anticipated subjecting to reconciliation “[b]ased on [its] analysis
of hospitals that ha[d] been consistently overpaid recently for
outliers.” Id. For that set of hospitals, HHS calculated
projection cost-to-charg ratios that it believed would more
accurately capture HHS’s net outlier payouts during the 2004
fiscal year, factoring in the amounts it expected to recoup
through reconciliation. See id. at 45,477. The Hospitals do not
challenge the methodology underlying those adjustments.
The Hospitals do, however, challenge several other
components of the methodology HHS employed in setting the
FY 2004 outlier threshold. This court has already adjudicated
a related challenge to the FY 2004 rulemaking. In District
Hospital Partners, 786 F.3d at 60, we held that HHS had
inadequately justified the methodology it employed in setting
the FY 2004 fixed-loss threshold. Although HHS’s 2003 Outlier
NPRM had identified 123 hospitals as turbo-chargers, the FY
2004 Final Rule “did not explain how the 50 hospitals [that HHS
anticipated subjecting to reconciliation] differed from the 123
. . . identified in the [2003] NPRM.” Id. at 58. Using projection
cost-to-charge ratios for the previously identified 123 turbo-
chargers was thus “a significant and obvious alternative” that
HHS was required to consider. Id. at 59.
On remand, HHS was tasked with explaining (i) “why [it]
corrected for only 50 turbo-charging hospitals . . . rather than for
the 123 [it] had identified in the [2003] NPRM,” and (ii) “what
additional measures (if any) were taken to account for the
distorting effect that turbo-charging hospitals had on the dataset
for the 2004 rulemaking.” Id. at 60. To the extent it decided to
recalculate the FY 2004 threshold on remand, HHS was further
32
directed to decide “what effect (if any)” this would have on the
FY 2005 and 2006 thresholds. Id. The district court in this
litigation, taking note of the remand order in District Hospital
Partners, likewise remanded the FY 2004 rule “to provide the
agency an opportunity to explain further why it did not exclude
the 123 identified turbo-charging hospitals from the charge
inflation calculation for FY 2004—or to recalculate the fixed[-]
loss threshold if necessary.” Banner Health 2015, 126 F. Supp.
3d at 98.
In a document issued in early 2016, HHS sought to address
the District Hospital Partners court’s concerns with the
methodological choices it made in setting the FY 2004
threshold. See Remand Explanation, 81 Fed. Reg. at 3,727–29.
This Remand Explanation aimed to provide clarification along
three axes.
First, HHS addressed why it did not exclude any of the 123
hospitals previously identified as turbo-chargers from the
MedPAR files it used to calculate the two-year average annual
rate of change in charges per case from FY 2000 to FY 2002.
See id. at 3,729. In other words, given that charging practices
during the 2000, 2001, and 2002 fiscal years were the product of
an age of artificial excess, HHS was tasked with justifying its
assumption that the model would accurately predict charge
inflation during a fiscal year governed by rules “expected . . . to
curb turbo[-]charging.” Id . The Remand Explanation suggested
that HHS believed past charge increases would reliably simulate
future growth, because “[t]he outlier final rule was in effect for
only part of the interval that our charge inflation estimate was
intended to reflect.” Id. HHS also reasoned that, because the
123 turbo-chargers could claim outlier payments in FY 2004,
“excluding them . . . would have introduced a different form of
distortion into our simulations, by causing the[m] to disregard
the impact of those hospitals.” Id.
33
Second, the Remand Explanation sought to shore up HHS’s
explanation for why only approximately 50 turbo-chargers were
selected as likely candidates for reconciliation. See id.
According to HHS, “reconciliation generally would be
performed only if a hospital met the criteria we had specified”:
“[a] 10-percentage point change in the hospital’s [cost-to-charge
ratio] from the time the claim was paid compared to the [cost-to-
charge ratio] at cost report settlement; and receipt of total outlier
payments exceeding $500,000.” Id. at 3,728–29. HHS claimed
to have “identified approximately 50 hospitals that [it]
determined likely to meet these criteria in FY 2004,” and
adjusted those hospitals’ projection cost-to-charge ratios
accordingly. Id. at 3,729. Not all 123 previously identified
turbo-chargers were selected for this treatment, because HHS
“did not expect that all of the 123 hospitals discussed in the
March 2003 proposed rule would be likely to meet the criteria
for reconciliation.” Id.
Third, HHS explained why it believed that its decision to
project cost-to-charge ratios for only 50 turbo-charging hospitals
had no “distorting effect” on the threshold calculation. Id. at
3,727; see id. at 3,728. HHS, in its midyear 2003 rule, switched
from using the most recent settled cost report for a hospital
when calculating its cost-to-charge ratio to using the hospital’s
most recent tentatively settled cost report. See 2003 Outlier
Final Rule, 68 Fed. Reg. at 34,502. HHS thus urged that its
“payment simulations employed cost-to-charge ratios calculated
from very recent data . . . and did not employ cost-to-charge
ratios drawn from older historical data.” Remand Explanation,
81 Fed. Reg. at 3,728. That adjustment “reduc[ed] any reason
for concern that cost-to-charge ratios drawn from older historical
data . . . would not reliably approximate the cost-to-charge ratios
that would be used to pay FY 2004 claims.” Id. HHS saw no
reason to adjust projection cost-to-charge ratios for the
34
remaining turbo-chargers, because it “anticipated that
implementation of the June 2003 outlier final rule would curb
. . . turbo[-]charging practices.” Id.
B.
In its FY 2004 Final Rule, HHS assumed that the rate at
which charges had inflated between FYs 2000 and 2002 would
accurately approximate charge growth during a period that
included an entire year (FY 2004) in which the anti-turbo-
charging reforms would be in effect. The Hospitals contend that
HHS’s Remand Explanation failed to offer a reasoned basis for
making that assumption. We agree.
