Banner Health v. Sebelius

UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF COLUMBIA

BANNER HEALTH f/b/o BANNER GOOD

SAMARITAN MEDICAL CENTER, et al.,

Plaintiffs

v.

Civil Action No. 10-1638 (CKK)

SYLVIA M. BURWELL, Secretary of the

U.S. Department of Health and Human

Services,

Defendant

MEMORANDUM OPINION

(September 2, 2015)

Plaintiffs are twenty-nine organizations that own or operate hospitals participating in the

Medicare program. They have sued the Secretary of the Department of Health and Human

Services (the “Secretary”), purporting to challenge various actions taken by the Secretary in the

course of administering Medicare’s “outlier” payment system, the system which provides

additional payments to hospitals for extremely high cost cases. Plaintiffs challenge a series of

regulations that, together, govern outlier payments for federal fiscal year (“FY”) 1997 through

FY 2007. Specifically, they challenge 14 regulations: outlier payment regulations promulgated in

1988, 1994 and 2003, and 11 annual fixed loss threshold regulations issued for FY 1997 through

FY 2007. 1 As explained in more detail below, the combination of the applicable outlier payment

1

Plaintiffs’ claims in this action have long been wide ranging, and the Court previously

dismissed those claims that exceed the scope of the proper judicial review of agency action. See

Banner Health v. Sebelius, 797 F. Supp. 2d 97, 110-11 (D.D.C. 2011). Over the course of the

lengthy procedural history of this case, it has become clear that Plaintiffs in fact challenge 14

regulations, promulgated between 1988 and 2007. Notwithstanding this clarification and

narrowing of this action, Plaintiffs continue to use broad language addressed at flaws of the

outlier program overall, in addition to identifying certain purported legal flaws with the

regulations challenged. Nonetheless, in addition to addressing Plaintiffs’ claims that are directed

at specific regulations, where the connections between Plaintiffs’ other arguments and individual

1

regulations and the applicable annual fixed loss threshold establishes the formula for calculating

the outlier payments made to individual hospitals, including payments to Plaintiffs and to the

facilities controlled by Plaintiffs, during each fiscal year. Plaintiffs challenge the individual

outlier payments made by applying those 14 regulations, as well. 2

Presently before the Court are Defendant’s [126] Motion to Dismiss for Lack of Subject

Matter Jurisdiction and for Summary Judgment, Plaintiffs’ [127/142] Motion for Summary

Judgment, and Plaintiffs’ [128] Motion (Related to Their Motion For Summary Judgment) for

Judicial Notice and/or for Extra-Record Consideration of Documents and Other Related Relief.

Upon consideration of the pleadings, 3 the relevant legal authorities, and the record as a whole,

rulemakings are apparent, the Court addresses those arguments in this Memorandum Opinion as

well.

2

Plaintiffs do not claim that the agency applied the regulations incorrectly in calculating the

individual outlier payments; they claim that, because of flaws with the underlying regulations,

the resultant outlier payments were necessarily incorrect.

3

The Court’s consideration has focused on the following documents:

• Def.’s Mot. to Dismiss for Lack of Subject Matter Jurisdiction and for Summary

Judgment (“Def.’s Mot.”), ECF No. 126;

• Pls.’ Corrected Opp’n to Def.’s Mem. in Support of Mot. to Dismiss for Lack of

Subject Matter Jurisdiction and for Summary Judgment (“Pls.’ Opp’n”), ECF No.

143;

• Def.’s Reply Mem. in Support of Mot. to Dismiss for Lack of Subject Matter

Jurisdiction and for Summary Judgment (“Def.’s Reply”), ECF No. 134;

• Pls.’ Corrected Mot. for Summary Judgment (“Pls.’ Mot.”), ECF No. 142;

• Def.’s Mem. in Opp’n to Pls.’ Mot. for Summary Judgment (“Def.’s Opp’n”), ECF

No. 132;

• Pls.’ Corrected Reply in Support of Pls.’ Mot. for Summary Judgment (“Pls.’ Reply”),

ECF No. 144;

• Pls.’ Motion (Related to their Motion for Summary Judgment) for Judicial Notice

and/or for Extra-Record Consideration of Documents and Other Related Relief (“Pls.’

Extra-Record Mot.”), ECF No. 128;

• Def.’s Mem. in Opp’n to Pls.’ Mot. to Supplement Administrative Records With

Extra-Record Evidence and for Leave to Exceed Page Limit (“Def.’s Extra-Record

Opp’n”), ECF No. 129; and

2

the Court DENIES Defendant’s [126] Motion to Dismiss for Lack of Subject Matter Jurisdiction,

GRANTS IN PART and DENIES IN PART Defendant’s [126] Motion for Summary Judgment,

GRANTS IN PART and DENIES IN PART Plaintiffs’ [127/142] Motion for Summary Judgment,

and GRANTS IN PART and DENIES IN PART Plaintiffs’ [128] Motion for Judicial Notice

and/or for Extra-Record Consideration of Documents and Other Related Relief.

As an initial matter, the Court concludes that it has subject matter jurisdiction over all of

the claims in this action. With respect to the FY 2004 fixed loss threshold rule, the Court

REMANDS the rule to the agency to allow the agency to explain its decision regarding its

treatment of certain data—or to recalculate the fixed loss threshold if necessary—as explained

further below. In all other respects, the Court DENIES Plaintiffs’ challenges to all of the

regulations at issue in this case.

With respect to Plaintiffs’[128] Motion for Judicial Notice and/or Extra-Record

Consideration of Documents and Other Related Relief, the Court DENIES Plaintiffs’ request to

supplement the record and for extra-record consideration of documents, but the Court GRANTS

the motion insofar as the Court will take judicial notice of the publicly available materials

subject to the motion, as relevant. The Court DENIES Plaintiffs’ request to submit three

additional tables and STRIKES from the record exhibits 5, 7, and 8 to Plaintiffs’ Motion for

• Pls.’ Reply in Support of Mot. for Judicial Notice and/or for Extra-Record

Consideration of Documents and Other Related Relief (“Pls.’ Extra-Record Reply”),

ECF No. 130.

In light of the voluminous administrative record pertaining to numerous regulations, the Court

cites to the administrative record by referring to the specific agency action for which that portion

of the administrative record was assembled, e.g., “A.R. (FY 2004)” or “A.R. (2003

amendments).” In an exercise of its discretion, the Court finds that holding oral argument in this

action would not be of assistance in rendering a decision. See LCvR 7(f).

3

Summary Judgment. The Court will retain jurisdiction pending the limited remand to the agency

regarding the FY 2004 rulemaking.

I. BACKGROUND

A. Factual Background

While this action emerges from Plaintiffs’ challenge to the outlier payments they received

for FY 1997 through FY 2007, the hospitals do not challenge the calculation of the individual

outlier payments; instead, they level their substantive challenges at the 14 regulations that

established the formulas for outlier payments in each of the relevant years. Plaintiffs challenge

two sets of interrelated regulations that, taken together, create a formula that generates the actual

outlier payments paid each year. With these regulations in hand, the calculations of the actual

outlier payments are effectively a ministerial task. The first set of regulations consists of three

rules—promulgated in 1988, 1994, and 2004—revising the outlier payment regulations, which

are codified at 42 C.F.R. § 412.84. As presented below in greater detail, these regulations set a

formula for how individual outlier payments will be calculated for each fiscal year, a formula

that was revised over the course of time by these regulations. For all of the years after 1994,

including the years for which outlier payments are at issue in this litigation, that formula

involved a fixed loss threshold that was set annually. As described below in greater detail, the

fixed loss threshold represents the dollar amount of loss that a hospital must absorb in any case

in which the hospital incurs estimated costs for treating a patient above and beyond the payment

rate set for that type of case. Accordingly, the second set of regulations challenged in this action

consists of 11 annual fixed loss threshold rulemakings issued for FY 1997 to FY 2007. In each of

those annual rulemakings, the agency established a methodology for setting a fixed loss

4

threshold and set the dollar value of the fixed loss threshold itself. 4 The outlier payment

regulations that were applicable for the relevant fiscal year are effectively inputs for the fixed

loss threshold rulemakings. That is, using the methodology selected for the fiscal year, the

agency uses the applicable outlier payment regulations together with selected past data to

generate an annual fixed loss threshold that complies with the statutory requirements.

Because of the wide-ranging nature of Plaintiffs’ challenge—challenging 11 annual fixed

loss threshold regulations and outlier payment regulations issued over the course of three

decades—and because of the technical complexity of the program involved—it is necessary to

review the history of the program in some detail. 5 Moreover, it is important that significant

changes to the program occurred over the course of the years covered in this challenge. Because

Plaintiffs challenge rulemakings that occurred as early as 1988, it is necessary to explain the

changes that occurred as the outlier payment program unfolded over time. That said, the Court

provides the greatest detail on fiscal years 1997 through 2007 that are the core of the claims in

this case. The Court reserves certain details for its discussion of the discrete issues presented by

the parties below.

The Statutory Framework

Medicare “provides federally funded health insurance for the elderly and disabled,”

Methodist Hosp. of Sacramento v. Shalala, 38 F.3d 1225, 1226-27 (D.C. Cir. 1994), through a

4

For FY 2007, the agency only set a tentative final fixed loss threshold in the rule that finalized

the methodology for setting the fixed loss threshold because of uncertainty about certain other

data. See infra note 16. The agency later set the actual final fixed loss threshold for that year. See

id. That distinction is of no moment to this litigation.

5

The Court notes that, by contrast, Plaintiffs persist in taking a blunderbuss approach to this

challenge, despite the Court’s previous opinions indicating that doing so was not permissible,

eliding certain key differences between the variety of regulations they challenge and the years in

which they were promulgated.

5

“complex statutory and regulatory regime,” Good Samaritan Hosp. v. Shalala, 508 U.S. 402

(1993). The program is administered by the Secretary through the Centers for Medicare and

Medicaid Services (“CMS”). Cape Cod Hosp. v. Sebelius, 630 F.3d 203, 205 (D.C. Cir. 2011).

From its inception in 1965 until 1983, Medicare reimbursed hospitals based on “the

‘reasonable costs’ of the inpatient services that they furnished.” Cnty. of Los Angeles v. Shalala,

192 F.3d 1005, 1008 (D.C. Cir. 1999) (quoting 42 U.S.C. § 1395f(b)), cert. denied, 530 U.S.

1204 (2000). However, “[e]xperience proved … that this system bred ‘little incentive for

hospitals to keep costs down’ because ‘[t]he more they spent, the more they were reimbursed.’”

Id. (quoting Tucson Med. Ctr. v. Sullivan, 947 F.2d 971, 974 (D.C. Cir. 1991)).

In 1983, with the aim of “stem[ming] the program’s escalating costs and perceived

inefficiency, Congress fundamentally overhauled the Medicare reimbursement methodology.”

Cnty. of Los Angeles, 192 F.3d at 1008 (citing Social Security Amendments of 1983, Pub. L. No.

98–21, § 601, 97 Stat. 65, 149). Since then, the Prospective Payment System, as the overhauled

regime is known, has reimbursed qualifying hospitals at prospectively fixed rates. Id. By

enacting this overhaul, Congress sought to “reform the financial incentives hospitals face,

promoting efficiency in the provision of services by rewarding cost[-]effective hospital

practices.” H.R. Rep. No. 98–25, at 132 (1983), reprinted in 1983 U.S.C.C.A.N. 219, 351.

Under the Prospective Payment System, Hospitals are reimbursed “based on the average

rate of ‘operating costs [for] inpatient hospital services.’” Dist. Hosp. Partners, L.P. v. Burwell,

786 F.3d 46, 49 (D.C. Cir. 2015) (quoting Cnty. of Los Angeles, 192 F.3d at 1008). “Because

different illnesses entail varying costs of treatment, the Secretary uses diagnosis-related groups

(DRGs) to ‘modif[y]’ the average rate.” Id. (quoting Cape Cod Hosp., 630 F.3d at 205). “A DRG

is a group of related illnesses to which the Secretary assigns a weight representing ‘the

6

relationship between the cost of treating patients within that group and the average cost of

treating all Medicare patients.’” Id. (quoting Cape Cod Hosp., 630 F.3d at 205–06). “To calculate

a specific reimbursement, the Secretary ‘takes the [average] rate, adjusts it [to account for

regional labor costs], and then multiplies it by the weight assigned to the patient’s DRG.’” Id.

(quoting Cnty. of Los Angeles, 192 F.3d at 1009) (alteration in original).

“Congress recognized that health-care providers would inevitably care for some patients

whose hospitalization would be extraordinarily costly or lengthy” and devised a means to

“insulate hospitals from bearing a disproportionate share of these atypical costs.” Cnty. of Los

Angeles, 192 F.3d at 1009. Specifically, Congress authorized the Secretary to make supplemental

“outlier” payments to eligible providers. Id. While relatively simple in concept—hospitals

receive additional payments for extremely high cost treatments—implementing the outlier

payment concept entails a complex process, which has evolved substantially in the more than

three decades since outlier payments were introduced. Because Plaintiffs challenge aspects of the

implementation of the scheme that cover all three decades, it is necessary to review how the

program has evolved over time.

Pursuant to the 1983 legislation, the program provided for outlier payments for “day

outliers” and “cost outliers.” Cnty. of Los Angeles, 192 F.3d at 1009 (citing 42 U.S.C.

§ 1395ww(d)(5)(A)(i)-(ii) (Supp. IV 1986)). Day outliers are those patients whose “length of

stay exceeded the mean length of stay for that particular DRG by a fixed number of days or

standard deviations.” Cnty. of Los Angeles, 192 F.3d at 1009 (citing 42 U.S.C.

§ 1395ww(d)(5)(A)(i) (Supp. IV 1986)). In other words, day outlier payments cover patients

with extraordinarily lengthy hospital stays. Day outlier payments for extraordinary lengthy stays

were subsequently eliminated by Congress and are not at issue in this litigation. See 42 U.S.C.

7

§ 1395ww(d)(5)(A)(i) (day outlier payments only available for discharges occurring “during

fiscal years ending on or before September 30, 1997”). As specified by Congress in 1983, cost

outlier payments covered situations where “a hospital’s cost-adjusted charges surpassed either a

fixed multiple of the applicable DRG prospective-payment rate or such other fixed dollar amount

that the Secretary established.” 6 Cnty. of Los Angeles, 192 F.3d at 1009 (citing 42 U.S.C.

§ 1395ww(d)(5)(A)(ii) (Supp. IV 1986)). The 1983 statute further specified that the amount of

the outlier payments “shall be determined by the Secretary and shall approximate the marginal

cost of care beyond the cutoff point applicable” to day outliers or to cost outliers. 42 U.S.C.

§ 1395ww(d)(5)(A)(iii); see also Cnty. of Los Angeles, 192 F.3d at 1009. Finally, the statute

provides that “[t]he total amount of the additional [outlier] payments made under this

subparagraph for discharges in a fiscal year may not be less than 5 percent nor more than 6

percent of the total payments projected or estimated to be made based on DRG prospective

payment rates for discharges in that year.” 42 U.S.C. § 1395ww(d)(5)(A)(iv). In County of Los

Angeles, the D.C. Circuit Court of Appeals approved the Secretary’s interpretation of that final

provision—regarding the 5 to 6 percent range—under which the agency was required to set the

outlier threshold in advance such that the projected outlier payments would be between 5 and 6

percent of the total projected payments. See 192 F.3d at 1020. The Court of Appeals concluded

6

As explained further below, this provision of the statute was subsequently amended such that

outlier payments are made for “discharges in fiscal years beginning on or after October 1,

1994”—that is, the first day of FY 1995—where “charge, adjusted to cost, … exceed the sum of

the applicable DRG prospective payment rate plus any amounts payable under subparagraphs (B)

and (F) plus a fixed dollar amount determined by the Secretary.” 42 U.S.C.

§ 1395ww(d)(5)(A)(iii) (emphasis added). It is the annually-set “fixed dollar amount” and

factors related to the agency’s method of setting that amount that are the core of the dispute in

this case.

8

that the agency was not required to retroactively adjust the outlier thresholds such that the actual

outlier payments would be between 5 and 6 percent of the total payments. See id. at 1019-20.

Since the introduction of the Prospective Payment System, the applicable statutory

provision has provided for cost outlier payments only when “charges, adjusted to cost,” exceed a

certain cutoff. 42 U.S.C. § 1395ww(d)(5)(A)(ii). Because hospitals “markup” their costs in their

billing, a calculation is necessary in order to estimate the actual costs of a given treatment based

on the amount charged by a medical facility. See Dist. Hosp. Partners, 786 F.3d at 50. Until

1988, the agency used a standard cost-to-charge ratio for all facilities. See 53 Fed. Reg. 38,476,

38,502 (Sept. 30, 1988) (“We currently determine the cost of the discharge to be equal to 66

percent of the billed charges for covered services based on the average ratio of operating costs to

charges for Medicare discharges nationwide.”). However, in 1988 the agency decided to shift to

using hospital-specific cost-to-charge ratios, reasoning that “[t]he use of hospital-specific cost-to-

charge ratios should 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. Accordingly, the agency codified that change by adding the

following provision to the Code of Federal Regulations specifying that that hospital-specific

cost-to-charge ratios would be used:

The cost-to-charge ratio used to adjust covered charges is computed annually by

the intermediary for each hospital based on the latest available settled cost report

for that hospital and charge data for the same time period as that covered by the

cost report. Statewide cost-to-charge ratios are used in those instances in which a

hospital’s cost-to-charge ratio falls outside reasonable parameters. HCFA sets

forth these parameters and the Statewide cost-to-charge ratios in each year’s

annual notice of prospective payment rates published under § 412.8(b).

