District Hospital Partners, L.P. v. Sebelius

UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF COLUMBIA

)
DISTRICT HOSPITAL PARTNERS, L.P., )
d/b/a The George Washington University )
Hospital, et al. )
)
Plaintiffs, )
)
v. ) Civil Action No. 11-0116 (ESH)
)
KATHLEEN SEBELIUS, )
Secretary, Department of Health and )
Human Services )
)
Defendant. )
)

MEMORANDUM OPINION

Plaintiffs own and operate 186 hospitals that participate in the Medicare program. They

have sued the Secretary of the Department of Health and Human Services (“Secretary”) in her

official capacity, alleging that her methodology for setting fixed loss thresholds for outlier

payments to their hospitals, under the Medicare Act, 42 U.S.C. § 1395 et seq., was arbitrary and

capricious for the Inpatient Prospective Payment System (“IPPS”) rules for federal fiscal years

(“FFYs”) 2004, 2005, and 2006. The factual and procedural history of this case has been set

forth in this Court’s earlier Memorandum Opinions.1

Now before the Court are the parties’ cross-motions for summary judgment.2 Plaintiffs

challenge the Secretary’s methodology for calculating the fixed loss threshold determinations for

1
See Mem. Op., July 5, 2011 [Dkt. No. 14] at 1, 6-7; Mem. Op. and Order, Sept. 10, 2013 [Dkt.
No. 111] at 2-5; Mem. Op. and Order, Sept. 19, 2013 [Dkt. No. 112].
2
See Def.’s Mem. of P. & A. in Support of Mot. for Summ. J. (“Def.’s Mot.”), April 15, 2013
[Dkt. No. 91-1]; Pls.’ Mem. of P. & A. in Opp’n to Def.’s Mot. for Summ. J and in Support of Pls.’
Cross-Mot. for Summ. J. (Pls.’ Mot.), May 17, 2013 [Dkt. No. 95]; Def.’s Reply Mem. in Support of Mot.
for Summ. J. and Mem. of P. & A. in Opp’n to Pls.’ Cross Mot. for Summ. J. (“Def.’s Reply”), June 20,
FFYs 2004-2006, claiming that she used historical charge inflation data and cost-to-charge ratios

that failed to account for the June 9, 2003 Outlier Correction Rule and thereby resulted in

underpayments to participating hospitals. Having considered the administrative record and the

parties’ briefings, the Court concludes that the Secretary made reasonable methodological

choices in determining the fixed loss thresholds for FFYs 2004-2006. Accordingly, the Court

will grant the Secretary’s motion for summary judgment and deny plaintiffs’ motion.

ANALYSIS

I. LEGAL STANDARDS

A. MEDICARE

Medicare is a federally funded system of health insurance for the aged and disabled. It is

administered by Centers for Medicare and Medicaid Services (“CMS”) under the direction of the

Secretary. 42 U.S.C. § 1395kk; 42 C.F.R. § 400.200 et seq. When Medicare providers treat the

program’s beneficiaries, they receive coinsurance and deductible payments from the patient and

then seek reimbursement for remaining costs from the Medicare program. Foothill Hosp.—

Morris L. Johnston Mem’l v. Leavitt, 558 F. Supp. 2d 1, 2 (D.D.C. 2008).

Rather than pay hospitals for the specific cost of treating each Medicare patient, Medicare

uses a “Prospective Payment System” (“PPS”), which compensates them at a fixed “federal rate”

that is based on the “average operating costs of inpatient hospital services.” Cnty. of Los Angeles

v. Shalala, 192 F.3d 1005, 1008 (D.C. Cir. 1999). Because Medicare payments are standardized

in this way, hospitals may be over- or under-compensated for any given procedure. The

2013 [Dkt. No. 101]; Pls.’ Reply Mem. in Support of Pls.’ Cross-Mot. for Summ. J. (“Pls.’ Reply”), July
24, 2013 [Dkt. No. 105]; Pls.’ Suppl. Mem. of P. & A. in Opp’n to Def.’s Mot. for Summ. J. and in
Support of Pls.’ Cross-Mot. for Summ. J. (“Pls.’ Suppl. Mem.”), Oct. 17, 2013 [Dkt. No. 119]; Def.’s
Suppl. Mem. on Parties’ Cross-Mots. for Summ. J. (“Def.’s Suppl. Mem.”), Oct. 31, 2013 [Dkt. No. 121];
Pl.’s Reply to Def.’s Suppl. Mem. on Parties’ Cross-Mot. for Summ. J. (“Pls.’ Suppl. Reply”), Nov. 8,
2013 [Dkt. No. 123].

