Health Law Daily Rural hospitals lose battle alleging Secretary’s reimbursement calculations were arbitrary
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Thursday, April 23, 2020

Rural hospitals lose battle alleging Secretary’s reimbursement calculations were arbitrary

By Susan L. Smith, JD, MA

Eleven rural hospitals failed in their appeal of the district court’s judgment that the method that HHS used to calculate their Medicare reimbursements was arbitrary or capricious.

The district court properly granted the HHS Secretary’s motion for summary judgment finding that the method for calculating rural hospitals’ hospital-specific reimbursement was not arbitrary or capricious. Eleven rural hospitals alleged the Secretary’s method was arbitrary and capricious under the Administrative Procedure Act (APA) (5 U.S.C. §706(2)(A)) claiming that the Secretary’s methodology was double counting the budget neutrality adjustment. The appellate court affirmed the district court’s judgment finding that the Secretary’s methodology is not arbitrary or capricious. The appellate court disagreed with the hospital’s double application argument, concluding that the hospitals arguments rested on flawed premises. The court also rejected the hospital’s contention that the Secretary misunderstood the methodology (Hays Medical Center v. Jones, April 21, 2020, Holmes, J.).

The district court’s ruling. The rural hospitals challenged the Secretary’s use of cumulative budget neutrality adjustments in calculating hospital specific rates for Medicare dependent hospitals (MDHs) and sole-community hospitals (SCHs) claiming that the Secretary’s decision to reduce a new base year’s costs by the cumulative budget neutrality adjustment for years prior to that new base year is arbitrary and capricious under the APA, in part because it is effectively double counting those adjustments. The hospitals contended that the budget neutrality adjustment is used first in the calculations for the diagnosis-related groups (DRG) and a second time when it is applied to the payment rates. As a result, the hospitals allegedly were not given the option of receiving 100 percent of the allowable operating costs of inpatient hospital services. Further, the cumulative budget neutrality adjustment reduced payments to MDHs and SCHs by an additional 1.74 percent and 2.28 percent, respectively, every year since 2009. The district court granted the HHS Secretary’s motion for summary judgment concluding that the Secretary’s decision to use cumulative budget neutrality adjustments in a calculation of a hospital’s new base-year hospital-specific rates was within the confines of the authority delegated to her by Congress and the actions were not arbitrary, capricious, or an abuse of discretion (Court upholds HHS’ cumulative budget neutrality adjustmentsSeptember 5, 2017).

Special payment provisions for SCHs and MDHs. There are special payment provisions for SCHs and MDHs. Such hospitals have the option of selecting reimbursement based on a hospital-specific rate instead of the federal rate. The hospital-specific rate is different for each eligible hospital. To calculate a hospital-specific rate it identifies target amount, which is the hospital’s historic operating costs in a given year. The Secretary adjusts the hospital specific rate to account for variables such as inflation and wage levels and applies the cumulative budget-neutrality adjustment to the hospital specific rate. When Congress adds a new base year, the hospital-specific rate for that new year is calculated according to the following four-step formula:

  • Step One: Divide the hospital’s target amount for the new base year by the number of discharges that year (42 C.F.R. §§ 412.78(c), 412.79(b)).
  • Step Two: Divide the figure from step one by the hospital’s normalized average DRG weight for the new base year (42 C.F.R. §§ 412.78(d), 412.79(c)).
  • Step Three: Apply an update factor to account for specific variables such as inflation and wage levels (42 C.F.R. §§ 412.73(c), 412.78(e), 412.79(d)).
  • Step Four: Apply a cumulative budget-neutrality adjustment to the resulting rate figure. (42 C.F.R. §§ 412.78(j), 412.79)

The hospitals’ contentions. In their appeal, the hospitals specifically dispute the consequences of the Secretary apply a cumulative budget-neutrality adjustment twice in the four-step formula for calculating the hospital-specific rate. First, it is applied in step two to the normalized average DRG for the new base year and again in step four to the resulting rate figure. The hospitals also argue that the Secretary’s methodology is arbitrary and capricious because it yields a different payment than had he budgeted-neutralized the weights themselves. Finally, they contend that the Secretary’s method is arbitrary and capricious because it would not reimburse a hospital its full base-year allowable operating costs.

The appellate court’s conclusion. The appellate court affirmed the district court’s judgment finding that the Secretary’s methodology is not arbitrary or capricious. Specifically, the court determined that the Secretary does not apply the cumulative budget neutrality adjustment twice. The appellate court concluded that the hospitals argument demonstrates a misunderstanding of the role of normalization and the budget-neutrality adjustment. Further, the appellate court said that the Secretary has discretion on how to accomplish the statutory budget-neutrality directive, doing so primarily through the normalization process. The court also noted that imprecise wording in a fiscal year 2010 proposed rule (74 FR. 24079) "planted seeds for the hospital’s confusion," but added that the Secretary clarified his statements in the 2010 final rule (74 FR 43753) and reiterated the explanation over the years stating that normalization offsets any increase in recalibration but other factors require a cumulative budget neutrality adjustment to ensure budget neutrality in aggregate payments achieved. Therefore, the court rejected the hospital’s contention that the Secretary misunderstood the methodology.

The court also rejected the hospitals’ assertion that one purpose of the budget neutrality adjustment under Congress’ statutory theme is to budget neutralize the DRG weights. The court stated that the according to the statute, the purpose of the budget neutrality adjustment "is to achieve budget neutrality in aggregate payment systemwide, not to guarantee that the diagnosis-related group weights themselves are budget neutral."

The case is No. 17-3232.

Attorneys: Daniel John Hettich (King & Spalding LLP) for John Holmquist, Mercy Hospital Lebanon, Mercy Hospital Ardmore, Inc., North Platte Nebraska Hospital Corp., Hanover Hospital, Inc., Knox Community Hospital, Labette County Medical Center, Memorial Hospital of Sweetwater County, Newman Memorial County Hospital, Northwestern Medical Center, Inc. and Pocatello Hospital, LLC. Michael Raab, U.S. Department of Justice, for Alex M. Azar, II.

Companies: Mercy Hospital Lebanon; Mercy Hospital Ardmore, Inc.; North Platte Nebraska Hospital Corp.; Hanover Hospital, Inc.; Knox Community Hospital; Labette County Medical Center; Memorial Hospital of Sweetwater County; Newman Memorial County Hospital; Northwestern Medical Center, Inc.; Pocatello Hospital, LLC and Richland Memorial Hospital

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