53 Fed. Reg. at 38,529 (providing text of provision codified at 42 C.F.R. § 412.84(h)). In

explaining the choice to use the “latest available settled cost report,” the Secretary reasoned that

“the hospital-specific cost-to-charge ratios should be developed using the most current and

9

accurate data available.” 53 Fed. Reg. at 38,507. Furthermore, the Secretary reasoned that,

“[w]hile the latest filed cost report represents the most current data, we have found that Medicare

costs are generally overstated on the filed cost report and are subsequently reduced as a result of

audit.” Id. The agency considered the range of reasonable cost-to-charge ratios to be “3.0

standard deviations (plus or minus) from the mean of the log distribution of cost-to-charge ratios

for all hospitals.” Id. The agency explained that it “believe[d] that ratios falling outside this range

are unreasonable and are probably due to faulty data reporting or entry.” Id. at 38,507-08. In

other words, pursuant to the 1988 regulation, to determine whether a hospital’s cases qualified

for outlier payments, the agency would use the ratio between the latest available settled cost

report—that is, the most recent audited cost report—and the associated charges. But if the cost-

to-charge ratio was either extremely high or extremely low in comparison to the other hospitals,

the agency would use the statewide average cost-to-charge ratio in determining whether outlier

payments were warranted. These two aspects of the formula for calculating outlier payments—

the use of the latest available settled cost reports and the statewide average default—remained

applicable until they were modified by regulation in 2003. See 68 Fed. Reg. 34,494, 34,497-500

(June 9, 2003); 42 C.F.R. § 412.84(i)(3) (2003).

In 1993, Congress amended the statutory provisions establishing the outlier payment

framework—for FY 1995 and beyond—through Section 13501(c) of the Omnibus Budget

Reconciliation Act of 1993 (Public Law 103-66). 59 Fed. Reg. 45,330, 45,368 (Sept. 1, 1994).

Previously a “hospital [could] receive payment for a cost outlier if the adjusted costs for a

discharge exceed the greater of a fixed dollar amount or a fixed multiple of the DRG payment for

the case.” Id. Pursuant to the 1993 legislation, for discharges on or after October 1, 1994, a

hospital can request an outlier payment when the charges, adjusted to cost, “exceed the sum of

10

the applicable DRG prospective payment rate … plus a fixed dollar amount determined by the

Secretary.” 7 42 U.S.C. § 1395ww(d)(5)(A)(ii); see also 59 Fed. Reg. at 45,368. The “fixed dollar

amount” is known as the fixed loss threshold. “In effect, this threshold ‘acts like an insurance

deductible because the hospital is responsible for that portion of the treatment’s excessive cost’

above the applicable DRG rate.” Dist. Hosp. Partners, 786 F.3d at 50 (quoting Boca Raton Cmty.

Hosp., Inc. v. Tenet Health Care Corp., 582 F.3d 1227, 1229 (11th Cir. 2009)). The fixed loss

threshold is set by the Secretary each fiscal year. Id. The agency must set that fixed loss

threshold such that the projected outlier payments are between 5 and 6 percent of the total

projected DRG-based payments for the applicable fiscal year. See Cnty. of Los Angeles, 192 F.3d

at 1020.

To implement the amended statutory provisions, the agency amended its outlier payment

regulations—promulgating the second regulation challenged by Plaintiffs in this action. For all

discharges on or after October 1, 1994, cost outlier payments would be available when charges,

adjusted to cost, “exceed the DRG payment for the case plus a fixed dollar amount.” 59 Fed.

Reg. 45,330, 45398 (Sept. 1, 1994) (amending 42 C.F.R. § 412.80). The agency acknowledged

that the language of the statutory amendment contained some ambiguity as to whether the new

formula was required for future discharges or whether it provided an optional alternative to the

previous outlier payment formula. See id. at 45,370. But the agency concluded that adopting the

new fixed loss cost methodology exclusively was both substantively appropriate and consistent

with the intent of Congress in amending the relevant statutory provisions. See id.

7

The 1993 Act also eliminated the day outlier payment provision, discussed above, for all

discharges after September 30, 1997. 59 Fed. Reg. at 45,367. The Act also specified that the day

outlier payments must be a declining percentage of the total outlier payments for FY 1995, FY

1996, and FY 1997. See id.

11

In this same regulation, the agency set the fixed loss threshold for FY 1995 at $20,500.

See id. at 45,407. Pursuant to section 1395ww(d)(5)(A)(iii), there is a requirement that the outlier

payment “approximate the marginal cost of care beyond the cutoff point.” For FY 1995, the

agency set the marginal cost factor for cost outliers at 80 percent. 8 59 Fed. Reg. at 45,407.

Accordingly, cost outlier payments would be provided where a charge, adjusted to cost, was

greater than the applicable DRG rate plus $20,500. In such a circumstance, the amount of the

cost outlier payment would be 80 percent of the difference between the charges, adjusted to cost,

and the sum of the DRG rate and $20,500. For FY 1995, the agency set the fixed loss threshold

such that “estimated outlier payments equal 5.1 percent of estimated DRG payments.” Id. The

5.1 percent level satisfies the statutory requirement that the predicted outlier payments be

between 5 and 6 percent of the total DRG payments. See Cnty. of Los Angeles, 192 F.3d at 1020.

In order to set the fixed loss threshold such that outlier payments would meet this 5.1 percent

level, it was necessary to model the outlier and DRG payments for the upcoming fiscal year.

Whereas the agency had used a charge inflation methodology through FY 1993, the agency used

a cost inflation methodology for FY 1995 as it had done the previous fiscal year. 9 See 59 Fed.

Reg. at 45,407. In modeling the outlier payments for FY 1994, the agency concluded that a cost

inflation methodology would be more accurate than a charge inflation methodology. 58 Fed.

Reg. 46,270, 46,347 (Sept. 1, 1993). Specifically, the agency reasoned that, because charges

were rising faster than costs and because the cost-to-charge ratios used could be “as much as 2

years old” due to the use of the latest available settled cost reports, a charge inflation

8

The marginal cost factor is not at issue in this litigation.

9

Prior to FY 1994, the agency had used a charge inflation methodology, which involved inflating

a prior year’s charges by the level of charge inflation, and then adjusting those inflated charges to

costs using hospital-specific cost-to-charge ratios. 59 Fed. Reg. at 45,407.

12

methodology could be leading to “overestimating outlier payments in setting the thresholds.” Id.

The agency continued to use the cost inflation methodology in FY 1995 and through FY 2002.

See 68 Fed. Reg. 45,346, 45,476 (Aug. 1, 2003). Under the cost inflation methodology, to

generate a data set of projected costs for FY 1995, the agency first took the FY 1993 charge data

and adjusted the charges by the applicable cost-to-charge ratios. Id. Then the agency inflated

those costs to account for two years of cost inflation. Id. The agency then used this data set to

determine what fixed loss threshold would generate projected outlier payments that were 5.1

percent of the total projected DRG payments for FY 1995.

The final prong of the statutory scheme is that the payments based on the DRG

prospective payment rates—non-outlier payments—are reduced each year by a percentage equal

to the percentage established by the Secretary for outlier payments for that year. See 42 U.S.C.

§ 1395ww(d)(3)(B). This reduction offsets, approximately, the cost of the outlier payments for

each year. Accordingly, for those years where the Secretary set the fixed loss threshold such that

outlier payments were projected to be 5.1 percent of the total DRG-based payments, the

payments based on the DRG prospective payment rates were reduced by 5.1 percent. See 62 Fed.

Reg. 45,966, 46,011 (Aug. 29, 1997) (“Thus, for example, we set outlier thresholds so that the

outlier payments for operating costs are projected to equal 5.1 percent of total DRG operating

payments, and we adjust the operating standardized amounts correspondingly. We do not set

aside a pool of money to fund outlier cases.”). However, there is no guarantee that the actual

total outlier payments will equal the reduction in DRG payments. See Cnty. of Los Angeles, 192

F.3d at 1019-20.

13

Outlier Payments and Fixed Loss Thresholds: FY 1997 through FY 2003

Because Plaintiffs challenge each of the fixed loss thresholds set for FY 1997 through FY

2007, the Court reviews each of the rulemakings in which those thresholds were set. As

explained above, under the Secretary’s interpretation of the statute, which has been upheld by the

United States Court of Appeals for the District of Columbia Circuit, “she must establish the fixed

[loss] thresholds beyond which hospitals will qualify for outlier payments” at the start of each

fiscal year. Cnty. of Los Angeles, 192 F.3d at 1009. For each of these fiscal years, the agency

modeled the expected payments for that upcoming fiscal year and set the fixed loss threshold at a

rate such that the level of outlier payments was predicted to be 5.1 percent of the anticipated total

payments based on the DRG rates, which is within the 5 to 6 percent range of total DRG-based

payments set by the statute. See Cnty. of Los Angeles, 192 F.3d at 1009. As explained in further

detail below, the year 2003 was a critical pivot point in the outlier payment program. Based on

the discovery of abusive charging practices by certain hospitals, the agency set out to change the

rules for outlier payments to curb these abuses, ultimately modifying the regulations governing

outlier payments in a regulation promulgated in June 2003. See Dist. Hosp. Partners, 786 F.3d at

51-52. Accordingly, for the annual fixed loss threshold rulemakings between FY 1997 and FY

2003, the agency applied the outlier payment regulations promulgated in 1988 and in 1994, both

discussed above. For the annual fixed loss threshold rulemakings for FY 2004 through FY 2007,

the agency applied the outlier payment regulations as modified by the June 2003 regulation. The

Court first reviews, briefly, each of the fixed loss threshold rulemakings for FY 1997 through FY

2003. After reviewing the 2003 changes to the outlier payment regulations, the Court turns to the

four challenged fixed loss threshold rulemakings following those changes, for FY 2004 through

FY 2007.

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Fixed Loss Threshold Rulemaking for FY 199710

In a proposed rule published in the Federal Register on May 31, 1996, the agency

proposed a fixed loss threshold of $11,050 and proposed to maintain the marginal cost factor for

cost outliers at 80 percent. 11 61 Fed. Reg. 27,444, 27,495 (May 31, 1996). The agency calculated

the outlier thresholds so that outlier payments were projected to equal 5.1 percent of the total

projected DRG payments. Id. In a final rule promulgated on August 30, 1996, the agency

concluded that a fixed loss threshold of $9,700 was appropriate in order to satisfy the 5.1 percent

projection. See 61 Fed. Reg. 46,166, 46,228 (Aug. 30, 1996). The agency maintained the 80

percent marginal cost factor as proposed. Id. The agency concluded that a $9,700 fixed loss

threshold was appropriate because of updated cost inflation data. Specifically, the agency noted

that “[t]he latest available Medicare cost reports indicate that hospital cost per case decreased

from FY 1993 to FY 1994 as well as from FY 1994 to FY 1995.” Id. The agency concluded that

the data “suggests a continued trend in cost deflation,” whereas the agency had assumed zero

cost inflation in the proposed rule. Id. (emphasis in original). Accordingly, in order to project the

costs and the associated Medicare payments for FY 1997, the agency used a negative annual

inflation factor of 1.906 percent. Id. Specifically, the agency deflated the cost data for 1995 by

1.906 percent, twice, to generate a set of projected cost data for FY 1997. Because of the

10

Pursuant to the 1993 legislation amending the outlier payment program, FY 1997 was the final

year that the outlier program included both day outliers and cost outliers. The Court does not

address certain complexities of the fixed loss threshold calculation for FY 1997 that result from

the relationship of the day outlier provisions and the cost outlier provisions because the parties

have not indicated that any issues result from the inclusion of day outliers in the calculations for

FY 1997.

11

The agency proposed a lower fixed loss threshold of $10,075 for those hospitals that had not

yet entered the Prospective Payment System for capital related costs. See 61 Fed. Reg. at 27,495.

The Court does not discuss the lower thresholds set for such hospitals further because it does not

affect the analysis below, nor do the parties emphasize this distinction.

15

predicted cost deflation, it was necessary to lower the fixed loss threshold, in comparison to the

proposed threshold, so that the outlier payments would be 5.1 percent of the total DRG-based

payments. See id. at 46,228-29.

Fixed Loss Threshold Rulemaking for FY 1998

In a proposed rule issued on June 2, 1997, the agency proposed a fixed loss threshold for

cost outliers of $7,600. See 62 Fed. Reg. 29,902, 29,946 (June 2, 1997). The agency proposed to

maintain the marginal cost factor for cost outliers of 80 percent. Id. Once again, the agency set

the threshold so that the projected outlier payments would be 5.1 percent of the projected total

DRG-based payments. See id. The proposed fixed loss threshold was premised on continued cost

deflation—which the agency derived by analyzing cost data from previous years—and the

agency used an annual cost deflation factor of 1.969 percent to project costs for FY 1998. See id.

In a final rule issued August 29, 1997, the agency selected a fixed loss threshold of $11,050, such

that outlier payments were projected to be 5.1 percent of the projected total DRG-based

payments. 12 62 Fed. Reg. at 46,040. The increase in comparison to the proposed threshold was

due, in part, to amendments to the outlier payment provisions of the statute, which required

adjusting the outlier payment model to account for other factors not relevant to the issues in this

action. 13 Cf. Dist. Hosp. Partners, 786 F.3d at 50, n.1 (noting that these factors were immaterial

12

The agency retained the proposed marginal cost factor of 80 percent. 62 Fed. Reg. at 46,040.

13

Between the issuance of the proposed rule and the issuance of the final rule on August 29,

1997, Congress amended the applicable statutory provision such that the cost outlier threshold

would be “based on ‘the sum of the applicable DRG prospective payment rate plus any amounts

payable under subparagraphs (B) [IME payments] and (F) [DSH payments] plus a fixed dollar

amount determined by the Secretary.’” 62 Fed. Reg. at 46,040 (quoting Balanced Budget, Pub.

Law 105–33, August 5, 1997, 111 Stat. 251). IME payments are for indirect medical education,

and DSH payments are for disproportionate share hospitals. As a result of this change, the

agency no longer adjusted hospital costs to exclude these payments. See id. The IME and DSH

payments themselves are not at issue in this action.

16

to the analysis of challenges to outlier payments). Based on more recent data available at the

time of the promulgation of the final rule, which showed continued declining costs, the agency

used an annual cost inflation factor of minus 2.005 percent. See 62 Fed. Reg. at 46,041.

Accordingly, for FY 1998, the fixed loss threshold was set at $11,050.

Fixed Loss Threshold Rulemaking for FY 1999

In a proposed rule issued on May 8, 1998, the agency proposed a fixed loss threshold for

cost outliers of $11,350. 63 Fed. Reg. 25,576 (May 8, 1998). The agency proposed maintaining

the marginal cost factor of 80 percent. Id. The agency calculated the proposed outlier threshold

so that the projected outlier payments would be 5.1 percent of the total projected DRG-based

payments. Id. As in previous years, these calculations were made using a cost inflation

methodology. See id. at 25,611. In the agency’s proposed rule, the projections were based on an

annual cost inflation factor of minus 1.831 percent. See id. In a final rule promulgated on July

31, 1998, the agency established a fixed loss threshold for FY 1999 of $11,100 and maintained

the marginal cost factor at 80 percent. 63 Fed. Reg. 40,954, 41,008 (July 31, 1998). The agency

continued to use a cost inflation methodology but used an updated cost inflation factor of minus

1.724 percent, which was suggested by the more recent data available at the time of the

promulgation of the final rule. See id. The agency calculated that the projected cost outlier

payments using the fixed loss threshold of $11,100 would be 5.1 percent of the total projected

DRG-based payments. See id.

Fixed Loss Threshold Rulemaking for FY 2000

In a proposed rule issued on May 7, 1999, the agency proposed a fixed loss threshold of

$14,575. 64 Fed. Reg. 24,716, 24,754 (May 7, 1999). The agency also proposed maintaining the

marginal cost factor of 80 percent. Id. The agency calculated the proposed outlier threshold so

17

that the projected outlier payments would be 5.1 percent of the total DRG-based payments. Id.

Once again, these calculations were made using a cost-inflation methodology. See id. For FY

2000, the agency proposed using a zero inflation factor. The use of a zero inflation factor

“reflects [the agency’s] analysis of the best available cost report data as well as calculations

(using the best available data) indicating that the percentage of actual outlier payments for FY

1998, is higher than [] projected before the beginning of FY 1998, and that the percentage of

actual outlier payments for FY 1999 will likely be higher than [] projected before the beginning

of FY 1999.” Id. In a final rule promulgated on July 30, 1999, the agency established a fixed loss

threshold for FY 2000 of $14,050 and maintained the marginal cost factor at 80 percent. 64 Fed.