2
Secretary therefore provides hospitals with additional “outlier payments” to compensate for

patients “whose hospitalization would be extraordinarily costly or lengthy.” Id. at 1009. This

case is about the Secretary’s setting of thresholds that determine these outlier payments.

The Secretary enters into contracts with private firms to “review provider reimbursement

claims and determine the amount due.” Catholic Health Initiatives v. Sebelius, 617 F.3d 490,

491 (D.C. Cir. 2010). These “fiscal intermediaries” determine the outlier payments awarded to

the hospitals. See id. & n. 1. Outlier payments are intended to “approximate the marginal cost of

care beyond certain thresholds.” Lenox Hill Hosp. v. Shalala, 131 F. Supp. 2d 136, 138 (D.D.C.

2000) (internal quotation marks omitted). The Medicare statute provides that

(ii) . . . [A hospital paid under the PPS] may request additional payments in any
case where charges, adjusted to cost . . . exceed the sum of the applicable DRG3
prospective payment rate plus any amounts payable under subparagraphs (B) and
(F) plus a fixed dollar amount determined by the Secretary.

(iii) The amount of such additional payment . . . shall be determined by the
Secretary and shall . . . approximate the marginal cost of care beyond the cutoff
point applicable. . . .

42 U.S.C. § 1395ww(d)(5)(A). The phrase “charges, adjusted to cost” refers to the Secretary’s

duty to “estimate a hospital’s costs based on the charges the hospital has billed for covered

services in the case.” (Def.’s Mot. at 3.) Cost is estimated by multiplying the amount that the

hospital charges by a “cost-to-charge ratio,” which is a number that represents a “hospital's

average markup.” Appalachian Reg’l Healthcare, Inc. v. Shalala, 131 F.3d 1050, 1052 (D.C.

Cir. 1997). The estimate of the hospital’s costs in a given case is then compared to the sum of

3
“DRG” stands for “diagnosis related group.” There are 470 DRGs, each of which is intended to
cover a medical condition. Cnty. of Los Angeles, 192 F.3d at 1008. The “DRG prospective payment rate”
is the standardized rate paid by the Secretary to a hospital after it has been adjusted for various factors,
including the “wage index” and the “weight assigned to the patient's DRG.” Id. at 1009.

3
two other factors (the “outlier threshold”).4 42 U.S.C. § 1395ww(d)(5)(A)(ii). If the estimate of

the costs is greater than the outlier threshold, the hospital is eligible for an outlier payment. See

id.

The amount of the outlier payment is proportional to the amount by which the hospital’s

loss exceeds the outlier threshold. Currently, hospitals are entitled to reimbursement of eighty

percent of costs above the outlier threshold. 42 C.F.R. § 412.84(k). Thus, if the outlier threshold

is $20,000 and a hospital’s cost estimate is $80,000, the hospital will be entitled to eighty percent

of $60,000 (the difference between the costs and the outlier threshold).

The outlier threshold represents the sum of two amounts: the DRG prospective payment

rate and the fixed loss threshold. Only the fixed loss threshold is at issue in this case. In

calculating the fixed loss threshold, the Secretary applies section 1395ww(d)(5)(A)(iv), which

requires the “total amount of the additional” outlier payments to be not “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.” See Cnty. of Los Angeles, 192 F.3d at

1013. The Secretary has interpreted this provision to require her to “select outlier thresholds

which, when tested against historical data, will likely produce aggregate outlier payments

totaling between five and six percent of projected or estimated DRG-related payments.” Id. She

has also interpreted the provision to mean that “she has no obligation to ensure that actual outlier

payments for the year total five percent of projected DRG-related payments.” Id.

The Secretary sets a fixed loss threshold for each FFY as part of massive annual IPPS

rulemakings that often span over four hundred pages in the Federal Register. For the three

rulemakings at issue in this case, the Secretary calculated the fixed loss threshold as follows.