When HHS set its FY 2004 threshold on August 1, 2003, it
was well aware that scores of hospitals in recent years had
“inappropriately maximiz[ed] their outlier payments” and
“caused the threshold to increase dramatically.” 2003 Outlier
Final Rule, 68 Fed. Reg. at 34,496. That exploitative practice
prompted HHS to reassess its entire framework for making
outlier payments. HHS believed that its 2003 reforms, once in
place, would “greatly reduce the opportunity for hospitals to
manipulate the system to maximize outlier payments.” Id. at
34,503. It declared that it was “essential to eliminate those
effects as soon as possible,” id. at 34,497, in order to avoid
underpaying “hospitals that ha[d] already been harmed by the
inappropriate redistribution” of outlier payments, id. at 34,499.
Yet its decision to project future charges using turbo-
charging-infected data foreseeably “allow[ed] the effects of this
inappropriate redistribution . . . to continue into the future.” Id.
at 34,497. In setting the FY 2004 threshold, HHS sought to
predict hospitals’ charging behavior for a full year after the
structural causes of turbo-charging had been eradicated. HHS
nonetheless multiplied the 2002 MedPAR charge data by the
rate at which charges had inflated between FYs 2000 and 2002,
35
without removing charge data attributable to the 123 hospitals
it had identified as turbo-chargers. See FY 2004 Final Rule, 68
Fed. Reg. at 45,476. The 2004 Rule gave no indication as to
why HHS thought it rational to use turbo-charging-infused data
to forecast charges for a year in which hospitals’ “opportunity
. . . to manipulate the system” had been “greatly reduce[d].”
2003 Outlier Final Rule, 68 Fed. Reg. at 34,503.
The two reasons HHS provided in its Remand Explanation
likewise fail to explain why it believed “past charge growth
would still be a satisfactory basis for estimating more recent
charge growth.” 81 Fed. Reg. at 3,729. The first was that “[t]he
outlier final rule was in effect for only part of the interval that
our charge inflation estimate was intended to reflect.” Id. But
even if it may have been reasonable to expect turbo-charging-era
levels of charge inflation to persist during FY 2003, HHS
repeatedly intimated that it expected charging practices to return
to normal in FY 2004. And even if HHS could have reasonably
predicted “future significant charge growth due to other
reasons,” Appellee’s Br. 61, it never identified what those
reasons might be, or why they would likely lead to turbo-
charging-era levels of charge inflation during FY 2004.
The Remand Explanation’s second reason for including
turbo-chargers’ data is equally unsatisfying. HHS submits that,
because “[t]he 123 hospitals were not excluded from claiming
outlier payments” during FY 2004, “excluding them from our
simulations would have introduced a different form of distortion
into our simulations, by causing the simulations to disregard the
impact of those hospitals.” Remand Explanation, 81 Fed. Reg.
at 3,729. That alleged symmetry is illusory. There is no
necessary linkage between, on one hand, the hospitals whose
data are used to calculate the two-year average annual rate of
change in charges per case, and, on the other hand, the hospitals
that are eligible to receive outlier payments during an upcoming
36
fiscal year. Nothing would have precluded HHS from
calculating the industry-average rate of charge inflation after
removing a series of warped data points, while still accounting
for the reality that all hospitals remained eligible to collect
outlier payments during the upcoming fiscal year.
It was entirely predictable that including turbo-charged data
would lead to a charge-inflation projection that greatly exceeded
the actual rate of charge inflation during FY 2004, as in fact
actually happened. FY 2006 Final Rule, 70 Fed. Reg. at 47,494.
HHS thus overlooked an important consideration in attempting
to “ensure that [its] simulated FY 2004 payments would match
up as closely as possible with how FY 2004 claims would
actually be paid.” Remand Explanation, 81 Fed. Reg. at 3,728.
As a result, we hold that HHS acted arbitrarily and capriciously
in failing to exclude charge data for the 123 historical turbo-
chargers from its FY 2004 charge-inflation calculation.
C.
The Hospitals next contend that HHS, in setting the FY
2004 fixed-loss threshold, failed to offer a reasoned explanation
for adjusting the projection cost-to-charge ratios of only 50
turbo-chargers in order to account for the possibility of
reconciliation. Although the issue is a close one, we affirm the
adequacy of HHS’s explanation.
HHS has repeatedly reiterated its belief that the June 2003
outlier rule would “curb the turbo[-]charging practices that had
caused rapid increases in charges.” Id. at 3,729. Yet HHS
acknowledged that the time lag between issuing outlier
payments and tentatively settling hospitals’ cost reports left a
large enough window for a hospital’s true cost-to-charge ratio to
vary from the cost-to-charge ratio used to make outlier payments
during a fiscal year. See id. at 3,728. In its FY 2004 Final Rule,
HHS announced that fiscal intermediaries would reconcile
37
outlier payments if, once the intermediary had settled a
hospital’s FY 2004 cost report, it found that the hospital’s actual
cost-to-charge ratio during the period was “substantially
different” from that used to make outlier payments to it during
the fiscal year. 68 Fed. Reg. at 45,476. HHS explained that it
expected to subject 50 hospitals’ payments to reconciliation,
“[b]ased on [its] analysis of hospitals that ha[d] been
consistently overpaid recently for outliers.” Id.
As far as the District Hospital Partners court could tell,
however, all 123 previously identified turbo-chargers — not just
the 50 hospitals selected as candidates for reconciliation — had
been drastically “overpaid recently.” 786 F.3d at 68 (quoting
FY 2004 Final Rule, 68 Fed. Reg. at 45,476). According to
HHS itself, all of the turbo-charging hospitals had initiated
“dramatic increases in charges.” 2003 Outlier NPRM, 68 Fed.