Reg. 41,490, 41,546 (July 30, 1999). The agency used a zero inflation factor, as proposed,

reflecting the latest cost report data, as well as the relationship of actual outlier payments to the

previously projected outlier payments for FY 1998 and FY 1999, as discussed in the FY 2000

proposed rule. Id. The agency noted that it was “attempting to improve [its] estimate of payments

for FY 2000 by using a cost inflation factor of zero percent rather than a negative inflation

factor,” as the agency had done for several years prior to FY 2000. Id. at 41,547.

Fixed Loss Threshold Rulemaking for FY 2001

In a proposed rule issued on May 5, 2000, the agency proposed a fixed loss threshold of

$17,250. 65 Fed. Reg. 26,282, 26,329 (May 5, 2000). The agency also proposed maintaining the

marginal cost factor of 80 percent. Id. The agency calculated the proposed outlier threshold so

that the projected outlier payments would be 5.1 percent of the total DRG-based payments. Id.

Once again, these calculations were made using a cost-inflation methodology. See id. For FY

2001, the agency proposed using a 1.0 percent inflation factor. The use of a 1.0 percent inflation

factor “reflects [the agency’s] analysis of the best available cost report data as well as

18

calculations (using the best available data) indicating that the percentage of actual outlier

payments for FY 1999, is higher than [] projected before the beginning of FY 1999, and that the

percentage of actual outlier payments for FY 2000 will likely be higher than [] projected before

the beginning of FY 2000.” Id. In a final rule promulgated on August 1, 2000, the agency

established a fixed loss threshold for FY 2001 of $17,550 and maintained the marginal cost

factor at 80 percent. 65 Fed. Reg. 47,054, 47,113 (Aug. 1, 2000). The agency used a 1.8 percent

inflation factor—as opposed to the proposed inflation factor of 1.0 percent—reflecting the latest

cost report data, as well as the relationship of actual outlier payments to the previously projected

outlier payments for FY 1999 and FY 2000, as discussed in the FY 2001 proposed rule. Id.

Fixed Loss Threshold Rulemaking for FY 2002

In a proposed rule issued on May 4, 2001, the agency proposed a fixed loss threshold of

$21,000. 66 Fed. Reg. 22,646, 22,726-27 (May 4, 2001). The agency also proposed maintaining

the marginal cost factor of 80 percent. Id. at 22,727. The agency calculated the proposed outlier

threshold so that the projected outlier payments would be 5.1 percent of the total DRG-based

payments. Id. Once again, these calculations were made using a cost-inflation methodology. See

id. For FY 2002, the agency proposed using a 5.5 percent inflation factor. The use of the 5.5

percent inflation factor “reflects [the agency’s] analysis of the best available cost report data as

well as calculations (using the best available data) indicating that the percentage of actual outlier

payments for FY 2000, is higher than [] projected before the beginning of FY 2000, and that the

percentage of actual outlier payments for FY 2001 will likely be higher than [] projected before

the beginning of FY 2001.” Id. In a final rule promulgated on August 1, 2001, the agency

established a fixed loss threshold for FY 2002 of $21,025 and maintained the marginal cost

factor at 80 percent. 66 Fed. Reg. 39,828, 39,941 (Aug. 1, 2001). The agency used a 2.8 percent

19

inflation factor—as opposed to the proposed inflation factor of 5.5 percent—reflecting the latest

cost report data, as well as the relationship of actual outlier payments to the previously projected

outlier payments for FY 2000 and FY 2001, as discussed in the FY 2002 proposed rule.

Fixed Loss Threshold Rulemaking for FY 2003: Shift from Cost Inflation to Charge Inflation

Methodology

In a proposed rule issued on May 9, 2002, the agency proposed a fixed loss threshold of

$33,450. 67 Fed. Reg. 31,404, 31,510 (May 9, 2002). The agency also proposed maintaining the

marginal cost factor of 80 percent. Id. at 22,727. The agency calculated the proposed outlier

threshold so that the projected outlier payments would be 5.1 percent of the total DRG-based

payments. Id. While these calculations were made using a cost-inflation methodology, the

agency proposed a calculation that differed from those employed in previous years because of

the data that was available at the time of the FY 2003 proposed rule. See id. The agency noted

that, previously, “inflation factors have been calculated by measuring the percent change in costs

using the two most recently available cost report files.” Id. For example, for FY 2002, those were

the FY 1998 and FY 1999 cost reports. Id. However, when the agency was proposing the

threshold for FY 2003, the FY 2000 cost reports were not available because of processing delays.

See id. Therefore, the agency proposed projecting the cost inflation factor by constructing an

averaging model based on the changes to the data available from FY 1995 through FY 1999, the

most recent cost data available. See id. The agency emphasized that this proposal was based on

the unavailability of the FY 2000 data. See id. As a result of the model, the agency proposed

applying a 15 percent cost inflation factor to the FY 2001 data to generate the projected FY 2003

data. See id.

After receiving a significant numbers of comments regarding the methodology proposed

for accounting for inflation—which was proposed in light of the unavailability of the FY 2000

20

cost data—the agency declined to adopt the proposed cost inflation methodology in the final FY

2003 fixed loss threshold regulation. 67 Fed. Reg. 49,982, 50,124 (Aug. 1, 2002). Instead, in the

final rule promulgated on August 1, 2002, the agency adopted a charge inflation methodology.

See id. The agency reasoned that, because of substantial increases in the growth of charges,

which were increasing faster than costs, predicting future payments using a charge inflation

methodology would be more accurate than using a cost inflation methodology. See id.

Accordingly, in order to determine the fixed loss threshold for FY 2003, the agency calculated

the rate of charge inflation from FY 1999 to FY 2000 and from FY 2000 to FY 2001 and applied

this two-year rate of inflation—a total of 17.6398 percent—to the FY 2001 charge data to

generate a set of projected FY 2003 charge data. See id. The agency adjusted these projected

charges to cost for use in modeling outlier payments for FY 2003. See id. Using this charge

inflation methodology, as well as continuing to use a marginal cost factor of 80 percent, the

agency set the fixed loss threshold at $33,560 for FY 2003. See id. With this fixed loss threshold,

the agency predicted that outlier payments would be 5.1 percent of the total DRG-based

payments. See id.

Changes to the Outlier Payment Program in 2003

By 2003, it appeared that the outlier payment system was breaking down. See Dist. Hosp.

Partners, 786 F.3d at 51. In particular, concerns emerged that hospitals “could manipulate the

outlier regulations if their charges were ‘not sufficiently comparable in magnitude to their

costs.’” Id. (quoting 68 Fed. Reg. 10,420, 10,423 (Mar. 5, 2003)). In February 2003, the

Secretary transmitted a draft interim final rule discussing several possible changes to the outlier

21

payment system to the Office of Management and Budget (“OMB”). 14 See AR (2003

amendments) 4417.338. Based on analysis of trends in the cost and charge data, the draft also

would have revised the previously-established fixed loss threshold for FY 2003, lowering it to

$20,760 for discharges occurring between the would-be date of publication of the interim final

rule and the end of FY 2003. See AR (2003 amendments) 4417.376. Specifically, the draft

highlighted 123 hospitals that had rapidly increased their charges between FY 1999 and FY 2001

and whose outlier payments were a disproportionately high percentage of their total DRG

payments. See AR (2003 amendments) 4417.373. However, the Secretary later abandoned this

draft rule and never published it in the Federal Register. See Dist. Hosp. Partners, 786 F.3d at 54,

58.

Instead, on March 5, 2003, the agency published a notice of proposed rulemaking that

proposed several of the same changes to the outlier payment system suggested in the draft

interim final rule. See 68 Fed. Reg. at 10,420. In the notice of proposed rulemaking, the agency

described how a hospital could take advantage of “the time lag between the current charges on a

submitted bill and the cost-to-charge ratio taken from the most recent settled cost report.” Id. at

10,423. As the D.C. Circuit Court of Appeals described in District Hospital Partners, “[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 for which

reimbursement is sought, its cost-to-charge ratio would ‘be too high’ and would ‘overestimate

the hospital’s costs.’” 786 F.3d at 51 (quoting 68 Fed. Reg. at 10,423). Reviewing actual outlier

payments from several previous years, the agency discovered “123 hospitals whose percentage

14

By executive order, agencies taking “significant regulatory action” are required to send OMB

“[t]he text of the draft regulatory action” before publishing that action in the Federal Register.

Exec. Order No. 12,866 § 6(a)(3)(B)(i), 58 Fed. Reg. 51,735 (Sept. 30, 1993).

22

of outlier payments relative to total DRG payments increased by at least 5 percentage points”

from FY 1999 to FY 2001. 68 Fed. Reg. at 10,423. Furthermore, for those 123 hospitals, “the

mean rate of increase in charges was 70 percent.” Id. at 10,424. Yet, cost-to-charge ratios for

these hospitals, which were based upon cost reports from prior periods, declined by only 2

percent.” Id. (emphasis added). While charges were increasing rapidly, the cost-to-charge ratios

did not reflect this change because they were based on earlier time periods. These hospitals, with

rapidly increasing charges, have become called turbo-chargers. Dist. Hosp. Partners, 786 F.3d at

51.

To address these concerns, the agency proposed three changes to the outlier payment

regulations. First, whereas previously the regulations—promulgated in 1988—required using the

most recent settled cost report when determining the cost-to-charge ratios for hospitals, the

agency proposed to use either the tentatively settled cost report or the final settled cost report,

whichever would be from the later cost reporting period. Id. at 10,423-24. Because it can take 12

to 24 months between the tentative settling of a cost report and the final settling of that cost

report, allowing the use of the tentatively settled cost reports would allow more up-to-date data

to be used in determining the outlier payments. See id. at 10,424. Second, the agency proposed

that it would no longer default to statewide average cost-to-charge ratios for hospitals with low

cost-to-charge ratios. See id. Previously the regulations—again, promulgated in 1988—specified

that, for hospitals with extremely high or extremely low cost-to-charge ratios, the statewide

average cost-to-charge ratio would be used in determining outlier payments. See id. The agency

proposed that the statewide average would still be used for hospitals that had not yet filed cost

reports and situations where the hospital-specific cost-to-charge ratios would exceed the upper

threshold, id., which had previously been set at three standard deviations above the mean of the

23

log distribution of cost-to-charge ratios for all hospitals. See 53 Fed. Reg. at 38,507. But for

hospitals that had low cost-to-charge ratios, they would “receive their actual cost-to-charge

ratios, no matter how low their ratios fall.” 68 Fed. Reg. at 10,424. Third, the agency proposed

reconciling outlier payments after settled cost reports were issued. Id. at 10,424-25. The agency

proposed adding a provision to the regulations such that outlier payments would “become subject

to adjustment when hospitals’ cost reports are settled.” Id. at 10,425. Beyond three major

changes, in contrast to the draft interim final rule, the agency did not propose a mid-year

correction for the FY 2003 fixed loss threshold because of uncertainty regarding charging

practices during FY 2003. See id. at 10,426-27.

On June 9, 2003, the agency promulgated a final rule, which included the three major

changes to the outlier payment regime proposed in the March 2003 notice of proposed

rulemaking. See 68 Fed. Reg. 34,494, 34,497-503 (June 9, 2003). First, for all discharges on or

after October 1, 2003, the cost-to-charge ratios would be based on more recent data—based on

tentatively settled cost reports rather than on final settled cost reports. See id. at 34,497-99,

34,515 (codified at 42 C.F.R. § 412.84(i)(1)-(2)). Second, for discharges on or after August 8,

2003, the agency would not default to statewide averages for hospitals with low cost-to-charge

ratios. See id. at 34,500 (codified at 42 C.F.R. §§ 412.84(h) and (i)(1)). Third, for discharges on

or after August 8, 2003, outlier payments would “become subject to adjustment when hospitals’

cost reports coinciding with the discharge are settled.” 15 Id. at 34,504 (codified at 42 C.F.R.

§ 412.84(i)(4)). Finally, consistent with the agency’s suggestion in the notice of proposed

15

For discharges between August 8, 2003, and October 1, 2003, the outlier payments were only

partially subject to reconciliation in light of the fact that the use of tentatively settled cost reports

was not yet in effect. See 42 C.F.R. § 412.525(a)(4); 68 Fed. Reg. at 34,515.

24

rulemaking, the agency concluded that adjusting the fixed loss threshold for the remainder of FY

2003 was not warranted. See id. at 34,506.

Fixed Loss Threshold Rulemakings for FY 2004 through 2007

Plaintiffs challenge four annual fixed loss threshold rules—for FY 2004 through FY

2007—issued after the agency promulgated the 2003 regulations that changed the methodology

for calculating outlier payments. As with the fixed loss thresholds for FY 1997 through FY 2003,

the agency was required to set the fixed loss threshold in order that the projected outlier

payments would be between 5 and 6 percent of the total projected DRG-based payments for the

applicable fiscal years. See Cnty. of Los Angeles, 192 F.3d at 1020. Each of the annual fixed loss

thresholds for FY 2004 through FY 2007 was set using the outlier payment methodology updated

in 2003. In setting each of these thresholds, the agency used a charge inflation methodology,

which had been reintroduced in 2003. For each of these years, the agency set the fixed loss

threshold so as to result in outlier payments being 5.1 percent of total DRG-based payments and,

for each of these years, the agency adopted a marginal cost factor of 80 percent. See 68 Fed. Reg.

45,346, 45,478 (Aug. 1, 2003); 69 Fed. Reg. 48,916, 49,278 (Aug. 11, 2004); 70 Fed. Reg.

47,278, 47,495 (Aug. 12, 2005); 71 Fed. Reg. 47,870, 48,151 (Aug. 18, 2006). However, there

are differences in the setting of each of these fixed loss thresholds, particularly regarding the data

sets that were used to calculate the threshold for each year. The Court, therefore, reviews how the

fixed loss threshold was set for each of these fiscal years.

Fixed Loss Threshold Rulemaking for FY 2004

In a proposed rule issued May 19, 2003, the agency proposed setting the fixed loss

threshold for FY 2004 at $50,645. 68 Fed. Reg. 27,154, 27,235 (May 19, 2003). The agency

proposed using a charge inflation rate of 12.8083 percent annually (27.3 percent over two years).

25

Id. The agency also proposed maintaining the marginal cost factor at 80 percent. Id. Notably this

proposed rule was published prior to the promulgation of the revised outlier payment

regulations—finalized on June 9, 2003—and therefore used the methodology that was in place

before the 2003 changes to the outlier payment regulations. See id. In issuing the proposed fixed

loss threshold rule, the agency noted that “any final rule subsequent to the March 5, 2003

proposed rule that implements changes to the outlier payment methodology is likely to affect

how we will calculate the final FY 2004 outlier threshold.” Id. The agency further noted that “the

final FY 2004 threshold is likely to be different from this proposed threshold, as a result of any

changes subsequent to the March 5, 2003 proposed rule.” Id.

The final fixed loss threshold rule for FY 2004 was issued on August 1, 2003—two

months after the changes to the outlier payment regulations were promulgated. 68 Fed. at 45,346.

The final fixed loss threshold rule took account of the revised outlier payment regulations, which

would govern outlier payments for discharges occurring in FY 2004 and beyond. See id.

Specifically, using the charge inflation methodology that the agency had re-introduced in the FY

2003 rulemaking, the agency used charge data from 2002 and inflated it by a two-year charge

inflation rate to project charges for FY 2004. Id. The agency used “the 2-year average annual rate

of change in charges per case,” from FY 2000 to FY 2001 and from FY 2001 to FY 2002, which

was 12.5978 percent annually (or 26.8 percent over two years). Id. To calculate projected costs

for FY 2004, the agency adjusted the projected charges by hospital-specific cost-to-charge ratios.

In doing so, the agency implemented changes introduced by the 2003 revisions to the outlier

payment regulations. First, the agency adjusted its methodology to use more recent data to

generate the cost-to-charge ratios because, in issuing the outlier payments for FY 2004, the latest

tentatively settled cost reports would be used rather than the latest settled cost reports. See id.

26

Therefore, whereas the agency had previously used cost-to-charge ratios from the Provider

Specific File to calculate the fixed loss threshold, the agency instead “matched charges-per-case

to costs-per-case from the most recent cost reporting year” and “then divided each hospital’s

costs by its charges to calculate the cost-to-charge ratio for each hospital.” Id. Second, whereas

previously the agency had used a statewide average cost-to-charge ratio for hospitals with low

cost-to-charge ratios, the revised outlier payment regulations specified that the hospital-specific

cost-to-charge ratio would be used “no matter how low their ratios actually fall.” Id. The agency

used the resultant hospital-specific cost-to-charge ratios to adjust the projected FY 2004 charges

to costs for that fiscal year. See id.