4
Several other factors may affect the calculation of the outlier threshold but, as they are not at
issue in this case, they are omitted from this discussion. (See Def.’s Mot. at 4 n.4.)

4
First, the Secretary adjusted historical charge data using an inflation factor (also based on

historical data) to approximate hospitals charges in the upcoming FFY. Next, the Secretary

multiplied the inflation-adjusted charge universe by hospital-specific cost-to-charge ratios,

thereby projecting hospital costs for each case in the model. Third, the Secretary, after making

other adjustments not relevant to this case, modeled the effect different fixed loss thresholds

would have on outlier payments. (See Def.’s Mot. at 7; Pls.’ Mot. at 17-18.) Finally, the

Secretary selected a fixed loss threshold that she projected would satisfy the statutory target

under section 1395ww(d)(5)(A)(iv).

The Secretary’s methodology reveals three relevant arithmetic axioms. First, all things

being equal, a higher charge inflation factor will result in a higher fixed loss threshold. Second,

all things being equal, higher cost-to-charge ratios will result in a higher fixed loss threshold.

And finally, again all things being equal, a higher fixed loss threshold will result in a higher

outlier threshold and thus lower outlier payments to participating hospitals. (Pls.’ Mot. at 18.)

B. JUDICIAL REVIEW

Judicial review of plaintiffs’ claims under the Medicare Act rests on 42 U.S.C. §

1395oo(f)(1), which incorporates the Administrative Procedure Act (“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.”). The Court accordingly reviews the Secretary’s actions under the APA,

“pursuant to which [it] will uphold them unless they are ‘arbitrary, capricious, an abuse of

discretion, or otherwise not in accordance with law.’” Se. Ala. Med. Ctr. v. Sebelius, 572 F.3d

912, 916-17 (D.C. Cir. 2009) (quoting 5 U.S.C. § 706(2)(A)); see also St. Elizabeth’s Med. Ctr.

of Boston, Inc. v. Thompson, 396 F.3d 1228, 1233 (D.C. Cir. 2005) (“[J]udicial review of HHS

reimbursement decisions shall be made under APA standards”). “An agency decision is arbitrary

5
and capricious if it ‘relied on factors which Congress has not intended it to consider, entirely

failed to consider an important aspect of the problem, offered an explanation for its decision that

runs counter to the evidence before the agency, or is so implausible that it could not be ascribed

to a difference in view or the product of agency expertise.’” Cablevision Sys. Corp. v. F.C.C.,

649 F.3d 695, 714 (D.C. Cir. 2011) (quoting Motor Vehicle Mfrs. Ass’n of U.S., Inc. v. State

Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983)). The Court’s inquiry must focus on the

“reasonableness of the agency’s decisionmaking process,” and the Court “will not substitute [its]

judgment for that of the agency.” Rural Cellular Ass’n v. FCC, 588 F.3d 1095, 1105 (D.C. Cir.

2009). The Court has a “limited” role and its review is “particularly deferential” where the

agency’s decision is “primarily predictive.” Id. Thus, the Court will “‘defer to the agency’s

decision on how to balance the cost and complexity of a more elaborate model against the

oversimplification of a simpler model,’” West Virginia v. E.P.A., 362 F.3d 861, 868 (D.C. Cir.

2004) (quoting Small Refiner Lead Phase-Down Task Force v. E.P.A., 705 F.2d 506, 535 (D.C.

Cir. 1983), and “require[s] only that the agency acknowledge factual uncertainties and identify

the considerations it found persuasive.”5 Rural Cellular Ass’n, 588 F.3d at 1105. With these

principles in mind, the Court will now address each of plaintiffs’ challenges to the fixed loss

threshold determinations.6

5
Plaintiffs argue that the Secretary is not owed deference in this case due to “procedural
defect[s],” including, inter alia, her alleged “failure to use the best available data,” “failure to provide
reasoned explanations justifying certain actions,” and “fail[ure] to consider an important factor that, if
considered properly, would have formed the basis for a different policy.” (See Pls.’ Mot. at 30.) In so
arguing, plaintiffs misapprehend the standard of review. While procedural irregularities certainly could
render even predictive decisions arbitrary and capricious, the standard remains “particularly deferential,”
regardless of whether the Court ultimately defers to the Secretary’s determination.
6
Before turning to the merits, the Court will address plaintiffs’ renewal of “their request to have
the Scully Testimony included in the [administrative] records.” (Pls.’ Suppl. Mem. at 9-10 n.4.) The
Court previously rejected plaintiffs’ motion to compel the inclusion of the Scully Testimony in the
administrative records of this case (9/19/13 Mem. Op. at 22-24 & n.14) and interprets plaintiff’s attempt
to “renew their request” as a motion for reconsideration under Fed. R. Civ. P. 54(b). While relief is