Reg. at 10,424. The court therefore remanded for HHS to
explain why it selected only 50 turbo-chargers as likely
candidates for reconciliation, and thus for adjustment of their
projection cost-to-charge ratios. District Hospital Partners, 786
F.3d at 59.
On remand, HHS claimed it had identified a past turbo-
charging hospital as a candidate for reconciliation if it expected
that the hospital would satisfy the following two conditions for
FY 2004: (i) “[a] 10-percentage point change in the hospital’s
[cost-to-charge ratio] from the time the claim was paid
compared to the [cost-to-charge ratio] at cost report settlement;”
and (ii) “receipt of total outlier payments exceeding $500,000
during the cost reporting period.” Remand Explanation, 81 Fed.
Reg. at 3,728–29. Though HHS acknowledged “it was difficult
to project which hospitals would be subject to reconciliation of
their outlier payments using then-available data,” it anticipated
that only approximately 50 turbo-charging hospitals would end
up satisfying those criteria. Id. at 3,728.
 38
The Hospitals object to the adequacy of the Remand
Explanation. They contend that HHS’s contemporaneous
statements belie any articulation of a rule-like formula for
determining which hospitals’ projection cost-to-charge ratios to
adjust. Although the Remand Explanation categorized the
above two conditions as “criteria we had specified for
reconciliation,” id., the Hospitals argue that the June 2003
outlier rule introducing those conditions offered them only as
tentative guidelines for fiscal intermediaries to consider when
deciding whether to engage in reconciliation. In the Hospitals’
view, HHS cannot have actually employed those criteria to
identify the 50 reconciliation candidates.
In response, HHS points to the language of the 2003 Outlier
Final Rule. According to the Remand Explanation, that Rule
“instructed our contractors to put a hospital through outlier
reconciliation” if it complied with both purported requirements.
Id. As a claim about the Outlier Rule’s instructive force, that
statement is problematic. The Rule did recite the criteria quoted
above, but it prefaced them by saying that “we are considering
instructing fiscal intermediaries to conduct reconciliation [in that
manner].” 2003 Outlier Final Rule, 68 Fed. Reg. at 34,503
(emphasis added). In the same document, HHS explicitly
disclaimed any pretense of finality in the proposed formula:
“We intend to issue program instructions to the fiscal
intermediaries that will provide specific criteria for identifying
those hospitals subject to reconciliation . . . for FY 2004.” Id. at
34,504. There is no record evidence that HHS followed up on
that intention in any way.
Making matters worse, the text of the FY 2004 Final Rule
recites a reconciliation policy that, while not technically
inconsistent with the two-part formula identified by the Remand
Explanation, is expressed in a significantly less rule-like fashion.
39
In short, the FY 2004 Final Rule explained that reconciliation
would occur when “a hospital’s actual . . . cost-to-charge ratios
are found to be substantially different from the cost-to-charge
ratios used during that time period to make outlier payments.”
68 Fed. Reg. at 45,476. If the Remand Explanation accurately
captures the 2004 Rule’s methodology, the formula’s absence
from the Rule itself is a surprising omission.
Certain statements in later rules’ descriptions of the
reconciliation process also tend to undermine the Remand
Explanation’s account of definite reconciliation criteria. The FY
2005 Final Rule, for example, stated that reconciliation would
occur when the cost-to-charge ratios from hospitals’ final settled
cost reports “are different than” those appearing on tentatively
settled cost reports. 69 Fed. Reg. at 49,278. And as late as the
FY 2006 Final Rule, HHS suggested that hospitals qualified for
reconciliation if their cost-to-charge ratios “fluctuate[d]
significantly,” but noted that it still “plan[ned] on issuing
instructions to fiscal intermediaries” to “detail the specifics of
reconciling outlier payments.” 70 Fed. Reg. at 47,495.
Still, enough record evidence exists to sustain the Remand
Explanation’s description of how HHS settled upon expecting
to reconcile only approximately 50 turbo-charging hospitals.
We find HHS’s contemporaneous characterization of two
comments on its proposed FY 2004 Rule to be particularly
significant. Per HHS, those comments expressed concern with
“the criterion in the final rule on outliers that specifically
addressed our policy on reconciliation (that if a hospital’s cost-
to-charge ratio changed by 10 or more percentage points, a
hospital would be subject to reconciliation).” FY 2004 Final
Rule, 68 Fed. Reg. at 45,477. HHS is thus on record for FY
2004 as characterizing one component of the Remand
Explanation as “our policy.” The Rule also acknowledged
commenters’ request that HHS “modify the trigger for outlier
40
reconciliation by promulgating a scale of cost-to-charge ratios
rather than a constant amount.” Id. (emphasis added). We
doubt that HHS would have implicitly ratified that description
of its methodology unless reconciliation were to be
presumptively “trigger[ed]” upon the satisfaction of “constant”
conditions.
HHS’s FY 2005 Final Rule spoke in similar terms. It
observed that “the majority of hospitals’ cost-to-charge ratios
will not fluctuate significantly enough . . . to meet the criteria to
trigger reconciliation of their outlier payments.” 69 Fed. Reg.
at 49,278 (emphasis added). That phrasing immediately
followed an assertion that “[r]econciliation occurs when
hospitals’ cost-to-charge ratios at the time of cost report
settlement are different than the tentatively settled cost-to-
charge ratios used to make outlier payments.” Id. (emphasis
added). So HHS evidently saw no incompatibility between
using broad, general language to describe its approach to
reconciliation, and nonetheless using predetermined “criteria” to
“trigger” the recoupment of excess outlier payments.