The final change introduced by the 2003 outlier payment regulations was that outlier

payments would become subject to reconciliation “at the time of cost report final settlement if 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.” Id. The agency noted that it

was “difficult to project which hospitals will be subject to reconciliation of their outlier payments

using available data.” Id. The agency also noted that “resources necessary to undertake

reconciliation will ultimately influence the number of hospitals reconciled.” Id. For all of those

reasons, it was “difficult to predict the number of hospitals that [would] be reconciled.”

Nonetheless, based on previous data, the agency “identified approximately 50 hospitals [it]

believe[d] will be reconciled.” Id. For these hospitals, the agency attempted to integrate the

effects of reconciliation in the predictive model for FY 2004 by using a modified methodology

for projecting outlier payments for FY 2004. See id. at 45,476-77. Using this revised

methodology, in light of the changes to the outlier payment regulations in 2003, the agency

established a fixed loss outlier of $31,000. Id. at 45,477.

27

Fixed Loss Threshold Rulemaking for FY 2005

In a proposed rule issued May 18, 2004, the agency proposed a fixed loss threshold of

$35,085. 69 Fed. Reg. 28,196, 28,376 (May 18, 2004). To arrive at this proposed threshold, the

agency once again used a charge inflation methodology. The agency took FY 2003 charge data

and inflated it two years—based on the two-year average annual rate of change in charges from

FY 2001 to FY 2002 and FY 2002 to FY 2003, which was 14.5083 percent annually. See id.

Pursuant to the 2003 changes to the outlier payment regulations, the agency then used hospital-

specific cost-to-charge ratios that reflected the most recent settled or the most recent tentatively

settled cost reports, whichever was more recent, for each hospital. See id. In proposing this

threshold, the agency acknowledged that the inflation data “derive[d] from the years just prior to

the adoption of the policy changes, when some hospitals were increasing charges at a rapid rate

in order to increase their outlier payments.” Id. As a result, the agency noted that they “represent

rates of increase that may be higher than the rates of increase under our new policy.” Id.

Accordingly, the agency welcomed suggestions that might enable predictions that “better reflect

current trends in charge increases.” Id.

Given these concerns, as well as comments received in response to the proposed rule, the

agency adjusted the methodology for predicting FY 2005 data in order to set the final FY 2005

fixed loss threshold. See 69 Fed. Reg. at 49,277. In the final rule promulgated on August 11,

2004, the agency used the FY 2003 charge data as a baseline. Id. To derive an inflation factor, the

agency took the “unprecedented step of using the first half-year of data from FY 2003 and

comparing this data to the first half year of FY 2004.” Id. The agency concluded that “this

comparison will result in a more accurate determination of the rate of change in charges per case

between FY 2003 and FY 2005.” Id. Using this data, the agency calculated a one-year annual rate

of charge inflation of 8.9772, or 18.76 percent over two years, and then inflated the FY 2003 data

28

by this two-year charge inflation figure. Id. The agency then converted the projected charge data

to costs using hospital-specific cost-to-charge ratios from the April 2004 update of the Provider

Specific File. Id. As with the calculation of the cost-to-charge ratios for the setting of the FY

2004 fixed loss threshold, this analysis incorporated the changes introduced by the 2003

revisions to the outlier payment regulations, specifically the use of tentatively settled cost reports

and the use of hospital-specific ratios even for hospitals with extremely low cost-to-charge ratios.

See id. However, unlike the FY 2004 fixed loss threshold calculation, the agency did not change

its methodology to explicitly account for the possibility of reconciliation in setting the FY 2005

threshold. See id. at 49,278. The agency concluded that “due to changes in hospital charging

practices following implementation of the new outlier regulations in the June 9, 2003 final rule,

the majority of hospitals’ cost-to-charge ratios will not fluctuate significantly enough between

the tentatively settled cost report and the final settled cost report to meet the criteria to trigger

reconciliation of their outlier payments.” Id. Moreover, the agency noted that it would be

“difficult to predict which specific hospitals may be subject to reconciliation in any given year.”

Id. Using this methodology, the agency established a fixed loss threshold of $25,800 for FY

2005. Id.

Fixed Loss Threshold Rulemaking for FY 2006

In a proposed rule issued May 4, 2005, the agency proposed a fixed loss threshold of

$26,675. 70 Fed. Reg. 23,306, 23,469 (May 4, 2005). In order to account for changes in the rate

of charge inflation, the agency generated projected data for FY 2006 using FY 2004 charge data

as a baseline. See id. The agency calculated the rate of charge inflation from the combination of

the last quarter of FY 2003 and the first quarter of FY 2004 to the combination of the last quarter

of FY 2004 and the first quarter of FY 2005. See id. For this period, the agency calculated an

29

annual rate of charge inflation of 8.65 percent, or 18.04 percent over two years. See id. The

agency then inflated the FY 2004 charge data by this two-year inflation factor. See id. To derive

projected cost data, the agency adjusted the projected charge data by the hospital-specific charge

ratios from the most recent update to the Provider Specific File (for December 2004), which

reflected the 2003 changes to the outlier payment regulations. See id.

For the final rule, promulgated August 12, 2005, the agency calculated the FY 2006 fixed

loss threshold “using the methodology proposed in the proposed rule, but using updated data.” 70

Fed. Reg. at 47,494. Specifically, the agency calculated a charge inflation factor based on a

comparison between the first six months of FY 2004 and the first six months of FY 2005. Id.

Using this data, the agency calculated a two-year charge inflation factor of 14.94 percent. Id. The

agency used this inflation factor to inflate charges from FY 2004, id. at 47,495, and then adjusted

the projected charges to projected costs using hospital-specific cost-to-charge ratios from the

March 2005 update of the Provider Specific File, which included cost-to-charge ratios based on

the most recent tentatively settled cost reports, id. at 47,494. Just as in calculating the FY 2005

fixed loss threshold, the agency did not adjust its methodology to explicitly account for

reconciliation in establishing the FY 2006 threshold. Id. at 47,495. Based on this methodology,

the agency established a fixed loss threshold of $23,600. Id.

Fixed Loss Threshold Rulemaking for FY 2007

In a proposed rule issued on April 25, 2006, the agency proposed a fixed loss threshold of

$25,530. 71 Fed. Reg. 23,996, 24,150 (Apr. 25, 2006). The agency proposed to use the same

methodology to calculate the fixed loss threshold as it had in the past. Specifically, it proposed to

inflate FY 2005 charge data by two years of charge inflation. Id. at 24,149. The agency

calculated the rate of charge inflation by calculating the one-year average annual rate of change

30

from the combination of the last quarter of FY 2004 with the first quarter of FY 2005 to the

combination of the last quarter of FY 2005 with the first quarter of FY 2006. Id. at 24,149-50.

For this period, the agency calculated a one-year inflation rate of 7.57 percent, or 15.15 percent

over two years. Id. at 24,150. The agency inflated the FY 2005 charge data by this two-year rate

and then adjusted it to cost using the hospital-specific cost-to-charge ratios from the most recent

update to the Provider Specific File. Id.

For the final rule, promulgated on August 18, 2006, the agency calculated the FY 2007

fixed loss threshold “using the same methodology [] proposed, except [] using more recent data

to determine the charge inflation factor.” 71 Fed. Reg. at 48,150. In addition, however, the

agency also “appl[ied] an adjustment factor to the [cost-to-charge ratios] to account for cost and

charge inflation.” Id. Specifically, the agency calculated a charge inflation factor based on a

comparison between the first six months of FY 2005 and the first six months of FY 2006. Id.

Using this data, the agency calculated a two-year charge inflation factor of 16.42 percent. Id. The

agency used this inflation factor to inflate charges from FY 2005. Id. As in previous years, the

agency used hospital-specific cost-to-charge ratios to adjust the projected FY 2007 charges to

cost. Id. However, in response to comments submitted, the agency agreed “that it is appropriate

to apply an adjustment factor to the [cost-to-charge ratios] so that the [cost-to-charge ratios] we

are using in our simulation more closely reflect the [cost-to-charge ratios] that will be used in FY

2007.” Id. The agency calculated the ratio between the one-year change in costs and the one-year

change in charges, and derived an adjustment factor of 0.9973. Id. The agency applied this

adjustment factor to the cost-to-charge ratios contained in the Provider Specific File, which itself

was based on the most recent tentatively settled cost reports. Id. The agency then used these

adjusted cost-to-charge ratios to adjust the projected FY 2007 charges, generating projected FY

31

2007 costs. See id. Finally, just as in calculating the FY 2005 and FY 2006 fixed loss thresholds,

the agency did not adjust its methodology to explicitly account for reconciliation in establishing

the FY 2007 threshold. Id. at 48,149. Following this methodology, the agency adopted a tentative

fixed loss threshold of $24,475. Id. at 48,151. 16

* * *

In sum, for each fiscal year between 1997 and 2007, the Secretary determined the fixed

loss threshold, a fixed dollar amount that, when added to the DRG prospective payment rate,

serves as the cutoff point triggering eligibility for outlier payments. See 42 U.S.C.

§ 1395ww(d)(5)(A)(ii), (iv); 42 C.F.R. § 412.80(a)(2)-(3). When a hospital’s approximate costs

actually incurred in treating a patient exceed the sum of the DRG prospective payment rate

applicable to that patient and the fixed loss threshold, the hospital would be eligible for an outlier

payment in that case. See 42 U.S.C. § 1395ww(d)(5)(A)(ii)-(iii); 42 C.F.R. § 412.80(a)(2)-(3). In

this way, the fixed loss threshold represents the dollar amount of loss that a hospital must absorb

16

The agency adopted the actual final dollar amount in a subsequent rule. See 71 Fed. Reg. at

48,151. As the agency explained in full:

[T]he wage index tables, rates, and impacts will not be final in this final rule

because we are yet to determine occupational mix adjusted wage indices.

Therefore, we are only able to provide tentative standardized amounts, relative

weights, offsets, and budget neutrality factors in this final rule. Once we have the

final occupational mix data, we will recalculate these amounts to reflect the final

occupational mix adjusted wage indices. The same circumstances apply to the

outlier threshold. Without final wage index data, final standardized amounts, final

offsets and final budget neutrality factors, we are only able to provide a tentative

fixed loss outlier threshold in this final rule. Subsequent to this final rule, we will

publish a final fixed loss outlier threshold that will be effective for discharges on

and after October 1, 2006 for FY 2007. However, in this final rule, we are

adopting as final the methodology we will use to calculate the final outlier fixed-

loss cost threshold.

Id. at 48,149. Although the final fixed loss threshold was set at a later time, the

methodology, which is at issue in this case, was final as of the promulgation of the

August 2006 regulation.

32

in any case in which the hospital incurs estimated actual costs for treating a patient that are above

the DRG prospective payment rate. The amount of the outlier payment is “determined by the

Secretary” and must “approximate the marginal cost of care” beyond the fixed loss threshold. 42

U.S.C. § 1395ww(d)(5)(A)(iii). During the time period relevant to this action, the implementing

regulations generally provided for outlier payments equal to eighty percent of the difference

between the hospital’s estimated operating and capital costs and the fixed loss threshold. See 42

C.F.R. § 412.84(k). Accordingly, an increase in the fixed loss threshold reduces the number of

cases that will qualify for outlier payments, as well as the amounts of such payments for

qualifying cases. In light of this scheme, Plaintiffs challenge the rulemakings revising the outlier

payment regulations and the annual fixed loss threshold rulemakings that are applicable to the

payment determinations—for FY 1997 through FY 2007—that are challenged in this action.

B. Procedural Background

The procedural history is long and complex, and the Court limits its presentation of the

procedural history to the relevant facts for resolving the motions before the Court. Additional

procedural history can be found in the Court’s previous opinions in this case. See Banner Health

v. Sebelius (“Banner Health I”), 797 F. Supp. 2d 97 (D.D.C. 2011); Banner Health v. Sebelius

(“Banner Health II”), 905 F. Supp. 2d 174 (D.D.C. 2012); Banner Health v. Sebelius (“Banner

Health III”), 945 F. Supp. 2d 1 (D.D.C. 2013).

Plaintiffs in this case challenge outlier payment determinations for fiscal years 1997

through 2007. As required by statute, Plaintiffs filed various appeals with the Provider

Reimbursement Review Board (“PRRB”), each challenging the Secretary’s final outlier payment

determinations for the fiscal years in question, and Plaintiffs requested expedited judicial review

in those appeals. All but two of Plaintiffs’ requests for expedited judicial review were made in a

33

consolidated filing dated June 25, 2010. See PRRB Rs. at 27, 172, 428, 647, 980, 1304, 1771,

2410, 2831, 3125, 3556, 4091, 4594, 5037, 5383. Two additional requests were filed, on June 25,

2010, and on September 7, 2011, that were subsequently consolidated in this action. See PRRB

Rs. at 5633; PRRB R. (Case No. 11-0026) at 211. The June 25, 2010, request identified the legal

question at issue as follows:

Whether the Medicare Outlier Regulations, and the “fixed loss thresholds”

thereunder established by the Secretary of Health and Human Services (the

“Secretary”), and its Center for Medicare and Medicaid Services (“CMS”) and as

in effect for the Appealed Years, are substantively and/or procedurally invalid?

PRRB Rs. at 29. The legal requests presented in the two other separate requests for expedited

review did not differ in any substantive matter from the consolidated request. See PRRB Rs. at

5633; PRRB R. (Case No. 11-0026) at 211. Because Plaintiffs’ administrative appeals called into

question the underlying validity of regulations promulgated by the Secretary, the PRRB

determined that it was without authority to resolve the matters raised and authorized expedited

judicial review pursuant to 42 U.S.C. § 1395oo(f)(1). See PRRB Rs. at 1-3; PRRB R. (Case No.

11-0026) at 208-10.

Plaintiffs commenced this action on September 27, 2010, claiming that this Court has

jurisdiction under the Medicare Act, 42 U.S.C. § 1395oo(f)(1), and the Mandamus Act, 28

U.S.C. § 1361. See Compl., ECF No. 1. On December 23, 2010, Plaintiffs filed an Amended

Complaint as a matter of right, which remains the operative iteration of the Complaint in this

action (with a minor exception discussed below). See Am. Compl., ECF No. 16. As this Court

has previously observed, Plaintiffs’ Amended Complaint was “sprawling,” containing over two

hundred paragraphs, spanning fifty-nine pages, and including two lengthy exhibits. See Banner

Health III, 945 F. Supp. 2d at 9-10. On January 28, 2011, the Secretary filed a motion to dismiss

Plaintiffs’ Amended Complaint, which this Court granted in part and denied in part. See Banner

34

Health I, 797 F. Supp. 2d at 97. Specifically, the Court first concluded that Plaintiffs’ allegations

were sufficient, for the pleading stage, to establish their standing to challenge the several actions

at issue in this case. See id. at 109. The Court noted that this conclusion was not intended to

foreclose the Secretary from raising standing arguments upon filing motions for summary

judgment, after the record had been developed. See id. However, the Court dismissed—for

failure to state a plausible claim for relief—Plaintiffs’ claims seeking payments under the

Mandamus Act, 28 U.S.C. § 1361, as well as Plaintiffs’ claims under the Medicare Act to the

extent that such claims relied on vague allegations challenging the Secretary’s “implementation”

and “enforcement” of the outlier payment system that are “unconnected to any discrete agency

action.” See id. at 118. The Court otherwise denied the Secretary’s motion to dismiss. Looking

forward, the Court concluded that, in light of the extraordinary breadth of the allegations in the

Amended Complaint, proceeding immediately to the filing of the administrative record and the

subsequent briefing of motions for summary judgment would not be the most expeditious

manner of proceeding in the action. Rather, in order to gain further clarity as to the precise

contours of Plaintiffs’ claims, the Court ordered Plaintiffs to file a “notice of claims,”

identifying, in bullet-point format, each circumscribed, discrete agency action that Plaintiffs

intended to challenge. Id. at 117-18.

On July 27, 2011, Plaintiffs filed their Notice of Claims, which enumerated the claims

Plaintiffs were bringing in this action. Plaintiffs’ Notice of Claims likewise listed among the

challenged agency actions “the Secretary’s directions, starting in late 2002, to CMS’s fiscal

intermediaries to reopen hospital cost reports only for purposes of reconciling and recovering

outlier overpayments, but not for purposes of reconciling and recovering outlier underpayments,

as set forth in the Secretary’s issuance, through CMS, of Program Memorandum A–02–122

35

(December 3, 2002), Program Memorandum A–02–126 (December 20, 2002), Program

Memorandum A–03–058 (July 3, 2003)[, and] Transmittal 707 (Medicare Claims Processing

Manual, Chapter 3, § 20.1.2.5(A)).” However, on November 26, 2012, the Court granted the

Secretary’s motion to dismiss all claims premised on this agency action because, among other

reasons, Plaintiffs failed to rebut the Secretary’s well-reasoned jurisdictional arguments and in

fact expressly disclaimed any intent to bring a direct challenge to reopening determinations or

instructions as such. See Banner Health I, 797 F. Supp. 2d at 97; Banner Health II, 905 F. Supp.