6
II. FFY 2004 FIXED LOSS THRESHOLD DETERMINATION

In the FFY 2004 IPPS Rule, the Secretary established a fixed loss threshold of $31,000.

See Medicare Program; Changes to the Hospital Inpatient Prospective Payment Systems and

Fiscal Year 2004 Rates (“FFY 2004 IPPS Rule”), 68 Fed. Reg. 45346, 45476-78 (Aug. 1, 2003).

Although the Secretary had proposed a $50,645 fixed loss threshold for FFY 2004, id. at 45476,

she “lowered the [final] outlier threshold in response to the new provisions on outliers”

promulgated two months earlier in the June 9, 2003 Outlier Correction Rule. See id. at 45478;

see also id. at 45477.

The Secretary calculated the charge inflation factor for the FFY 2004 fixed loss threshold

by utilizing “the 2-year average annual rate of change in charges per case,” the same method she

had used for FFY 2003. Id. at 45476. For FFY 2004, the Secretary calculated the rate of change

using charge data from FFY 2000 to 2001 and FFY 2001 to 2002. Id.

In contrast, the Secretary adopted a new method for calculating cost-to-charge ratios. Id.

The Secretary explained: “[a]fter the changes in policy enacted by the final [Outlier Correction

Rule] this year, it is necessary to calculate more recent cost-to-charge ratios because fiscal

intermediaries will now use the latest tentatively settled cost report instead of the latest settled

available under Rule 54(b) within the discretion of the court “as justice requires,” see Cobell v. Norton,
355 F. Supp. 2d 531, 539 (D.D.C. 2005), generally “a court will grant [the] motion . . . only when the
movant demonstrates: (1) an intervening change in the law; (2) the discovery of new evidence not
previously available; or (3) a clear error in the first order.” Zeigler v. Potter, 555 F. Supp. 2d 126, 129
(D.D.C. 2008) (internal quotation marks omitted). Here, plaintiff argues the Court erred in concluding
that the relevant portions of the Scully Testimony were Administrator Scully’s personal opinions, rather
than the official position of CMS. In support of this position, plaintiffs attach a declaration from
Administrator Scully stating that his relevant testimony “did not represent any of [his] personal views.”
(Pls.’ Suppl. Mem. at 9-10 n.4). Even considering the newly produced declaration, the Court is
unpersuaded that the relevant portions of the Scully Testimony represent anything other than
Administrator Scully’s “personal opinion.” (See 9/19/13 Mem. Op. at 23 (quoting Scully Testimony at 13
(“And so I do think the outlier threshold – my personal opinion is that it probably, if we fix the abuses,
would be too high . . . .” (emphasis added))).) In any event, the new declaration from Administrator
Scully does not represent an intervening change in law or new evidence previously unavailable, or
otherwise demonstrate that the Court clearly erred in denying plaintiffs’ initial motion to compel.
Accordingly, the Court will deny plaintiffs’ renewed motion to compel.

7
cost report to determine a hospital’s cost-to-charge ratio.” Id. As a result, the Secretary

“approximated the latest tentatively settled cost reports” by

match[ing] charges-per-case to costs-per-case from the most recent cost reporting
year; . . . then divid[ing] each hospital’s costs by its charges to calculate the cost-
to-charge ratio for each hospital; and . . . [then] multipl[ying] charges from each
case in the FY 2002 MedPAR (inflated to FY 2004) by this cost-to-charge ratio to
calculate the cost per case.

Id.