To be sure, the Remand Explanation does not dovetail
seamlessly with HHS’s contemporaneous statements. But for
the reasons just given, we find a sufficient basis to conclude that
HHS has explained, and justified, the approach it took in
predicting which hospitals would be subject to reconciliation
upon settlement of FY 2004 cost reports. The Hospitals’ further
criticism that HHS failed to produce the exact data underlying
its identification of the 50 hospitals is similarly unavailing. As
we have previously noted, agency proceedings enjoy a
“presumption of regularity.” San Miguel Hosp. Corp., 697 F.3d
1186–87. In these limited circumstances, in which we are
satisfied that the agency employed a reasonable methodology in
a rulemaking that concluded well over a decade ago, we will not
41
remand simply because HHS is unable to reproduce the exact
data and calculations in question.
D.
The Hospitals lodge one further arbitrary-and-capricious
challenge to the FY 2004 Final Rule. They contend that it was
irrational for HHS to “appl[y] a charge[-]inflation factor” when
predicting hospital charges for the 2004 fiscal year “without
adjusting [hospitals’ cost-to-charge ratios],” as well.
Appellants’ Br. 49 (emphasis omitted). Notwithstanding the
considerable deference agencies typically receive when
analyzing data and projecting trends, see District Hospital
Partners, 786 F.3d at 60, we agree with the Hospitals.
Following the discovery of turbo-charging, HHS amended
its regulations to provide that the “cost-to-charge ratios applied
at the time a claim is processed are based on either the most
recent settled cost report or the most recent tentative[ly] settled
cost report, whichever is . . . latest.” 42 C.F.R. § 412.84(i)(2).
That means that when a new tentatively settled cost report is
released for a hospital at some point during each fiscal year,
HHS begins applying an updated cost-to-charge ratio for the
hospital calculated from that report rather than the projection
cost-to-charge ratio it used when generating the fixed-loss
threshold. As HHS concedes, therefore, projection cost-to-
charge ratios “apply for [only] part of the fiscal year.”
Appellee’s Br. 59.
Of course, HHS’s “ability to identify true outlier cases is
dependent on the accuracy of the cost-to-charge ratios.” 2003
Outlier Final Rule, 68 Fed. Reg. at 34,501. In its Remand
Explanation, HHS asserted that basing projection cost-to-charge
ratios on the most recent tentatively settled cost reports “reduced
any reason for concern” that those cost-to-charge ratios “would
not reliably approximate the cost-to-charge ratios that would be
42
used to pay FY 2004 [outlier] claims.” 81 Fed. Reg. at 3,729.
HHS thus found no reason to adjust its projection cost-to-charge
ratios to account for known or foreseeable trends in hospital
charge or cost levels (or to explain its decision not to do so).
HHS is mistaken: once it decided to use a charge-inflation
methodology, it ostensibly needed to adjust its projection cost-
to-charge ratios downward, as well.
Recall that prior to FY 2003, HHS had employed a cost-
inflation methodology to predict the outlier payments it would
make in an upcoming fiscal year. See Part I.B, supra. Because
an outlier payment aims to approximate a hospital’s costs (not
its charges), “the relevant variable” for outlier-payment purposes
“is [a hospital’s] estimated ‘costs’ for a given case.” FY 1997
NPRM, 61 Fed. Reg. 27,444, 27,497 (May 31, 1996). HHS’s
avowed basis for switching to a charge-inflation methodology
in FY 2003 was that “charges ha[d] been growing at a much
faster rate than recent estimates of cost growth,” leading it to
consistently underestimate the outlier payments it would end up
making in a given fiscal year. FY 2003 Final Rule, 67 Fed. Reg.
at 50,124.
Charging practices inform threshold calculations in another
way, as well: they supply the denominator of projection cost-to-
charge ratios. But, despite HHS’s awareness that, “[o]ver time,
cost-to-charge ratios will reflect the differential increase in
charges” relative to costs, id., HHS made no effort to account for
this differential with respect to its projection cost-to-charge
ratios. When HHS set the FY 2004 threshold in August 2003,
it knew it would end up using updated cost-to-charge ratios to
make outlier payments as tentatively settled cost reports came
in for each hospital. Yet it did not account for the fact that those
updated cost-to-charge ratios were likely to be considerably
lower than its projection cost-to-charge ratios, thereby leading
many hospitals to be underpaid for outlier cases.
43
We fail to understand why HHS expected charges to inflate
more rapidly relative to costs for some purposes but not for
others. The act of using a charge-inflation methodology
represented HHS’s considered view, irrespective of what it
might have otherwise been required to predict, that charges
would continue to rise more quickly than costs.
For those reasons, we conclude that HHS’s approach was
“internally inconsistent and inadequately explained.” District
Hospital Partners, 786 F.3d at 59 (quoting Gen. Chem. Corp. v.
United States, 817 F.2d 844, 846 (D.C. Cir. 1987)). HHS’s
broad discretion in this area “is not a license to . . . treat like
cases differently.” Cty. of L.A., 192 F.3d at 1023 (quoting
Airmark Corp. v. FAA, 758 F.2d 685, 691 (D.C. Cir. 1985))
(alteration in original). We hold that HHS acted arbitrarily and
capriciously in failing to adequately explain why it did not
adjust its projection cost-to-charge ratios downward.
VII.
The Hospitals also raise a number of challenges to the FY
2005 Final Rule. We agree with the district court in rejecting
the first two of the Hospitals’ challenges, but again conclude, as
with FY 2004, that HHS failed to adequately explain its decision
not to adjust its projection cost-to-charge ratios downward.
A.
For FY 2005, HHS employed substantially the same
methodology for calculating the outlier threshold that it had used
in FY 2004, with some notable modifications. See FY 2005
Final Rule, 69 Fed. Reg. at 49,277–78. Under its revised
formula, HHS first identified the charges listed in its FY 2003
MedPAR files. To inflate the FY 2003 charges to FY 2005,
HHS multiplied the 2003 MedPAR data by 1.1876, the average
44
rate of change in charges per case from the first half of FY 2003
to the first half of FY 2004, compounded over two years. It then
multiplied the product of that calculation by the cost-to-charge
ratios generated from hospitals’ most recent tentatively settled
cost reports to estimate each hospital’s costs for FY 2005.