2d at 174. The Court held it would not allow Plaintiffs to achieve supplementation of the

administrative record by injecting the action with ill-defined claims, but rather, whether the

administrative record should be supplemented to include the CMS documents was a question

more appropriately addressed in the context of the Court’s consideration of Plaintiffs’ motion to

compel. Id. In light of the Notice of Claims, in addition to the outlier payment determinations

specific to each of the hospital plaintiffs, the remaining claims in this action may be succinctly

summarized as challenging the promulgation and implementation of the following agency

actions: three rulemakings revising the outlier payment regulations, which were promulgated in

1988, 1994, and 2003; and eleven rulemakings establishing the annual fixed loss threshold for

federal fiscal years 1997 through 2007. See Banner Health III, 945 F. Supp. 2d at 13.

After Plaintiffs filed their Notice of Claims, the Court ordered the Secretary to file the

complete administrative record—which did not include any record relating to Plaintiffs’

dismissed claims regarding the four directives issued by CMS—by December 14, 2011. See

Scheduling and Procedures Order (Aug. 19, 2011), ECF No. 29. The Secretary filed the

administrative records for the fourteen challenged agency actions on November 8, 2011,

November 23, 2011, December 14, 2011, and December 28, 2011. See Banner Health III, 945 F.

36

Supp. 2d at 13 (citing ECF filings). 17 On January 6, 2012, the Secretary supplemented these

productions with additional data in electronic form after the Court entered a protective order

pertaining to such data. All together, the administrative records filed by the Secretary constitute

over 10,000 pages of documents, as well as tens of thousands of megabytes of electronic data

that have been produced to Plaintiffs.

On February 22, 2012, Plaintiffs filed a motion to compel, challenging the completeness

of the administrative record, Pls.’ Mot. to Compel Def. to File the Complete Administrative R.

and to Certify Same, ECF No. 52, which the Court dismissed without prejudice to renew, in light

of the Secretary’s represented intent to file supplements to the record. See Min. Order (Feb. 24,

2012). The Secretary subsequently filed two additional supplements. See Def.’s Notice of Filing

Supplements to Admin. R., ECF No. 57; Def.’s Notice of Filing Supplements to Admin. R., ECF

No. 58; see also Def.’s Notice of Filing Certified Copies of Previously Filed Supplements to

Admin. R., ECF No. 59.

On March 23, 2012, Plaintiffs filed a renewed motion to compel, requesting that the

Court order the Secretary to file the “complete administrative record,” by supplementing the

records she had previously filed with various documents, including certain data files identified

by Plaintiffs and all other documents that were before the agency in connection with its

rulemakings, and further requesting that the Court order the Secretary to certify to the Court and

Plaintiffs that the administrative record is complete. See Pls.’ Mem. of P. & A. in Supp. of

Renewed Mot. to Compel Def. to File the Complete Admin. R. and to Certify Same, ECF No. 60,

at 37. After the filing of several supplements by the parties, the Court granted in part and denied

17

The Secretary also filed the records of Plaintiffs’ proceedings before the PRRB. See Banner

Health III, 945 F. Supp. at 13 n.14.

37

in part the motion. See Banner Health III, 945 F. Supp. 2d at 39. The Court granted the motion

and ordered supplementation with respect to all or part of eight of the 36 discrete items subject to

Plaintiffs’ motion.18 See id. at 24-39. The Court denied Plaintiffs’ motion in all other respects.

See id.

After the Secretary filed the required supplementation of the Administrative record, the

Court granted the Secretary’s [99] Motion for Leave to File Motion to Dismiss for Lack of

Subject Matter Jurisdiction. However, instead of allowing Defendant to file the motion

separately, the Court ordered Defendant to file the motion simultaneously and, in the alternative

to, its motion for summary judgment. See Order and Docket Entry, dated August 13, 3013, ECF

No. 102. On July 7, 2014, the Court granted in part and denied in part Plaintiffs’ [108] Motion

for Leave to Further Amend and Supplement First Amended Complaint. Specifically, the Court

denied Plaintiffs’ request to include claims that the Secretary’s failure to disclose the draft 2003

interim final rule violated 5 U.S.C. § 553, but granted Plaintiffs’ request to amend their

Complaint to include factual allegations concerning the draft interim final rule. See Banner

Health v. Burwell, 55 F. Supp. 3d 1, 3 (D.D.C. 2014). Specifically, the Court allowed Plaintiffs to

18

Specifically, the Court ordered supplementation regarding the following items: the 2003 draft

interim final rule (item 1), Banner Health III, 945 F. Supp. at 27; the Impact Files relating to the

1988 and 2003 amendments to the outlier payment regulations, including the underlying

assumptions and associated data (items 14 and 15), id. at 33-34; Tables 8a and 8b for the fixed

loss threshold regulations for FY 1997 through FY 2007 (item 16), id. at 34; letters from the

Medicare Payment Advisory Commission and the American Hospital Association relating to the

FY 2004 fixed loss threshold determination (items 22 and 24), id. at 35; the April 22, 2002 Joint

Letter from CMS’ Center for Medicare Management, Office of Financial Management to the

fiscal intermediaries (item 26), id. at 37-38; and Program Memoranda A-02-122 and A-02-126

(item 33), id. Subsequently, the Court granted in part and denied in part the Secretary’s Motion

for Reconsideration, ECF No. 93. See Mem. Order, dated July 30, 2013, ECF No. 96. The Court

granted the motion with respect to the cost-to-charge data underlying the Impact Files and

vacated the previous order to supplement the record with the source data for those files. See id. at

19. In all other respects, the Court denied the Motion for Reconsideration and did not disturb its

previous decisions regarding the supplementation of the administrative record. See id. at 20.

38

amend their Complaint to include the allegations contained in sub-paragraphs 198.5(a)-(e) of

their Proposed Amendments. See id. at 14.

On September 9, 2014, Defendant filed her [126] Motion to Dismiss for Lack of Subject

Matter Jurisdiction and for Summary Judgment, and Plaintiffs filed their [127] Motion for

Summary Judgment. That same day, Plaintiffs also filed their [128] Motion (Related to Their

Motion For Summary Judgment) for Judicial Notice and/or for Extra-Record Consideration of

Documents and Other Related Relief. The parties briefed these motions and both, subsequently,

filed notices of supplemental authority. These motions are now ripe for resolution.

II. LEGAL STANDARD

Judicial review of Plaintiffs’ claims under the Medicare Act rests on 42 U.S.C.

§ 1395oo(f)(1), which incorporates the APA. See 42 U.S.C. § 1395oo(f)(1) (“Such action[s] …

shall be tried pursuant to the applicable provisions under chapter 7 of Title 5.”); see also

Abington Crest Nursing & Rehab. Ctr. v. Sebelius, 575 F.3d 717, 719 (D.C. Cir. 2009).

A. Supplementation of the Record

The Administrative Procedure Act directs the Court to “review the whole record or those

parts of it cited by a party.” 5 U.S.C. § 706. This requires the Court to review “the full

administrative record that was before the Secretary at the time he made his decision.” Citizens to

Preserve Overton Park v. Volpe, 401 U.S. 402, 420 (1971), abrogated on other grounds by

Califano v. Sanders, 430 U.S. 99 (1977). Courts in this Circuit have “interpreted the ‘whole

record’ to include all documents and materials that the agency directly or indirectly considered

… [and nothing] more nor less.” Pac. Shores Subdivision, Cal. Water Dist. v. U.S. Army Corps of

Eng’rs, 448 F. Supp. 2d 1, 4 (D.D.C. 2006) (citation omitted). “In other words, the administrative

record ‘should not include materials that were not considered by agency decisionmakers.’” Id.

39

(citation omitted). “[A]bsent clear evidence, an agency is entitled to a strong presumption of

regularity, that it properly designated the administrative record.” Id. at 5.

“Supplementation of the administrative record is the exception, not the rule.” Pac.

Shores, 448 F. Supp. 2d at 5 (quoting Motor & Equip. Mfrs. Ass’n, Inc. v. EPA, 627 F.2d 1095,

1105 (D.C. Cir. 1979)); Franks v. Salazar, 751 F. Supp. 2d 62, 67 (D.D.C. 2010) (“A court that

orders an administrative agency to supplement the record of its decision is a rare bird.”). This is

because “an agency is entitled to a strong presumption of regularity, that it properly designated

the administrative record.” Pac. Shores, 448 F. Supp. 2d at 5. “The rationale for this rule derives

from a commonsense understanding of the court’s functional role in the administrative state[:]

‘Were courts cavalierly to supplement the record, they would be tempted to second-guess agency

decisions in the belief that they were better informed than the administrators empowered by

Congress and appointed by the President.’ ” Amfac Resorts, L.L.C. v. Dep’t of Interior, 143 F.

Supp. 2d 7, 11 (D.D.C. 2001) (quoting San Luis Obispo Mothers for Peace v. Nuclear

Regulatory Comm’n, 751 F.2d 1287, 1325-26 (D.C. Cir. 1984)). However, an agency “may not

skew the record by excluding unfavorable information but must produce the full record that was

before the agency at the time the decision was made.” Blue Ocean Inst. v. Gutierrez, 503 F. Supp.

2d 366, 369 (D.D.C. 2007). The agency may not exclude information from the record simply

because it did not “rely” on the excluded information in its final decision. Maritel, Inc. v. Collins,

422 F. Supp. 2d 188, 196 (D.D.C. 2006). Rather, “a complete administrative record should

include all materials that might have influenced the agency’s decision[.]” Amfac Resorts, 143 F.

Supp. 2d at 12 (citations omitted). “[W]hile it is true that data and analysis compiled by

subordinates may be properly part of the administrative record despite not having actually passed

before the eyes of the Secretary,” to be included in the Administrative Record, “the data or

40

analysis must be sufficiently integral to the final analysis that was considered by the [agency],

and the [agency’s] reliance thereon sufficiently heavy, so as to suggest that the decisionmaker

constructively considered it.” Banner Health III, 945 F. Supp. 2d at 28.

B. Motion to Dismiss for Lack of Subject Matter Jurisdiction

Federal Rule of Civil Procedure 12(h)(3) provides that “[i]f the court determines at any

time that it lacks subject-matter jurisdiction, the court must dismiss the action.” Fed. R. Civ. P.

12(h)(3). In assessing its jurisdiction over the subject matter of the claims presented, a court

“must accept as true all of the factual allegations contained in the complaint” and draw all

reasonable inferences in favor of the plaintiff, Brown v. District of Columbia, 514 F.3d 1279,

1283 (D.C. Cir. 2008) (internal quotation marks omitted), but courts are “not required … to

accept inferences unsupported by the facts alleged or legal conclusions that are cast as factual

allegations.” Rann v. Chao, 154 F. Supp. 2d 61, 64 (D.D.C. 2001). Ultimately, the plaintiff bears

the burden of establishing the Court’s subject matter jurisdiction, Arpaio v. Obama, No. 14-5325,

2015 WL 4772774, at *5 (D.C. Cir. Aug. 14, 2015), and where subject-matter jurisdiction does

not exist, “the court cannot proceed at all in any cause.” Steel Co. v. Citizens for a Better Env’t,

523 U.S. 83, 94 (1998).

C. Motions for Summary Judgment

Under Rule 56(a) of the Federal Rules of Civil Procedure, “[t]he court shall grant

summary judgment if the movant shows that there is no genuine dispute as to any material fact

and the movant is entitled to judgment as a matter of law.” However, “when a party seeks review

of agency action under the APA [before a district court], the district judge sits as an appellate

tribunal. The ‘entire case’ on review is a question of law.” Am. Bioscience, Inc. v. Thompson, 269

F.3d 1077, 1083 (D.C. Cir. 2001). Accordingly, “the standard set forth in Rule 56[ ] does not

41

apply because of the limited role of a court in reviewing the administrative record.... Summary

judgment is [ ] the mechanism for deciding whether as a matter of law the agency action is

supported by the administrative record and is otherwise consistent with the APA standard of

review.” Southeast Conference v. Vilsack, 684 F. Supp. 2d 135, 142 (D.D.C. 2010).

The APA “sets forth the full extent of judicial authority to review executive agency

action for procedural correctness.” FCC v. Fox Television Stations, Inc., 556 U.S. 502, 513

(2009). It requires courts to “hold unlawful and set aside agency action, findings, and

conclusions” that are “arbitrary, capricious, an abuse of discretion, or otherwise not in

accordance with law.” 5 U.S.C. § 706(2)(A). “This is a ‘narrow’ standard of review as courts

defer to the agency’s expertise.” Ctr. for Food Safety v. Salazar, 898 F. Supp. 2d 130, 138

(D.D.C. 2012) (quoting Motor Vehicle Mfrs. Ass’n of U.S., Inc. v. State Farm Mut. Auto. Ins. Co.,

463 U.S. 29, 43 (1983)). An agency is required to “examine the relevant data and articulate a

satisfactory explanation for its action including a rational connection between the facts found and

the choice made.” Motor Vehicle Mfrs. Ass’n, 463 U.S. at 43 (internal quotation omitted).

“Moreover, an agency cannot ‘fail[ ] to consider an important aspect of the problem’ or ‘offer[ ]

an explanation for its decision that runs counter to the evidence’ before it.” Dist. Hosp. Partners,

786 F.3d at 57 (quoting Motor Vehicle Mfrs. Ass’n, 463 U.S. at 43). The reviewing court “is not

to substitute its judgment for that of the agency.” Id. Nevertheless, a decision that is not fully

explained may be upheld “if the agency’s path may reasonably be discerned.” Bowman Transp.,

Inc. v. Arkansas–Best Freight Sys., Inc., 419 U.S. 281, 286 (1974).

III. DISCUSSION

This action entails Plaintiffs’ challenges to 14 rulemakings, three rulemakings revising

the outlier payment regulations and 11 annual fixed loss threshold rulemakings. The parties filed

42

cross-motions for summary judgment, and Defendant moved to dismiss for lack of subject matter

jurisdiction with respect to certain claims. In addition, Plaintiffs moved the Court to take judicial

notice and/or extra-record consideration of certain other materials, as well as specified other

relief. The Court begins by considering Plaintiffs’ motion requesting the consideration of

additional materials because the resolution of that motion determines the scope of the materials

examined with respect to the other motions resolved today. The Court then turns to Defendant’s

arguments that this Court lacks subject matter jurisdiction over certain claims. Finally, having

resolved those issues, the Court addresses the cross-motions for summary judgment and resolves

the merits of this dispute.

A. Plaintiffs’ Motion Regarding Consideration of Additional Materials

On the same date that the parties filed their dispositive cross-motions—on the deadline

previously set by the Court for those cross-motions, see Scheduling and Procedures Order, ECF

No. 122—Plaintiffs filed a motion asking the Court to consider additional materials in resolving

the cross-motions filed that day. Plaintiffs asked the Court (1) to take judicial notice of six

identified documents, or in the alternative to consider them as extra-record materials, (2) to

supplement the administrative record with a comment to the FY 2004 fixed loss threshold

rulemaking, and (3) to “receive” three tables as demonstrative exhibits that exceed the allowed

page limits set by the Court for the briefing. Defendant opposes each of these requests.

As an initial matter, the Court notes that it considers this request to be tardy. Asking the

Court for permission to consider additional materials on the very day on which the dispositive

motions are filed is simply too late. Doing so meant that Plaintiffs precluded Defendant from

effectively objecting to the inclusion of these materials before Plaintiffs relied on them in their

briefing. At the same time, by waiting until the last moment to present these materials, Defendant

43

was prevented from being able to rely on them in her initial briefing. To say that Defendant could

file an opposition to this motion after the fact and could respond to the proposed materials in the

subsequent briefing is no answer at all. The orderly management of this litigation requires the

resolution of questions regarding the materials on which the parties may rely—and on which the

Court will base its ultimate decision—before the submission of the parties’ arguments regarding

the merits. Last minute surprises regarding materials on which Plaintiffs hope to rely are neither

efficient nor fair. With that in mind, the Court considers each of Plaintiffs’ requests.

Judicial Notice or Extra-record Consideration of Six Documents

Plaintiffs ask the Court to take judicial notice “as a matter of adjudicative fact” or, in the

alternative, to consider as extra-record evidence six documents (falling into four categories): (1)

two versions of a statement given by Thomas A. Scully, former Administrator of the Centers for

Medicare and Medicaid Services (“CMS”), on March 11, 2003, before a Senate subcommittee;

(2) a report of the Office of Inspector General of the Department of Health and Human Services

regarding the reconciliation of outlier payments 19; (3) the declaration of Peter Reisman, a CMS

official, that was submitted in a case filed in the Southern District of New York; and (4) two

amicus briefs submitted by the United States in a case relating to outlier payments in the

Southern District of Florida.

The Court agrees—as does Defendant—that parties may cite to publicly available

documents and that the Court may take judicial notice of such documents. See Pharm. Research

& Manufacturers of Am. v. United States Dep’t of Health & Human Servs., 43 F. Supp. 3d 28, 33

19

The full title of the report in question is as follows: The Centers for Medicare and Medicaid

Services Did Not Reconcile Medicare Outlier Payments In Accordance with Federal Regulations

and Guidance (2012), available at https://oig.hhs.gov/oas/reports/region7/71002764.pdf (last

visited July 23, 2015).