Plaintiffs challenge the Secretary’s methodologies for calculating the charge inflation

factor and the cost-to-charge ratios.7 As plaintiffs explain, their “chief concern is that the

Secretary’s projected hospital costs were too high because the Secretary used unreasonably high

inflation factors and [cost-to-charge ratios].” (Pls.’ Reply at 7.) Plaintiffs continue, “[b]ecause

the projected hospital costs were unrealistically high, the difference between the projected

hospital costs and the projected IPPS payment was higher than it should have been” (id.) and

“caused the outlier underpayments at issue.” (Id. at 8.)8

7
A central tenet of administrative law requires that “issues not raised in comments before the
agency” during a given rulemaking “are waived” for purposes of challenging the reasonableness of that
rulemaking in court. See Nat’l Wildlife Fed’n v. E.P.A., 286 F.3d 554, 562 (D.C. Cir. 2002). The
Secretary is not asserting this defense with regard to the FFY 2004 IPPS Rule because at least one public
comment she received during that rulemaking “has been lost and is not included in the administrative
record for that determination.” (Def.’s Mot. at 23-24.) The Secretary does, however, assert this defense
as to the FFYs 2005 and 2006 IPPS Rules. (Id. at 23.)
8
Although plaintiffs make much of the fact that the fixed loss thresholds for FFYs 2004-2006
resulted in payments that ultimately undershot the statutory target in section 1395ww(d)(5)(A)(iv) (see
Pls.’ Mot. at 20-21; Pls.’ Reply at 1), plaintiffs’ “results-oriented” approach has been rejected in the face
of the Secretary’s consistent interpretation that the statute prescribes a “prospective-only policy” that the
Secretary project fixed loss thresholds with the statutory target in mind. See Cnty. of Los Angeles, 192
F.3d at 1018-20. Thus, it is irrelevant that the fixed loss thresholds established for FFYs 2004-2006
actually resulted in underpayments. The relevant question is only whether the predictive methodologies
used to set those thresholds were arbitrary and capricious as judged by the record before the Secretary at
the time each threshold was set. Cf. Am. Mining Cong. v. E.P.A., 907 F.2d 1179, 1190 (D.C. Cir. 1990)
(holding that post-1980 data is irrelevant to review of an “agency’s determination, based on 1980 data,
that spent potliners are hazardous wastes.”)

8
 A. CHARGE INFLATION FACTOR

Plaintiffs first argue that the Secretary’s calculation of the charge inflation factor using

historical data from FFYs 2000-2002 was arbitrary and capricious because the data were from

the “turbo-charging”9 era when charge inflation was rampant and therefore failed to account for

predictable decreases in charge inflation following the promulgation of the Outlier Correction

Rule. (See Pls.’ Mot. at 33.) As a result, plaintiffs continue, the Secretary overinflated the

historical charge data when projecting FFY 2004 charges, resulting in an excessively high fixed

loss threshold determination. (Id. at 34.)

In support of their argument, plaintiffs point first to the Outlier Correction Interim Final

Rule (“IFR”). In the IFR, the Secretary considered a mid-year reduction in the FFY 2003 fixed

loss threshold to account for contemplated changes in outlier policy meant to eradicate turbo

charging. (See FFY 2004 AR at 2242-43.) To calculate a charge inflation factor for the

proposed mid-year fixed loss threshold reduction, the Secretary excluded data from 123 of the

worst turbo-charging hospitals for which she “could not reliably predict the . . . cost-to-charge

ratios.” (See id. at 2277, 2279.) However, by the time she issued her Proposed Outlier

Correction Rule, the Secretary had decided against any mid-year fixed loss threshold reduction

because of “extreme uncertainty regarding the effects of aggressive hospital charging practices.”

See Medicare Program; Proposed Change in Methodology for Determining Payment for

Extraordinarily High-Cost Cases (Cost Outliers) Under the Acute Care Hospital Inpatient

Prospective Payment System, 68 Fed. Reg. 10420, 10426-27 (March 5, 2003). Likewise, in the

9
“Turbo-charging” refers to “abusive, excessive charging practices” (Def.’s Mot. at 10) in which
“rapid increases in charges by certain hospitals . . . resulted in their cost-to-charge ratios being set too
high” and caused “excessive outlier payments to these hospitals.” Medicare Program; Change in
Methodology for Determining Payment for Extraordinarily High-Cost Cases (Cost Outliers) Under the
Acute Care Hospital Inpatient and Long-Term Care Hospital Prospective Payment Systems (“Outlier
Correction Rule”), 68 Fed. Reg. 34494, 34496 (June 9, 2003).
9
Final Outlier Correction Rule, the Secretary found, based on her analysis of more recent data,

that it was appropriate “not to change the FY 2003 outlier threshold” at that time. Outlier

Correction Rule, 68 Fed. Reg. at 34506.