Using those estimates, HHS determined that a threshold of
$25,800 — down from FY 2004’s figure of $31,000 — would
yield outlier payments totaling 5.1% of all non-outlier inpatient
payments. See id. at 49,278.
The dataset HHS used to generate this charge-inflation
figure relied in part on a half year’s worth of turbo-charged data.
HHS itself acknowledged the “exceptionally high rate of
hospital charge inflation that is reflected in the data” for the
2003 fiscal year, and admitted that its regime-spanning
projection would be imperfect. Id. at 49,277. Yet HHS
indicated that it “strongly prefer[red] to employ actual data
rather than projections” in calculating the outlier threshold, and
believed it “optimal to employ comparable periods” in
determining the annual rate of change. Id.
HHS again defended its continued practice of inflating past
years’ MedPAR data by the rate of charge inflation (rather than
cost inflation) by noting that “the basic tendency of charges to
increase faster than costs is still evident.” Id. As with FY 2004,
HHS also declined to adjust its historically derived projection
cost-to-charge ratios to account for the likelihood that charges
would continue to inflate more quickly than costs. That was
because HHS had “already taken into account the most
significant factor in the decline in cost-to-charge ratios,” by
using “the most recent tentatively settled cost report[s].” Id.
And lastly, HHS omitted any effects of reconciliation from its
FY 2005 threshold calculation. It did so principally because it
predicted that “the majority of hospitals’ cost-to-charge ratios
will not fluctuate significantly enough” to trigger reconciliation.
45
Id. at 49,278.
In District Hospital Partners, we rejected an
arbitrary-and-capricious challenge to HHS’s decision not to
“eliminate the turbo-charging hospitals from [the 2003
MedPAR] dataset” used in conjunction with FY 2004 MedPAR
data to determine the charge-inflation figure employed to set the
FY 2005 threshold. 786 F.3d at 61. The court concluded that it
would have made “little sense to remove turbo-charging
hospitals from th[e] half of the dataset” corresponding to FY
2003 “without making similar adjustments to the other half of
the dataset” corresponding to FY 2004. Id. But there was “no
need to modify the 2004 data because that information was
collected” after HHS’s anti-turbo-charging measures had taken
effect. Id. According to District Hospital Partners, HHS
“sensibly opted for a simpler approach that did not entail piling
projections atop projections”: it “reasonably left both halves
unaltered.” Id. HHS’s methodology was necessarily imperfect,
to be sure. But “imperfection alone does not amount to arbitrary
decision-making.” Id.
Notwithstanding our decision in District Hospital Partners,
the Hospitals challenge the FY 2005 threshold as arbitrary and
capricious in three separate respects. The district court rejected
each argument. It followed District Hospital Partners in
concluding that HHS could permissibly inflate FY 2003 charges
forward two years using charging data partially stemming from
the turbo-charging period. Banner Health 2015, 126 F. Supp. 3d
at 100. The court also detected no problem with HHS’s decision
not to account for reconciliation, especially since the outlier rule
had “obviated much of the need for [it].” Id. at 101. The court
further held that HHS had given a “cogent explanation” for
opting not to project a downward trend for its cost-to-charge
ratios. Id. at 100.
 46
B.
The Hospitals first repeat an argument they made with
respect to FY 2004 — that HHS acted arbitrarily in including
turbo-charged data in its FY 2005 charge-inflation formula.
That contention is squarely foreclosed by District Hospital
Partners.
The Hospitals seek to escape the holding of District
Hospital Partners by contending that the court in that case
labored under a factual misimpression. The court stated that
HHS “derived the charge[-] inflation factor [employed in the FY
2005 rulemaking] from the cost-to-charge ratios for individual
hospitals” — in other words, that the two came from the same
dataset. Dist. Hosp. Partners, 786 F.3d at 57 n.6. The Hospitals
are correct in questioning that account of HHS’s methodology.
As we explained above, HHS calculated the charge-inflation
factor — the average rate of change in charges per case —
solely from MedPAR data. Although HHS then multiplied that
charge-inflation factor by hospitals’ cost-to-charge ratios, it did
not derive the former from the latter.
Even so, the Hospitals have not identified any way in which
that apparent misapprehension affected District Hospital
Partner’s analysis. Nothing in District Hospital Partner’s logic
turned on which dataset HHS employed to generate its
charge-inflation factor, and the minor factual inaccuracy
identified by the Hospitals does not strip that decision of its
controlling force.
We further note that there is no inconsistency between our
FY 2004 and FY 2005 holdings pertaining to the inclusion of
turbo-chargers’ data in HHS’s charge-inflation calculation. The
MedPAR data used in calculating the FY 2004 threshold entirely
predated HHS’s anti-turbo-charging reforms. In contrast, the
District Hospital Partners court’s FY 2005 analysis hinged on
47
the fact that fully half of the charge-inflation dataset “was not
infected by turbo-charging” because it “came after the effective
date of the outlier correction rule.” Id. at 61. Excluding turbo-
chargers from only the first half of the dataset would have
prevented HHS from “employ[ing] comparable periods in
determining the rate of change from one year to the next.” Id.
(quoting FY 2005 Final Rule, 69 Fed. Reg. at 49,277) (internal
quotation marks omitted). Alternatively, excluding turbo-
chargers from both halves of HHS’s charge-inflation dataset
would have required HHS to ignore undisputedly valid
charge-inflation data from FY 2004 for more than one hundred
hospitals. We therefore reject the Hospitals’ first
arbitrary-and-capricious challenge to the FY 2005 Final Rule.
C.
The Hospitals also challenge HHS’s decision not to account
for future reconciliation in setting the FY 2005 threshold. We
find that HHS had no obligation to adjust any hospitals’
projection cost-to-charge ratios in anticipation of recouping
overpayments following the 2005 fiscal year.