44

(D.D.C. 2014). Each of the identified documents is publicly available, and the Court considers it

proper to take judicial notice of them. While Plaintiffs frame their request for judicial notice as

an alternative to their request for extra-record consideration of these documents, Plaintiffs have

revealed their hand. It appears that, regardless of Plaintiffs’ framing, Plaintiffs are effectively

asking the Court to consider these materials as extra-record evidence serving as the basis for the

Court’s review of the agency actions challenged here. Insofar as Plaintiffs seek to base their

challenge upon these extra-record materials, even those available to the public of which the

Court could take judicial notice, the Court concludes that it is necessary to apply the standard for

considering extra-record evidence.

It is “black-letter administrative law that in an [Administrative Procedure Act] case, a

reviewing court ‘should have before it neither more nor less information than did the agency

when it made its decision.’ ” Hill Dermaceuticals, Inc. v. FDA, 709 F.3d 44, 47 (D.C. Cir. 2013)

(quoting Walter O. Boswell Mem’l Hosp. v. Heckler, 749 F.2d 788, 792 (D.C. Cir. 1984)). As the

D.C. Circuit Court of Appeals has recently reiterated, “exceptions to that rule are quite narrow

and rarely invoked.” CTS Corp. v. EPA, 759 F.3d 52, 64 (D.C. Cir. 2014). “They are primarily

limited to cases where ‘the procedural validity of the agency’s action remains in serious

question,’ or the agency affirmatively excluded relevant evidence.” Id. (citations omitted).

Plaintiffs have not even attempted to show that this standard is met in this case. Plaintiffs

emphasize that these documents should be considered because they are “needed to assist the

court’s review.” Pls.’ Extra-Record Mot. at 9 (quoting Nat’l Mining Ass’n v. Jackson, 856 F.

Supp. 2d 150, 156-57 (D.D.C. 2012). But that is not enough. As the D.C. Circuit has emphasized,

consideration of such extra-record materials “at most [] may be invoked to challenge gross

procedural deficiencies—such as where the administrative record itself is so deficient as to

45

preclude effective review.” Hill, 709 F.3d at 47. This is not such a case. Plaintiffs are not using

these materials to “challenge gross procedural deficiencies.” CTS Corp., 759 F.3d at 64. While

some procedural deficiencies undoubtedly exist in this case—such as missing comments from

the FY 2004 fixed loss threshold rulemaking—the Court has adequately accounted for those

deficiencies in resolving the parties’ previous motions regarding the scope of the administrative

record. See Banner Health III, 945 F. Supp. 2d at 19. Contrary to Plaintiffs’ characterization, the

record readily permits “effective review” without adding the requested materials to the record.

The Court concludes that, pursuant to the standard for consideration of extra-record evidence, it

would not be proper to consider the presented materials along with the already-voluminous

administrative record. In other words, Plaintiffs cannot evade that strict standard by appealing to

the standard for judicial notice. Although the Court will take judicial notice of these documents

as necessary in resolving this matter, the documents cannot serve as the foundation for Plaintiffs’

claims.

Supplementation with Federation of American Hospitals Comment

Plaintiffs seek to supplement the administrative record for the FY 2004 fiscal loss

threshold rulemaking with a comment by the Federation of American Hospitals. The Court

concludes that it is too late to—once again—expand the administrative record in this case. The

Court previously set a deadline of March 23, 2012, for Plaintiffs’ motion to compel regarding the

contents of the administrative record in this case. See Minute Order dated February 24, 2012.

After numerous supplemental filings, the Court resolved Plaintiffs’ motion to compel on May 16,

2013, addressing a wide variety of challenges to the administrative record filed. See Banner

Health, 945 F. Supp. 2d at 6. Subsequently, the Court granted Defendant’s [93] Motion for

Partial Reconsideration or Clarification and modified its previous order compelling the

46

supplementation of the administrative record with respect to certain materials. See Order dated

July 30, 2013, ECF No. 96. Meanwhile, on September 19, 2013, another judge in this district

accepted the comment in question into the administrative record in an outlier case proceeding in

parallel to this one. See Dist. Hosp. Partners, L.P. v. Sebelius, 971 F. Supp. 2d 15, 27 (D.D.C.

2013) aff’d in part and rev’d in part sub nom. Dist. Hosp. Partners, L.P. v. Burwell, 786 F.3d 46

(D.C. Cir. 2015). It is undisputed that the parties in this case were aware of the proceedings in

District Hospital Partners; indeed, from time to time, the parties reported to this Court regarding

those parallel proceedings, particularly regarding disputes over the administrative record in that

case. See, e.g., Plaintiffs’ Notice of the Conclusion of Previously Reported Discovery

Proceedings in the District Hospital Partners Case, dated April 12, 2013, ECF No. 81. Despite

the fact that Federation of American Hospitals comment was added to the record in District

Hospital Partners approximately one year before the dispositive motions in this case were due,

Plaintiffs never sought leave to add the Federation of American Hospitals comment to this case

until the day they filed their dispositive motion.

Plaintiffs argue that Defendant cannot be prejudiced because the agency knew about this

comment, but that misses the point. Defendant had no reason to believe that Plaintiffs would—at

the very last minute—seek to add this particular comment to the record given that the

administrative record had been extensively litigated in this case and given the lag between the

addition of the comment in question to the District Hospital Partners record and the filing of the

dispositive motions in this case. Accordingly, the Court concludes that it would be improper to

add the Federation of American Hospitals comment to the administrative record. 20

20

In any event, as the Court explains below, even if the Federation of American Hospitals

comment were added to the administrative record, the outcome in this case would not be altered.

47

Three Additional Tables

Plaintiffs ask the court to “receive” three tables that are appended to Plaintiffs’ Motion for

Summary Judgment. Plaintiffs explain that “[a]ll three tables summarize data in the Impact Files

that are already part of the administrative record and concisely encapsulate what would

otherwise require resorting to a voluminous portion of the administrative records.” Pls.’ Extra-

Record Mot. at 7. They argue that, because these tables “merely restate information already

contained in the administrative record,” they should not be included in the page limitations

previously ordered by the Court. Id. at 7-8. Plaintiffs further state that the “tables are intended to

aid the parties and the Court by presenting visually concise data that would otherwise only be

accessible in cumbersome spreadsheets.” Id. at 8. Defendant responds that Plaintiffs’ request to

submit the tables was untimely, that the additional pages should not be exempt from the page

limit because they effectively present argument rather than materials from the administrative

record, and that the Court should not allow an expansion of the page limits. The Court agrees

with Defendant.

First, pursuant to Local Civil Rule 7(e), Plaintiffs should have requested leave to exceed

the page limits—or to submit what they believe should not be counted towards the page limits—

prior to the deadline for filing their briefs. Presenting this request simultaneous with the filing of

those briefs is neither fair—Defendant did not have an opportunity to file an expanded brief—

nor conducive to the orderly administration of this action.

Second, the Court concludes that the appended tables are not exempt from the page limit.

Contrary to Plaintiffs’ suggestion, the exhibits are not like a Joint Appendix. A Joint Appendix

contains excerpts of the unadorned administrative record to facilitate the Court’s review of those

portions of the administrative record on which the parties rely, which is particularly useful in

cases like this one with a voluminous record. See LCvR 7(n). A Joint Appendix does not provide

48

an opportunity for the parties to add analysis or commentary regarding the meaning of the

administrative record. The Court agrees that, as a general matter, charts or graphs may be a

helpful way to present complex information. See generally Edward Tufte, Beautiful Evidence

(2006). They also can be an effective way to present an argument. See id. However, the question

is not whether or not the charts are helpful. Any material describing the administrative record

that is not a faithful reproduction of the unadorned administrative record belongs in a

memorandum of points and authorities in support of, or in opposition to, a motion. Indeed, that is

essentially what a factual or background section of a memorandum is: it is a description of a

voluminous record to set the groundwork for a party’s legal arguments about the meaning of that

record. Whether the charts themselves are more like a background section of a brief or the

argument section itself is immaterial for present purposes; it is plain that they are not like

portions of the administrative itself and that they should be counted towards the page limit for

the briefing.

In that light, the Court arrives at the page limitation itself. The Court’s Scheduling and

Procedures Order, dated July 17, 2014, established a 70-page limit for Plaintiffs’ motion for

summary judgment. See ECF No. 122, at 3. In that Order, the Court also stated that the “page

limits identified above are similarly generous and equally firm,” just as the briefing schedule set

that day was generous and firm. Id. at 4. The Court also “caution[ed] the parties that any attempt

to subvert these page limits by including additional briefing in appendices will be rejected, and

such appendices will be stricken from the record.” Id. (citing Hajjar-Nejad v. George Washington

Univ., 37 F. Supp. 3d 90, 114 (D.D.C. 2014)). Despite their arguments to the contrary, Plaintiffs

have done precisely that. Plaintiffs submitted a memorandum of points and authorities in support

of their motion for summary judgment of 70 pages. In addition, they submitted three tables—

49

exhibits 5, 7, and 8—that purport to summarize relevant data in the administrative record. These

exhibits are properly considered portions of Plaintiffs’ memorandum and, therefore, exceed the

page limit.

Plaintiffs’ suggestion—as a basis for submitting the separate exhibits—that they could

not have effectively cited to the administrative record is immaterial. Insofar as they believe they

effectively cited to the record in their charts, and then relied on these charts in their briefing, they

could have simply included these charts within their briefing itself. 21 Parties always face

tradeoffs in choosing what to include in a page-limited filing. If Plaintiffs had concluded that

including the tables was valuable in presenting their arguments—more valuable than other

materials they did include—the Court is confident that Plaintiffs could have devised a way to

include those materials in their memorandum itself. Instead, Plaintiffs are trying to have it both

ways, but the Court will not allow them to do so. Accordingly, the Court will not grant Plaintiffs’

belated request to submit the tables, which is effectively a request to expand the page limit for

the briefing of this action. The Court denies Plaintiffs’ request to submit these additional exhibits

and strikes exhibits 5, 7, and 8 from the record.

Having resolved these preliminary issues, the Court proceeds to consider the Secretary’s

arguments that this Court does not have subject matter jurisdiction over certain claims in this

action.

21

It is similarly immaterial that they had space within the final page of the brief to list all of the

citations to the administrative record on which those three tables rely.

50

B. Secretary’s Motion to Dismiss for Lack of Subject Matter Jurisdiction

The Secretary argues that several of Plaintiffs’ claims should be dismissed for lack of

subject matter jurisdiction. The Court reviews each of those arguments in turn and concludes that

it has jurisdiction over the claims in this action.

First, the Secretary argues that Plaintiffs lack standing to pursue claims that rely on

speculation about how hospitals—other than Plaintiffs—would behave under a different set of

regulations. To satisfy the standing requirements of Article III, a plaintiff “must show (1) it has

suffered an ‘injury in fact’ that is (a) concrete and particularized and (b) actual or imminent, not

conjectural or hypothetical; (2) the injury is fairly traceable to the challenged action of the

defendant; and (3) it is likely, as opposed to merely speculative, that the injury will be redressed

by a favorable decision.” Friends of the Earth, Inc. v. Laidlaw Envtl. Servs. (TOC), Inc., 528 U.S.

167, 180-81 (2000). Essentially the Secretary argues that a subset of Plaintiffs’ claims—although

the Secretary does not identify specifically which claims—rely on assumptions about how

hospitals would, generally, respond to the regulations in question. Therefore, the Secretary

argues, the injury was not “fairly traceable” to the challenged agency action. Plaintiffs respond

that their injuries are directly linked to each of the challenged regulations. The Court agrees that

Plaintiffs have standing to challenge the 14 regulations at issue in this case.

As described above, in Banner Health I, in resolving the Secretary’s motion to dismiss,

the Court concluded that Plaintiffs’ allegations were sufficient, for the pleading stage, to establish

their standing over all of the claims that survived the motion to dismiss stage. 22 See 797 F. Supp.

2d at 109. At that time, the Court noted that this conclusion was not intended to foreclose the

Secretary from raising standing arguments upon filing a motion for summary judgment, after the

22

Whether Plaintiffs have standing over claims that the Court dismissed for failure to state a

claim is immaterial at this stage of the proceedings. See Banner Health I, 797 F. Supp. 2d at 109.

51

record had been developed. See id. The Secretary now does so. However, neither the subsequent

development of the record nor the gradual refining of Plaintiffs’ claims alters the Court’s

previous conclusion that Plaintiffs have standing. As the Court noted in resolving the Secretary’s

motion to dismiss, “[i]n many cases, a plaintiff's ‘standing to seek review of administrative

action is self-evident,’ including where, as here, ‘the complainant is an object of the action (or

forgone action) at issue—as is the case usually in review of a rulemaking and nearly always in

review of an adjudication.’” Id. at 108 (quoting Sierra Club v. Envtl. Prot. Agency, 292 F.3d 895,

900 (D.C. Cir. 2002)) (internal quotation marks and citation omitted). As the Court stated

previously, Plaintiffs certainly have standing to challenge the outlier payments that Plaintiffs

themselves received for FY 1997 through FY 2007 and, accordingly, Plaintiffs also have standing

to challenge the validity of the regulations on which those payments were based—i.e., three

rulemakings revising the outlier payment regulations and 11 annual fixed loss threshold

regulations. See id.

Essentially, the Secretary’s standing argument amounts to a claim that the challenged

regulations were not arbitrary or capricious, or otherwise not in accordance with law, because

Plaintiffs’ arguments rely on predictions about actions of third parties. As the Court said

previously, this argument is best considered on the merits because, even if the Secretary’s

arguments are correct, they would not undermine Plaintiffs’ standing to bring the challenges in

this action in the first instance. See id. at 108 n.11. Notwithstanding the subsequent development

of the record and of the parties’ arguments, the Court’s conclusion that the Plaintiffs have

standing to bring the claims in this action is unchanged.

Second, the Secretary argues that this Court has no subject matter jurisdiction over

Plaintiffs’ claim that it was arbitrary and capricious for the agency to fail to make a mid-year

52

adjustment to the FY 2003 fixed loss threshold because the PRRB had not approved that question

for judicial review. Plaintiffs respond that the question of the propriety of a mid-year adjustment

to the FY 2003 fixed loss threshold was within the scope of judicial review approved by

Plaintiffs. Regarding this question, the Court agrees with Plaintiffs.

Under the Medicare Act, “[j]udicial review may be had only after the claim has been

presented to the Secretary and administrative remedies have been exhausted.” Am. Chiropractic

Ass'n, Inc. v. Leavitt, 431 F.3d 812, 816 (D.C. Cir. 2005). In this case, Plaintiffs presented

requests for judicial review with respect to all of the payment determinations at issue in this case.

The question for which Plaintiffs requested judicial review was framed broadly:

Whether the Medicare Outlier Regulations, and the “fixed loss thresholds”

thereunder established by the Secretary of Health and Human Services (the

“Secretary”), and its Center for Medicare and Medicaid Services (“CMS”) and as

in effect for the Appealed Years, are substantively and/or procedurally invalid?"

PRRB Rs. 28. Plaintiffs’ request made it clear that they were challenging the 2003 rulemaking

promulgating amendments to the outlier payment regulations. See id. It is that rulemaking that

encompasses Plaintiffs’ mid-year adjustment claim—whereby Plaintiffs argue that the decision

not to lower the FY 2003 fixed loss threshold in a mid-year adjustment was arbitrary and

capricious. The Secretary argues that Plaintiffs’ request for judicial review does not include the

mid-year adjustment claim because Plaintiffs’ request included discussion of several other

specific questions—not including the mid-year adjustment question—and references to several

specific Federal Register pages—which did not include the pages on which the decision not to

adjust the FY 2003 fixed loss threshold was explained. However, the Court does not read

Plaintiffs’ request so narrowly so as to exclude a challenge to the decision to refrain from a mid-

year adjustment to the FY 2003 threshold.

53

The decision in District Hospital Partners, 794 F. Supp. 2d at 162, is not to the contrary.

In District Hospital Partners—another outlier case—another judge in this district concluded that

the court did not have subject matter jurisdiction over the claims of the hospital-plaintiffs in that

case, arguing that the agency had failed to adjust the fixed loss thresholds for FY 2004 through

FY 2006, because those plaintiffs had not presented the mid-year adjustment claims to the

agency, as required. See id. at 168-69. At the outset, it is important that different mid-year

adjustments were challenged in the two cases: the FY 2003 threshold in this case, and the FY

2004, FY 2005, and FY 2006 thresholds in District Hospital Partners. See id. at 167. In that

case, “[t]he question the Board certified was whether the ‘various elements used to project the

outlier thresholds were arbitrary and capricious.’” Id. at 168 (citing Complaint Ex. A at 1). That

court determined the plaintiffs’ request did not encompass any decisions not to adjust the

thresholds after the fact—which necessarily occurred after the setting of the fixed loss thresholds

for the applicable years. See id. In this case, however, Plaintiffs’ challenge encompassed a

challenge to the validity of the 2003 regulation, which promulgated changes to the outlier

payment regulations and encompassed the decision not to lower the FY 2003 fixed loss threshold

after the fact. The two cases, therefore, are distinguishable. Accordingly, the Court concludes that

Plaintiffs’ challenge to the June 9, 2003, decision to forego a mid-year adjustment of the FY

2003 fixed loss threshold was within the scope of the questions approved by the PRRB and,

therefore, that it is within the scope of this Court’s subject matter jurisdiction. The Court returns

to the merits of Plaintiffs’ claims regarding the agency’s decision not to undertake a FY 2003

mid-year adjustment below.