The Hospitals contend that, even though the three key
anti-turbo-charging reforms made in the June 2003 outlier rule
had been in effect for well over a year, it was arbitrary and
capricious for HHS not to forecast that particular hospitals
would continue collecting outlier payments significantly higher
than their actual costs. That contention is unsupportable. The
parties agree that the 2003 Outlier Final Rule “greatly reduce[d]
the opportunity for hospitals to manipulate the system to
maximize outlier payments.” 68 Fed. Reg. at 34,501. The
District Hospital Partners court credited the rule with having
“corrected the flaw in the outlier payment system that created
the opportunity-and incentive-to turbo-charge.” 786 F.3d at 61.
It also observed that, once the outlier rule was implemented,
“the specter of turbo-charging was nil.” Id. at 62. Those
48
statements cannot be squared with a putative obligation to
forecast a program of reconciliation for FY 2005 outlier
payments, even if HHS’s contractors ultimately flagged a
number of payments as reconcilable. HHS therefore did not act
arbitrarily in predicting that FY 2005 charging practices
“w[ould] not fluctuate significantly enough” to justify
accounting for reconciliation in setting the FY 2005 threshold.
FY 2005 Final Rule, 69 Fed. Reg. at 49,278.
D.
As with the FY 2004 rule, the Hospitals again object to
HHS’s decision not to adjust hospitals’ projection cost-to-charge
ratios downward in FY 2005. For the reasons given above, see
Part VI.D, supra, we agree that HHS was obligated to explain
why it employed projection cost-to-charge ratios that did not
reflect its prediction that charges would increase more quickly
than costs in FY 2005.
VIII.
The Hospitals next take issue with the FY 2006 Final Rule.
We agree with the Hospitals with respect to one of their
challenges, but not the other, for reasons previously explained.
A.
To calculate the FY 2006 fixed-loss threshold, HHS used
essentially the same methodology as in FY 2005, though with
the benefit of more current data. That formula generated a FY
2006 fixed-loss threshold of $23,600, which was $2,200 less
than the year before. See FY 2006 Final Rule, 70 Fed. Reg. at
47,494.
In the rule, HHS acknowledged commenters’ complaints
that it paid out less than its 5.1% target in FYs 2004 and 2005.
See id. But it noted that FY 2006 would be the first year in
49
which all three projection variables — MedPAR data, cost-to-
charge ratios, and charge-inflation data — would entirely
postdate the June 2003 anti-turbo-charging reforms. See id. at
47,494–95. HHS again declined to adjust its projection cost-to-
charge ratios. Id. at 47,495. Lastly, HHS declared that the
prospect of reconciliation was so remote as not to be worth
considering in setting the FY 2006 threshold. Because of the
June 2003 outlier rule, HHS believed that “cost-to-charge ratios
will no longer fluctuate significantly and . . . few hospitals, if
any, will actually have [their] ratios reconciled upon cost report
settlement.” Id.
In District Hospital Partners, this court rejected an
arbitrary-and-capricious challenge to the FY 2006 Final Rule,
finding it to be “plainly reasonable.” 786 F.3d at 62. That
holding, though, was tethered to the fact that “there was no need
to account for turbo-chargers” when inflating charges, because
“all of the charge data for the 2006 rule was collected with the
outlier correction rule in effect.” Id. at 62–63. District Hospital
Partners did not foreclose all possible challenges to the FY 2006
threshold.
The Hospitals challenge the FY 2006 Final Rule as arbitrary
and capricious on two familiar grounds. The district court
rejected both arguments. It first concluded that the 2006 Rule
“adequately justifie[d] the agency’s decision not to adjust” its
projection cost-to-charge ratios, especially since the projection
cost-to-charge ratios were “actually used, for some portion of
the fiscal year, to calculate outlier payments.” Banner Health
2015, 126 F. Supp. 3d at 103. And the court deemed “certainly
adequate” HHS’s “thorough explanation” for why it chose not
to account for potential reconciliation in calculating the FY 2006
threshold. Id. at 104.
 50
B.
We affirm the district court on the latter ground, but not the
former. For the same reasons explained above, HHS need not
have accounted for the possibility of reconciling excess
payments, because its anti-turbo-charging measures had by then
been in effect for years. See Part VII.C, supra. And as with
FYs 2004 and 2005, we again hold that HHS acted arbitrarily
and capriciously in failing to explain why it assumed that
charges would increase faster than costs throughout FY 2006 for
some purposes, but not for others. See Part VI.D, supra.
IX.
Finally, the Hospitals challenge two aspects of the FY 2007
Final Rule. The Hospitals’ primary objection targets the
methodology HHS employed to adjust its projection cost-to-
charge ratios downward when calculating the fixed-loss
threshold. We describe this methodology in further detail
below, and then address the merits of the Hospitals’ challenges,
finding both challenges lacking.
A.
In FY 2007, HHS finally attempted to account for the effect
of declining cost-to-charge ratios on its efforts to make total
outlier payments in a fiscal year equal 5.1% of non-outlier
inpatient payments. See FY 2007 Final Rule, 71 Fed. Reg. at
48,150–51. Because hospital charges during this period
consistently increased faster than costs, most hospitals saw their
cost-to-charge ratios drop each time HHS’s relevant database,
known as the “Provider Specific File,” was updated with a new
tentatively settled cost report for the hospital. Once those lower,
updated cost-to-charge ratios became available, fiscal
intermediaries immediately began using them “to calculate the
outlier payments” hospitals would receive. Id. at 48,150. That
differential between projection cost-to-charge ratios and
51
payment cost-to-charge ratios contributed to HHS setting the
fixed-loss threshold too high to hit its 5.1% target in FYs 2004,
2005, and 2006. To remedy that problem in FY 2007, HHS
decided to apply an “adjustment factor” to the cost-to-charge
ratios in the Provider Specific File when predicting the outlier
payments it anticipated making during the upcoming fiscal year.
Id.
HHS’s adjustment factor represented the following
quotient: the rate at which it predicted hospital costs in the
Provider Specific File would increase as a result of updated cost
reports coming in midyear, divided by the rate at which it
predicted hospital charges in the file would increase as a result
of those updates. See id. Because of the considerable time lag
between a hospital’s rendering a service and HHS’s learning the
hospital’s costs for the service, however, the adjustment factor
reflected costs and charges for medical services already
rendered. Each time the Provider Specific File was updated
with a hospital’s most recent tentatively settled cost report, HHS
would match that cost data with the charges billed by the
hospital for the corresponding medical services. Because “it
takes approximately 9 months for fiscal intermediaries to
tentatively settle a cost report from the fiscal year end of a
hospital’s cost reporting period,” much of the data in the
Provider Specific File at the time of the FY 2007 rulemaking
dated back to FYs 2004 and 2005. Id.
As previously noted, HHS learns a hospital’s charges for a
given service soon after it is performed. HHS therefore
possessed fairly reliable information, when generating its
adjustment factor, about charge inflation in the years leading up
to the FY 2007 outlier rule. To estimate how significantly
charges in the Provider Specific File would rise as a result of
updates during the 2007 fiscal year, HHS looked to the “average
annualized rate-of-change in charges-per-case” between the first
52
two quarters of FY 2005 and the first two quarters of FY 2006.
Id. That basic methodology appeared elsewhere in the FY 2007
Final Rule, see id., and it also mirrored the approach HHS had
employed for the past several years to predict hospital charges
in an upcoming fiscal year. The resulting figure then served as
the denominator of the adjustment factor.
With regard to costs, by contrast, HHS does not know a
hospital’s true costs for a given service at the time it is rendered.
At the time it set the fixed-loss threshold, therefore, HHS did not
possess actual cost-per-case data as to how updates to the
Provider Specific File would affect hospital-specific cost-to-
charge ratios during FY 2007. Instead, HHS decided to model
the rate at which it believed costs per case had inflated between
FYs 2004 and 2005.
To do so, HHS looked first to the FY 2005 “market basket
percentage increase.” Id. The “market basket measures the pure
price change of [goods and services] used by a provider in
supplying healthcare services,” such as the wages a hospital will
need to pay its employees and the cost of the equipment it will
need to buy to furnish medical services. Market Basket
Definitions and General Information, CTR. FOR MEDICARE &
MEDICAID SERVS., https://www.cms.gov/
Research-Statistics-Data-and-Systems/Statistics-Trends-and-
Reports/MedicareProgramRatesStats/Downloads/info.pdf (last
visited Aug. 7, 2017). Because the market basket represents the
cost of the various inputs that go into a hospital’s efforts to
provide care, the Medicare Act uses the annual “market basket
percentage increase” for such purposes as estimating a hospital’s
“expected costs” in an upcoming fiscal year. 42 U.S.C.
§ 1395ww(b)(2)(D). (HHS had also used the market basket
percentage increase in FY 2004 when modeling projection cost-
to-charge ratios for the 50 hospitals it anticipated subjecting to
reconciliation. FY 2004 Final Rule, 68 Fed. Reg. at 45,477.) In
53
cooperation with an economic forecasting firm, HHS can
determine “the final updated market basket increase” for a given
fiscal year in advance of receiving hospitals’ tentatively settled
cost reports for the same period. FY 2007 Final Rule, 71 Fed.
Reg. at 48,150.
To estimate the rate of cost inflation between FYs 2004 and
2005, HHS first calculated the average relationship between the
market basket percentage increase and industry-wide
cost-per-case inflation across three consecutive periods: FYs
2001 to 2002, 2002 to 2003, and 2003 to 2004. HHS then
multiplied that three-year average by the market basket
percentage increase for FY 2005 to approximate the inflation in
costs per case between FYs 2004 and 2005. Id. Put simply,
HHS used the known increase in the cost of the market basket
as a proxy for measuring the increase in costs per case. The
resulting figure then served as the numerator of the adjustment
factor. By dividing that numerator by the denominator
discussed above, HHS generated its ultimate adjustment factor
of -0.27%. Id.
B.
The Hospitals applaud HHS’s decision to adjust its
projection cost-to-charge ratios downward when setting the FY
2007 fixed-loss threshold. They challenge, however, the
magnitude of that adjustment. Specifically, the Hospitals note
that HHS’s own pronouncements indicated that cost-to-charge
ratios in the Provider Specific File had declined by
approximately 2% in the previous twelve months. From this, the
Hospitals infer that HHS acted arbitrarily and capriciously in
applying an adjustment figure (-.27%) that diverged so
substantially from the recent historical trend. Instead, the
Hospitals suggest, HHS should have adopted the “obvious
alternative” approach of assuming that cost-to-charge ratios
would continue declining at the same rate as in recent years.
54
Appellants’ Br. 73.
The Hospitals’ challenge in this respect falls short. As an
initial matter, it is unclear that HHS’s adjustment factor is as
inconsistent with the historical trend as the Hospitals suggest.
By the Hospitals’ own account, “the average annual drop in the
national average [cost-to-charge ratio] was 4.8%” between fiscal
years 2001 and 2005, whereas HHS had noted only a “one-year
actual decline . . . of 2%” during the twelve-month period
leading up to the FY 2007 rulemaking. Appellants’ Br. 74–75
(citing FY 2007 Final Rule, 71 Fed. Reg. at 48,151; FY 2007
NPRM, 71 Fed. Reg. 23,996, 24,150 (April 25, 2006))
(emphasis omitted). The Hospitals fail to explain why modeling
a further 1.5% slowdown was so inconsistent with the recent
record trend as to cast the adjustment factor into doubt. There
may well be many non-arbitrary reasons for predicting that costs
and charges in a particular industry will not continue on their
current trajectories. That is particularly so in the circumstances
presented here, involving fundamental changes to the
outlier-payment system to eradicate rampant charge inflation.