Furthermore, insofar as the Secretary’s argument that this Court lacks subject jurisdiction

is directed at “any other claims that were not properly channeled through the PRRB,” that

54

argument is unavailing as well. Def.’s Mot. at 30. Not only has the Secretary failed to identify

any other claims in this action that were not presented to the PRRB, but the Court concludes,

because it must assure itself of jurisdiction over the claims in this action, that each was

adequately presented to the PRRB. As explained above, the legal question presented to the

PRRB was framed broadly, referring to each of the revisions to the outlier payment regulations

and each of the fixed loss threshold regulations at issue for the payment years in question—that

is, each of the regulations challenged in this action. See PRRB Rs. at 29. Accordingly, Plaintiffs

have complied with the jurisdictional requirements of the Medicare Act, and the Court has

subject matter jurisdiction over each of the claims in this action.

Third, and finally, the Secretary argues that claims aimed at increasing Plaintiffs’ outlier

payments rather than at correcting an identifiable error would be barred by sovereign immunity.

It is true that Plaintiffs cannot bring a claim under the Medicare Act, which incorporates the

APA’s standard of review, in order to simply increase Plaintiffs’ payments that they receive from

the government. However, Plaintiffs are not doing so: they have brought claims identifying what

they argue are legal errors in each of the 14 rulemakings at issue in this case. That is enough to

fall within the government’s waiver of sovereign immunity.

Having concluded that the Court has subject matter jurisdiction over the claims in this

action, the Court turns to those claims—the legal errors Plaintiffs purport to identify with respect

to the 14 regulations in question—in the remainder of this Memorandum Opinion. However,

before addressing the individual claims, in light of the multitude of arguments that Plaintiffs

present with respect to the 14 regulations at issue in this case and the variety of arguments that

the Secretary presents in response, the Court reviews several fundamental principles regarding

the parameters of its review.

55

C. Framing Issues

Essentially, Plaintiffs present two sets of challenges in this case. First, Plaintiffs argue

that certain of the challenged regulations—specifically the outlier payment regulations from

1988 and 1994 and all of the fixed loss threshold regulations at issue—are at odds with the

language of the Medicare Act. 23 Plaintiffs refer to this set of arguments as their Chevron

challenge—under Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837

(1984). See Pls.’ Mot. at 25. Second, Plaintiffs argue that each of the regulations at issue in this

case was arbitrary and capricious. While Plaintiffs’ claims pertain to 14 different regulations over

the course of a thirty year period, there are several legal questions that recur in the parties’

briefing. In the interest of clarity, the Court first addresses several recurring legal issues before

addressing Plaintiffs’ individual challenges. The resolution of these issues sets the stage for the

Court’s discussion of Plaintiffs’ specific claims below.

Of these several framing questions, the Court first addresses Defendant’s argument that

Plaintiffs are barred from raising various arguments by failing to raise them in comments before

the agency at the time of the various rulemakings or, at a minimum, being able to point to other

parties who raised those arguments before the agency at the proper time. The Court disagrees.

The Medicare Act allows judicial review of legal issues pertaining to regulations pursuant to the

scheme described above: by filing timely appeals of payment determinations with the PRRB and

seeking judicial review on legal issues outside the scope of the PRRB’s authority. See 42 U.S.C.

§ 1395oo(a)(3); id. § 1395oo(f)(1). Plaintiffs have done so here. Indeed, Defendant does not

contest the timeliness of Plaintiffs’ challenges to the payment determinations from the relevant

23

Plaintiffs also argue that the failure to engage in reconciliation in FY 2004 through FY 2007

also violates the clear language of the statute. As discussed further below, the Court understands

this argument as linked to Plaintiffs’ arguments regarding the fixed loss threshold regulations for

those years.

56

fiscal years. Nor does Defendant contend that a challenge to those payment determination cannot

be the appropriate vehicle for challenging the regulations on which those payment

determinations depend. However, Defendant argues, nonetheless, that various arguments by

Plaintiffs are barred because they were never placed before the agency during the various

rulemaking proceedings subject to challenge in this action. In support of this proposition, they

cite to various cases that stand for the proposition that arguments must be raised before an

agency before they can be raised in court. See, e.g., Nuclear Energy Inst., Inc., v. EPA, 373 F.3d

1251, 1298 (D.C. Cir. 2004). But those cases do not tell the whole story. Even where a party has

waived its opportunity to pursue facial review of a regulation by failing to comment during a

rulemaking proceeding, 24 such a party can raise its arguments when the agency applies the rule.

See Koretoff v. Vilsack, 707 F.3d 394, 399 (D.C. Cir. 2013) (citing Murphy Exploration &

Production Co. v. U.S. Department of Interior, 270 F.3d 957, 958 (D.C. Cir. 2001)). The

Secretary responds, in turn, that this is a facial challenge because Plaintiffs are arguing that the

regulations in question cannot be validly applied in calculating any hospital’s payments—not

simply in calculating payments due to Plaintiffs. See Def.’s Reply at 17. For that proposition, the

Secretary looks to the oft-repeated standard for success on a facial challenge: “‘To prevail in

such a facial challenge, [a party] ‘must establish that no set of circumstances exists under which

the [regulations] would be valid.’” Ass’n of Private Sector Colleges & Universities v. Duncan,

681 F.3d 427, 442 (D.C. Cir. 2012) (citation omitted). However, in doing so, the Secretary has

transformed the standard for success on a facial challenge into the definition of a facial

24

The Court notes that, even in the facial challenge posture, “the waiver rule would not bar a

facial challenge if the agency has actually addressed the issue, either sua sponte or at the behest

of another party.” Koretoff, 707 F.3d at 400 n.3 (Williams, J., concurring) (citing Ohio v. EPA,

997 F.2d 1520, 1529 (D.C. Cir. 1993)).

57

challenge. They are not the same. The Secretary has not pointed to any authority suggesting that,

just because a plaintiff argues that a regulation is invalid, such a plaintiff has waived any

arguments not raised in a prior rulemaking proceeding. To the contrary, a series of cases from the

D.C. Circuit Court of Appeals indicate that a party may challenge the very validity of a

regulation when that regulation is applied without waiving arguments that were not raised before

the agency in the underlying rulemaking proceedings. See Weaver v. Fed. Motor Carrier Safety

Admin., 744 F.3d 142, 145 (D.C. Cir. 2014) (citing cases where the Court of Appeals “considered

the validity of rules that an agency applied” “despite want of a prior timely attack” to the

regulations in question) (emphasis added); see also Natural Res. Def. Council v. EPA, 513 F.3d

257, 260 (D.C. Cir. 2008) (describing “established doctrine that parties claiming substantive

invalidity of a rule for which direct statutory assault is time-barred are nonetheless free to raise

their claims in actions against agency decisions applying the earlier rule”) (emphasis in original).

That is precisely what Plaintiffs have done here. They have raised a timely challenge to the

outlier payments they received for FY 1997 through FY 2007, which entailed applying the 14

regulations subject to challenge in this action. Accordingly, they may raise arguments

challenging the validity of those regulations regardless of whether those arguments were raised

before the agency in the challenged rulemakings.

However, this conclusion is not the end of the story. Just because Plaintiffs are not barred

from raising at this time arguments that were not previously raised before the agency does not

mean that they will prevail on them. Indeed, whether comments have been presented to the

agency matters in applying the arbitrary and capricious standard of review. In addition to other

potential bases for determining that an agency action was arbitrary or capricious, discussed

further below, this Court cannot “uphold agency action if it fails to consider ‘significant and

58

viable and obvious alternatives.’” Dist. Hosp. Partners, 786 F.3d at 59 (quoting Nat’l Shooting

Sports Found., Inc. v. Jones, 716 F.3d 200, 215 (D.C. Cir. 2013) (internal quotation marks

omitted)). Determining whether comments have been presented to the agency regarding a

specific challenge is thus part—but not all—of the calculus entailed in determining whether the

agency has failed to consider “significant and viable and obvious alternatives.” The Court will

apply that standard below, as required, in resolving Plaintiffs’ arbitrary and capricious claims.

One particular application of that rule is worth explaining at this point because of its

general relevance to this case. Many of Plaintiffs’ arguments are dependent, in some form, on the

differences between the draft interim final rule sent to the Office of Management and Budget in

2003 and the subsequent rulemakings undertaken by the agency. However, the Court of Appeals

has determined that Plaintiffs cannot “[r]ely[] on the OMB draft rule to impugn the 2004

rulemaking.” Dist. Hosp. Partners, 786 F.3d at 58. Because “the OMB draft was never ‘on the

books’ in the first place”—that is to say, never published in the Federal Register—the Court of

Appeals concluded that the agency had no obligation to explain its departure from the provisions

of that internal draft. Id. That conclusion is wholly applicable here.

Furthermore, as the Court of Appeals recently clarified in District Hospital Partners,

contrary to Plaintiffs’ arguments here, the agency does not have an obligation to use the “best

available data” above and beyond the requirements of arbitrary and capricious review. See id. at

56 (rejecting argument that Gas Appliance Manufacturers Ass’n, Inc. v. DOE, 998 F.2d 1041

(D.C. Cir. 1993), “imposed a generic obligation on agencies to always use the best available

data”).

Next, the Court turns to the basis for its review of the various agency actions challenged

here. A fundamental principle of judicial review of agency actions is that such review is based

59

on—and limited to—the record before the agency at the time of the action. See Walter O.

Boswell Mem’l Hosp., 749 F.2d at 792 (“If a court is to review an agency’s action fairly, it should

have before it neither more nor less information than did the agency when it made its decision.”);

see also 5 U.S.C. § 706 (for review under the APA, “the court shall review the whole record or

those parts of it cited by a party”). The Supreme Court has cautioned that the record must be

limited to that which existed at the time of the decision. See Citizens to Preserve Overton Park,

401 U.S. at 420 (“[R]eview is to be based on the full administrative record that was before the

Secretary at the time he made his decision.”) (emphasis added). Accordingly, information that

was not yet before the agency at the time of a particular agency decision cannot provide the

ammunition for challenging that decision.

Here, Plaintiffs are challenging 14 discrete regulations. Only the information that was

before the agency at the time of each of those individual rulemakings can be used to challenge

that action. In evaluating each rulemaking, the Court must exclude all information that pertains

to events after that rulemaking, including information in the administrative records for

subsequent rulemakings. For example, in evaluating the FY 2004 fixed loss threshold

rulemaking, anything outside of the administrative record for that rulemaking—including

information in the administrative records for subsequent fixed loss threshold rulemakings—

cannot be considered. The same result applies to the Court’s evaluation of each of the three

outlier payment rulemakings and the 11 fixed loss threshold rulemakings challenged in this

action.

Furthermore, notwithstanding Plaintiffs’ suggestions to the contrary, the mere fact that a

subsequent rulemaking relied on a prior rulemaking does not mean that the earlier rulemaking

becomes open to challenge as a result of information before the agency at the time of the

60

subsequent rulemaking. See Biggerstaff v. FCC, 511 F.3d 178, 184 (D.C. Cir. 2007) (describing

reopening doctrine). Plaintiffs are correct that the issue directly before the Court of Appeals in

Biggerstaff was whether the petitioners in that case were time barred from challenging an earlier

agency action, which those petitioners claimed was encompassed in a later rulemaking. As

Plaintiffs argue, the issue of timeliness is not before this Court because Plaintiffs’ challenges to

each of the 14 regulations on which the challenged payment determinations rely are timely, as

explained above. However, the Court concludes that the reasoning in Biggerstaff, and the

associated line of reopening cases, is equally applicable here. In Biggerstaff, the Court of

Appeals concluded that, “for the court to examine the merits of his contention, [plaintiff] must

demonstrate that in the [subsequent] rulemaking the Commission reopened consideration of its

authority to adopt the [earlier-adopted] exemption, for otherwise his challenge is untimely.”

Biggerstaff, 511 F.3d at 185. The Court of Appeals also concluded that the agency’s “intention to

initiate a reopening must be clear from the administrative record.” Id. It is sensible to apply this

standard to determine whether actions taken in an earlier rulemaking can be evaluated in light of

the information in front of the agency at a later date. If the agency effectively reopened an earlier

rulemaking, such earlier decisions can be subject to challenge as a result of the later rulemaking.

Similarly, it is sensible that decisions made earlier can be challenged based on information

before the agency at the time of a later rulemaking only if the later rulemaking actually

considered and adopted, anew, the results of the earlier rulemaking—and only with respect to

applications of that decision after the later rulemaking. 25

25

To be clear, a subsequent re-adoption of a prior rule could not make that earlier rule

retroactively invalid as of the time it was originally adopted; but it could potentially make the re-

opened and re-adopted rule invalid as of the later adoption based on judicial evaluation of the

information before an agency at the time of the later adoption.

61

Despite Plaintiffs’ suggestions that the reopening line of cases is inapposite, Plaintiffs

have pointed to no authority suggesting an exception to the general rule that judicial review of an

agency action is limited to the record before the agency at the time of the agency action.

Accordingly, in the analysis below, the Court will evaluate the decisions made in each

rulemaking by analyzing the record before the agency at the time of each of those rulemakings.

Only in the limited circumstance where Plaintiffs have shown that one of the rules challenged

has been reopened and adopted through a later rulemaking will the Court review the later

adopted rule pursuant to the record before the agency at that later time, as well. 26

A final word is necessary regarding Plaintiffs’ framing of their challenges. While

Plaintiffs frame their Chevron arguments as a separate set of challenges, distinct from their

arbitrary and capricious arguments, Chevron does not provide an independent basis for reviewing

the agency’s actions. See Ass’n of Private Sector Colleges & Universities, 681 F.3d at 441.

Pursuant to the APA standard of review that is adopted by the Medicare Act, the Court reviews

agency actions, as relevant here, to determine whether they are “arbitrary, capricious, an abuse of

discretion, or otherwise not in accordance with law,” 5 U.S.C. § 706(2)(a), or “in excess of

statutory jurisdiction, authority, or limitations, or short of statutory right,” id. § 706(2)(C). 27

Chevron provides the two-step rubric for determining whether the agency actions were “not in

26

Somewhat analogously, Plaintiffs argue in several contexts that, in setting the fixed loss

threshold for a given year, the agency was aware of the relationship between actual outlier

payments from a previous year and previous projections as to outlier payments used in setting

the fixed loss threshold for that previous year. Although that claims recurs several times, it

requires a fact-specific inquiry—particular to the specific record before the agency at the time of

the respective challenged regulations. Accordingly, the Court will consider those arguments in

the context of Plaintiffs’ specific claims discussed below.

27

Notably, Plaintiffs never once cite the relevant statutory provisions that establish the

parameters for judicial review over agency action, which they seek in this case.

62

accordance with law” or “in excess of statutory jurisdiction, authority, or limitations, or short of

statutory right.” 28 See Ass’n of Private Sector Colleges & Universities, 681 F.3d at 441; Military

Toxics Project v. EPA, 146 F.3d 948, 954 (D.C. Cir. 1998). Accordingly, this Court applies the

analytic framework of Chevron in the context of Plaintiffs’ claims that the rulemakings at issue in

this case are inconsistent with the provisions of the Medicare Act. 29

Finally, even though Chevron does not provide an independent basis for review, in the

interest of clarity, the Court will address Plaintiffs’ challenges according to the manner in which

Plaintiffs organized them: first, a set of statutory challenges invoking Chevron with respect to

various regulations and, then, a series of claims that each of the regulations at issue in this case

was arbitrary and capricious. It is to the challenges invoking Chevron that the Court turns first.

D. Plaintiffs’ Chevron Arguments

Plaintiffs argue that the outlier payment model as a whole in effect for the fiscal years in

question was inconsistent with the outlier payment provisions of the Medicare Act, 42 U.S.C.

§ 1395ww(5)(A). Specifically, Plaintiffs claim that the payment model was inconsistent with

what they claim was the statute’s mandate to reimburse only for high cost cases because, they

claim, the agency actually reimbursed hospitals for high charge cases. Pls.’ Mot. at 25.

Defendant argues that the agency’s actions were a reasonable means of implementing the

28

Under the familiar Chevron standard, “[i]f the court determines ‘Congress has directly spoken

to the precise question at issue,’ and ‘the intent of Congress is clear, that is the end of the

matter.’” S. Carolina Pub. Serv. Auth. v. FERC, 762 F.3d 41, 54 (D.C. Cir. 2014) (quoting

Chevron, 467 U.S. at 842). “If, however, ‘the statute is silent or ambiguous with respect to the

specific issue,’ then the court must determine ‘whether the agency’s answer is based on a

permissible construction of the statute.’” Id. (quoting Chevron, 467 U.S. at 843).