More importantly, the Hospitals fail to identify any
meaningful concerns with the methodology HHS employed
beyond the fact that it generated a lower adjustment factor than
they would have preferred. The Hospitals first criticize HHS for
using cost data from FYs 2001 through 2005 in generating its
cost-inflation figure, given its expressions of skepticism
elsewhere in the FY 2007 Final Rule about the accuracy of
pre-FY 2004 data. That critique mischaracterizes HHS’s
position on data from the turbo-charging era. It is true that HHS
was hesitatant to make predictive judgments using charge data
from that period, during which a small number of hospitals
engaged in wildly inflated billing practices. See, e.g., FY 2007
Final Rule, 71 Fed. Reg. at 48,149 (“[W]e believe that charge
data from FY 2003 may be distorted due to the atypically high
55
rate of hospital charge inflation during FY 2003.”). But the
Hospitals provide no reason to think that hospital costs during
the turbo-charging era were similarly unreliable, and they point
to no evidence suggesting that HHS mistrusted (or should have
mistrusted) cost reports from that period.
Beyond that, the Hospitals merely criticize HHS for
“concoct[ing] a complex formula in an attempt to model the
most-recent one-year decline in [cost-to-charge ratios]
nationally,” rather than “basing its adjustment factor on the
actual relevant record trend.” Appellants’ Br. 73–74 (emphases
omitted). But an agency does not act arbitrarily and capriciously
simply by engaging in the enterprise of predictive modeling.
And the Hospitals have provided no reason to doubt that the
market basket percentage increase correlated reasonably well
with cost-per-case inflation. In fact, in various provisions in the
Medicare Act, Congress itself specified the use of the market
basket percentage increase as a measure of cost inflation. See,
e.g., 42 U.S.C. § 1395ww(b)(2)(C)–(D). HHS apparently
concluded that employing known information about hospital
costs during the period in question — in the form of the market
basket percentage increase — would more likely result in an
accurate estimate of cost-per-case inflation than would simply
extrapolating from historical patterns. The Hospitals give us no
persuasive basis for questioning that judgment.
To the extent the Hospitals separately object to the alleged
complexity of HHS’s model, that objection is without merit. A
model’s complexity, by itself, reveals little about its rationality.
When an agency seeks “to measure actual cost changes
experienced by [an] industry,” there will typically be “[m]any
methods . . . available” for doing so. Ass’n of Oil Pipe Lines v.
FERC, 281 F.3d 239, 241 (D.C. Cir. 2002) (internal quotation
marks omitted). Accordingly, “courts routinely defer to agency
modeling of complex phenomena.” Appalachian Power Co. v.
56
EPA, 249 F.3d 1032, 1053 (D.C. Cir. 2001). We will not
remand simply because HHS declined to explain the complexity
of its chosen formula relative to available alternatives.
We acknowledge that HHS’s explanation of its FY 2007
methodology may not have been a model of clarity. But while
we may not “supply a reasoned basis for the agency’s action that
the agency itself has not given,” Ark Initiative v. Tidwell, 816
F.3d 119, 127 (D.C. Cir. 2016) (quoting SEC v. Chenery Corp.,
332 U.S. 194, 196 (1947)), we must “uphold a decision of less
than ideal clarity if the agency’s path may reasonably be
discerned,” id. (quoting Motor Vehicle Mfrs. Ass’n v. State Farm
Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983)). Because we have
been able to discern HHS’s path, and because the Hospitals fail
to show why it should not receive the deference typically
accorded in this context, we reject the Hospitals’ challenge to
the FY 2007 adjustment factor.
C.
Finally, the Hospitals again take issue with HHS’s decision
not to account for the possibility of reconciliation in setting the
fixed-loss threshold. For the reasons explained above, see Part
VII.C, supra, HHS was under no obligation to do so. We
therefore reject this final challenge to the FY 2007 outlier rule,
as well.
X.
The Supreme Court has explained that “[i]f the record
before the agency does not support the agency action, . . . the
proper course, except in rare circumstances, is to remand to the
agency for additional investigation or explanation.” Fla. Power
& Light Co. v. Lorion, 470 U.S. 729, 744 (1985). In such
circumstances, the agency must first be “afford[ed] . . . an
opportunity to articulate, if possible, a better explanation.”
57
District Hospital Partners, 786 F.3d at 60 (quoting Cty. of L.A.,
192 F.3d at 1023). We follow that usual course here. On
remand, HHS will be given a chance to remedy the explanatory
deficiencies identified above.
We note that HHS has already attempted to rectify one of
the flaws identified in District Hospital Partners. As explained
above, we are unconvinced by the Remand Explanation’s stated
reasons for having used vastly unrepresentative charge data to
inform the FY 2004 charge-inflation factor. In these highly
unusual circumstances — in which an apparent methodological
flaw that HHS has not yet had an opportunity to explain must be
addressed before it could reasonably recalculate various fiscal
years’ fixed-loss thresholds — we remand both successfully
challenged aspects of the FY 2004 Final Rule to be considered
in the same posture. If HHS is again unable to supply a
satisfactory explanation for including the turbo-charged data,
that portion of the 2004 Rule will be subject to vacatur.
Accordingly, for the foregoing reasons, we reverse the
district court’s grant of summary judgment with respect to the
successfully challenged aspects of the FY 2004, 2005, and 2006
Final Rules, and remand for further proceedings consistent with
this opinion. In all other respects, we affirm the district court’s
grant of summary judgment in favor of HHS.