29

The Courts notes, as well, that Plaintiffs have pointed to nothing that suggests that this Court’s

analysis of their so-called Chevron challenges, including the Chevron step two determination of

whether an agency’s interpretation of a statute is permissible, is not limited to the record before

the agency the time of the respective rulemakings.

63

statutory provisions. Defendant also argues that Plaintiffs’ challenges are barred because they

were not presented to the agency previously. With respect to the latter argument, the Court

concludes that, for the reasons stated above, Plaintiffs may raise these arguments here even if

they were not presented in comments to the agency because this is a timely challenge to the

regulations as applied in outlier payment determinations challenged in this action. See Koretoff,

707 F.3d at 399 (arguments not raised before agency may be raised in timely challenge to

application of rule). With respect to the former argument, the Court agrees with Defendant: each

of the agency actions challenged as inconsistent with the statute entailed a reasonable,

interpretation of the statute. The Court reviews Plaintiffs’ arguments to the contrary here.

1. Challenge to Outlier Payments for FY 1997 through FY 2003

With respect to FY 1997 through FY 2003, the gravamen of Plaintiffs’ claim appears to

be that the agency made outlier payments for these years where the hospitals’ actual costs were

below the “cut off point,” 42 U.S.C. § 1395ww(5)(A)(iii), and that such payments are barred by

the language of the statute. There are several fatal flaws with Plaintiffs’ argument. First,

Plaintiffs persist in referring to the outlier payment regulations and the fixed loss threshold

rulemakings applicable in these fiscal years as a bundle. Plaintiffs do not pinpoint explicit

decisions in the nine agency rulemakings at play for this set of fiscal years—the revisions to the

outlier payment regulations promulgated in 1988 and 1994, as well the fixed loss threshold

rulemakings for these seven fiscal years—that are inconsistent with the requirements of the

statute. As the Court has stated previously, Plaintiffs’ challenges must be tethered to specific

agency actions. See Banner Health I, 797 F. Supp. 2d at 106. Plaintiffs’ failure to do so

adequately at this point would be enough, without more, to make Plaintiffs’ statutory challenge

fail. However, in the interest of thoroughness, the Court considers whether the underlying

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rulemakings are inconsistent with the statute. For the reasons stated below, the Court concludes

that they are not inconsistent because the statute does not require what Plaintiffs claim it

requires.

The Court begins, as it must, with the language of the statute itself. The statute requires

that the agency make payments, upon request, “in any case where charges, adjusted to cost”

exceed a certain cutoff point. 42 U.S.C. § 1395ww(5)(A)(ii). As a result of amendments to the

statute enacted in 1993, that cutoff point—for discharges after October 1, 1994, including all the

years at issue in this action—is the “sum of the applicable DRG prospective payment rate … plus

a fixed dollar amount determined by the secretary.” 30 Id. That fixed dollar amount is the amount

that has been referred to throughout this Memorandum Opinion as the fixed loss threshold. As a

reminder, the DRG prospective payment rate is the rate set for a particular year for a particular

category of medical diagnoses. The statute does not directly tell the agency how to set the fixed

loss threshold. However, the statute does require that “[t]he total amount of the additional

payments made under this subparagraph for discharges in a fiscal year may not be less than 5

percent nor more than 6 percent of the total payments projected or estimated to be made based on

DRG prospective payment rates for discharges in that year.” Id. § 1395ww(5)(A)(iv). The D.C.

Circuit Court of Appeals has determined that the agency complies with this requirement by

“selecting outlier thresholds that, ‘when tested against historical data, will likely produce

aggregate outlier payments totaling between five and six percent of projected … DRG-related

payments.’” Dist. Hosp. Partners, 786 F.3d at 51 (quoting Cnty. of Los Angeles, 192 F.3d at

30

As explained above, the calculus also includes other payments not subject to this challenge—

“any amount payable under subparagraphs (B) and (F)”—but leaving those payments to the side

simplifies the narrative but does not subtract anything from the relevant analysis. 42 U.S.C.

§ 1395ww(5)(A)(ii); see Dist. Hosp. Partners, 786 F.3d at 50 n.1.

65

1013). Finally, the statute directs the agency that the “amount of such additional payment …

shall … approximate the marginal cost of care beyond the cutoff point applicable.” Id.

§ 1395ww(5)(A)(iii).

With these remarkably few words, Congress established the framework for the outlier

payment scheme, leaving the details to be fleshed out by the agency. Cf. Cnty of L.A., 192 F.3d at

1016 (“Where, as here, Congress enacts an ambiguous provision within a statute entrusted to the

agency’s expertise, it has ‘implicitly delegated to the agency the power to fill those gaps.’”)

(quoting National Fuel Gas Supply Corp. v. FERC, 811 F.2d 1563, 1569 (D.C. Cir. 1987)).

Specifically, the statute establishes the framework for determining both when outlier payments

should be made and what amounts those payments should be. But the details necessary to

implement the statutory framework and to fulfill the statutory mandate are left to the agency.

Plaintiffs argue that the agency wrongly based outlier payments on cases with high

charges rather than high costs. See, e.g., Pls.’ Mot. at 25. However, notwithstanding Plaintiffs’

cut-and-paste citations of the statute, they ignore key language in the relevant statutory

provision. The statute specifies that outlier payments are available where “charges, adjusted to

cost” exceed the cutoff point. 42 U.S.C. § 1395ww(5)(A)(ii). In other words, the statute requires

the agency to make the determination of when an outlier payment should be made based on

“charges, adjusted to cost,” not based on hospital costs in the abstract. The statute does not

specify how to adjust charges to cost, but the statute clearly requires the agency take charges and

adjust them to cost, in some manner, in order to make that determination. In 1988, in a

rulemaking challenged in this action, the agency determined that it would adjust charges to cost

by using hospital-specific cost-to-charge ratios. 53 Fed. Reg. at 38,503. These cost-to-charge

ratios would be derived by using historical data, specifically using the latest settled cost reports.

66

Id. at 38,529. The agency also concluded that, for hospitals where the data indicated extremely

high or extremely low cost-to-charge ratios, the agency instead would use the relevant statewide

average cost-to-charge ratio to adjust charges to cost for those hospitals. Id. at 38,507-08.

Through that rulemaking, the agency amended the applicable regulations, codified at 42 C.F.R.

§ 412.84(h). These decisions were not revisited, nor were the relevant provisions of the

regulations amended, until later proceedings in 2003, discussed elsewhere in this Memorandum

Opinion. Therefore, these provisions were applicable for the fixed loss threshold rulemakings for

FY 1997 through FY 2003.

None of these conclusions are inconsistent with the statute. The statute plainly indicates

that charges adjusted to cost should be used to determine whether an outlier payment is

applicable for an individual case. See 42 U.S.C. § 1395ww(5)(A)(ii). The statute is just as plainly

ambiguous regarding the method of adjusting charges to cost. Because the statute is ambiguous,

the Court “defers to the agency’s interpretation as long as it is based on a permissible

construction of the statute.” Chevron, 467 U.S. at 843. “The question for a reviewing court is

whether in doing so the agency has acted reasonably and thus has ‘stayed within the bounds of

its statutory authority.’” Natural Res. Def. Council v. EPA, 777 F.3d 456, 463 (D.C. Cir. 2014)

(quoting City of Arlington v. FCC, 133 S. Ct. 1863, 1868 (2013)). The Court concludes that each

decision in the 1988 regulation regarding the adjustment of charges to cost was reasonable. 31

The agency’s decision to adjust charges to cost by looking at hospital-specific data was

reasonable. See 53 Fed. Reg. at 38,503 (describing conclusion that “use of hospital-specific cost-

to-charge ratios should greatly enhance the accuracy with which outlier cases are identified and

31

The Court addresses Plaintiffs’ specific arguments that the agency did not adequately explain

certain decisions in analyzing, below, Plaintiffs’ claims that each regulation at issue in this case

was arbitrary and capricious.

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outlier payments are computed, since there is wide variation among hospitals in these cost-to-

charge ratios”). So, too, was the agency’s decision to adjust charges to cost using historic cost-to-

charge ratios that are based on the latest settled cost reports. See 53 Fed. Reg. at 38,507

(explaining decision to use this dataset). As explained further below, just because the agency

later concluded—in 2003—that using somewhat more recent data (the tentatively settled cost

reports) was more sensible in light of the agency’s experience does not make the earlier decision

to use settled cost reports unreasonable. See 68 Fed. Reg. at 34,497-99. Similarly, the agency’s

decision to use statewide average data for hospitals with extremely high or low cost-to-charge

ratios was also reasonable. See 53 Fed. Reg. at 38,507-08 (explaining agency’s assessment that

“that ratios falling outside this range are unreasonable and are probably due to faulty data

reporting or entry”). Just because the agency later concluded—in 2003—that it would be more

sensible in light of the agency’s experience to use hospital-specific charge ratios for hospitals

with low cost-to-charge ratios rather than statewide averages, see 68 Fed. Reg. at 34,497-99,

does not mean that the decision to use statewide averages in 1988 was an unreasonable

construction of the statute. The Court notes that the agency never revisited these several

decisions until 2003 when the agency ultimately revised the outlier payment regulations.

Accordingly, the Court has no occasion to evaluate the reasoning behind these decisions in light

of events that occurred in those intervening years.

The same considerations apply with respect to the “amount of such additional payment”

under section 1395ww(5)(A)(iii). The statute requires that that amount “approximate the

marginal cost of care beyond the cutoff point applicable under clause (i) or clause (ii).” 42

U.S.C. § 1395ww(5)(A)(iii). In a 1983 regulation not challenged in this action, the agency

determined that the amount of a cost outlier payment would be determined by applying a

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marginal cost factor to the difference between charges, adjusted to cost, and the applicable

threshold. 32 See 48 Fed. Reg. 39,752, 39,777 (Sept. 1, 1983). The Court notes that it does not

appear that the agency actually reconsidered the decision to use cost-adjusted charges to

determine the amount of the outlier payment in promulgating the 1988 revisions to the outlier

payment. See 53 Fed. Reg. at 38,502 (describing the consideration of the level of the marginal

cost factor without reconsidering the use of cost-adjusted charges). In any event, Court concludes

that it is reasonable to determine the amount of an outlier payment based on cost-adjusted

charges derived by the same methodology of cost-adjustment as used to determine whether a

case qualifies for an outlier payment.

It is important that this clause requiring that the “amount of such additional payment …

shall approximate the marginal cost of care beyond the cutoff point applicable” is applicable both

to day outliers and to cost outliers. 42 U.S.C. § 1395ww(5)(A)(iii). The language of this clause is

necessarily capacious enough to accommodate both forms of outliers. 33 It is reasonable that the

agency treated “cost of care” similarly to the calculation of “charges, adjusted to cost” used to

determine whether a cost outlier payment was applicable for an individual case—in accordance

with the provisions regarding the outlier threshold just discussed. Pursuant to the regulations that

32

In the 1983 rulemaking, the agency explained why it was necessary to use a marginal cost

factor: “Marginal cost is the change in total cost associated with a one unit change in output. Due

to the presence of fixed costs, the marginal cost of care is generally less than the average cost.”

48 Fed. Reg. at 39,776. The use of a marginal cost factor to transform the average costs above

the threshold into the marginal costs above that threshold is not in dispute. Nor are the individual

marginal cost factors that the agency used in the fiscal years relevant to this dispute.

33

“For day outliers, an additional per diem payment is made for each covered day of care beyond

the length of stay threshold.” 53 Fed. Reg. at 38,502; see 42 C.F.R. § 412.82. “The per diem

payment is equal to 60 percent of the average per diem Federal rate for the DRG, which is

calculated by dividing the wage-adjusted Federal rate for the DRG by the geometric mean length

of stay for the DRG.” 53 Fed. Reg. at 38,502. The applicable percentage was set annually. 42

C.F.R. § 412.82. Day outliers are not at issue in this action.

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the agency promulgated, the agency adjusted charges to cost to determine whether those cost-

adjusted charges were above the applicable threshold, and then made a payment based on the

amount by which the cost-adjusted charges exceeded that threshold. See 53 Fed. Reg. at 38,503.

Although the statute does not refer to “cost of care” in clause (iii) as being derived from

“charges, adjusted to cost,” as it did in clause (i) regarding the determination of whether an

outlier payment is applicable, the agency’s interpretation that cost-adjusted charges should be

used to determine the amount of the cost outlier payment—just as cost-adjusted charges were

used to determine whether a case exceeds the threshold for payment—is wholly reasonable. See

Nat’l Credit Union Admin. v. First Nat. Bank & Trust Co., 522 U.S. 479, 501 (1998) (describing

“established canon of construction that similar language contained within the same section of a

statute must be accorded a consistent meaning”); see also Janko v. Gates, 741 F.3d 136, 141

(D.C. Cir. 2014) cert. denied, 135 S. Ct. 1530 (2015). So, too, is the agency’s determination that

it should use the same methodology for cost-adjustment in determining the amount of the outlier

payment as in determining the applicability of the outlier payment. Not only does consistency in

this context have the virtue of simplicity, it is also plainly reasonable.

In District Hospital Partners, the D.C. Circuit Court of Appeals used an example to

explain how outlier payments were generated for FY 2004 through FY 2006 and to explain the

relationship among fixed loss thresholds, cost-adjusted charges, and outlier payments for those

fiscal years. 786 F.3d at 50-51 (citing 62 Fed. Reg. at 45,997). Similarly, an example may be

helpful in explaining the relationship between the determination whether a specific case qualifies

for an outlier payment and the determination of the amount of any such outlier payment—with

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respect to the years at issue in this action. 34 Assume that the “cutoff point” for a certain DRG

category is $20,000. Pursuant to the regulations, the agency would adjust charges to cost based

on the applicable cost-to-charge ratio. If that cost-adjusted charge was above $20,000, a payment

would be available. If the charge for an individual case were $40,000 and the applicable cost-to-

charge ratio were 0.75 (or 75 percent), the cost-adjusted charge would be $30,000. Because that

amount is above $20,000, a payment would be available. The amount of the payment would be

the difference between the cost-adjusted charge ($30,000 in this example) and the threshold

($20,000)—after applying a marginal cost factor. If the marginal cost factor were 0.80, the

payment would be $8,000, or 80 percent of the difference between the cost-adjusted charge and

the threshold. It is reasonable to use the same the cost-adjusted charge—here a $40,000 charge

adjusted to a $30,000 estimated cost—to determine the amount of the payment as used to

determine whether a payment was warranted in the first place. Accordingly, the court concludes

that using cost-adjusted charges, pursuant to the methodology outlined above, to determine the

amount of the payment is a reasonable interpretation of the statutory requirement that the

“amount of the payment … shall … approximate the marginal cost of care beyond the cutoff

point applicable.” 42 U.S.C. § 1395ww(5)(A)(iii). In other words, the 1988 rulemaking was a

reasonable construction of the statute and is therefore consistent with the statute’s terms.

Turning to the 1994 rulemaking, only a brief discussion is necessary. In 1993, Congress

introduced the fixed loss threshold as the method of determining the applicable cutoff point used

to determine whether an outlier payment is available for a given case and to determine the

34

This analysis is equally applicable with respect to the statutory scheme extant in 1988 and with

respect to the statutory scheme as revised in 1993, when the “fixed loss threshold” was

introduced. For the purposes of this example, it is not necessary to review the calculation of the

threshold itself under those two schemes.

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amount of the outlier payments for such a case. 35 See 59 Fed. Reg. at 45,368. The following year,

the agency revised the outlier payment regulations to use the altered methodology specified by

statute for determining when payments would be available and the amounts of such payments.

See id. The changes to the outlier payment regulations in this rulemaking were limited to

implementing the 1993 statutory changes. See id. Although Plaintiffs name the 1994 rulemaking

as a source of the inconsistency between the statute and the regulations applicable for fiscal years

1997 through 2003, Plaintiffs point to nothing about the 1994 rulemaking that would create that

inconsistency. Perhaps Plaintiffs mean to suggest that the 1994 regulation implicitly re-adopted

the decisions promulgated in the 1988 regulation—although they do not identify anything in the

record suggesting that the agency had done so. Moreover, Plaintiffs do not point to anything that

would make those 1988 regulations unreasonable in 1994—but would not have made them

unreasonable in 1988. Accordingly, just as the Court concluded that the 1988 revisions to the

outlier payment regulations were consistent with the Medicare Act, the Court concludes that the

1994 regulations are consistent with the Medicare Act, as amended in1993.

Finally, the Court turns to the seven fixed loss threshold rulemakings for FY 1997

through FY 2003—when the 1988 and 1994 regulations were operative. Critically, each of those

rulemakings took the formula for outlier payments established by the applicable outlier payment

regulations—as amended in 1988 and then in 1994—as a given. For each year, taking those

formulas as given, the agency calculated a fixed loss threshold that was predicted to generate

35

Prior to the 1993 statutory amendments, outlier payments were made w

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