Because the Secretary decided against making a mid-year adjustment to the FFY 2003

fixed loss threshold in the Outlier Correction Rule, her consideration in the IFR of excluding data

from the 123 worst turbo-charging hospitals when adjusting the threshold was not addressed in

either the Proposed or Final Outlier Correction Rules. Plaintiffs now argue that the Secretary

acted arbitrarily and capriciously during the subsequent FFY 2004 IPPS Rulemaking by failing

to adopt what she had considered doing in the IFR – i.e., excluding data from these 123 hospitals

when calculating the charge inflation factor. This argument comprises several sub-arguments.

Plaintiffs first argue the Secretary’s abandonment, “without explanation,” of the IFR’s

exclusion of data from the 123 turbo-charging hospitals, is itself arbitrary and capricious. (Pls.’

Mot. at 33; cf. Pls.’ Suppl. Mem. at 6-8.) However, this is not a case where the Secretary

“rescinded a policy or reversed course without explaining why [she] did not take a more limited

action.” See Nat’l Shooting Sports Found., Inc. v. Jones, 716 F.3d 200, 216-17 (collecting

cases); cf. Motor Vehicle Mfrs. Ass’n, 463 U.S. at 42 (“[A]n agency changing its course by

rescinding a rule is obligated to supply a reasoned analysis for the change beyond that which

may be required when an agency does not act in the first instance.”). Instead, this is a case where

a particular methodology considered when drafting an interim version of a rule, but never

adopted formally, even in a proposed rule, was tacitly rejected in favor of continued practice of

including data from all hospitals when calculating the charge inflation factor. “[U]p to the point

of announcement, agency decisions are freely changeable, as are the bases of those decisions.”

PLMRS Narrowband Corp. v. F.C.C., 182 F.3d 995, 1001-02 (D.C. Cir. 1999) (quoting

10
Checkosky v. S.E.C., 23 F.3d 452, 489 (D.C. Cir. 1994)); cf. Kennecott Utah Copper Corp. v.

U.S. Dep’t of Interior, 88 F.3d 1191, 1208-09 (D.C. Cir. 1996) (holding final regulation that was

withdrawn after being signed, but before being filed for public inspection, was never a binding

rule or regulation requiring repeal or modification, and rejecting plaintiff’s view that “whenever

agencies propose rules, receive comments from the public, and internally approve a draft version

of the final regulations, the APA would prevent agencies from discarding those documents

without again requesting public comment”). Thus, because the IFR’s exclusion of data from 123

turbo-charging hospitals never represented agency policy, the Secretary was under no duty to

explain why she chose to follow her prior practice and not adopt that new methodology during

the later FFY 2004 IPPS Rulemaking.

Plaintiffs relatedly argue that, even if the Secretary were not obligated to explain why she

did not adopt the methodologies considered in the IFR, she was obligated to explain why she

included the charge data for the 123 turbo-charging hospitals when calculating the FFY 2004

outlier threshold. (See Pls.’ Mot. at 36-37; Pls.’ Suppl. Mem. at 6-8.)10 While the Secretary

“must consider reasonably obvious alternative[s] . . . and explain its reasons for rejecting

alternatives in sufficient detail to permit judicial review,” see Walter O. Boswell Mem’l Hosp. v.

Heckler, 749 F.2d 788, 797 (D.C. Cir. 1984) (internal quotation marks omitted), the Secretary’s

10
Plaintiffs also suggested that the Secretary acted arbitrarily and capriciously by “not explaining
why she found in the IFR that the data from 123 high charging hospitals was so distorted . . . that it had to
be excluded” but in the FFY 2004 IPPS rulemaking “only identified 50 such hospitals that required
special treatment” – i.e., reconciliation. (See Pls.’ Mot. at 37; id. at 41-42.) However, as the Secretary
explains, the IFR and the FFY 2004 IPPS Rule’s reconciliation provision “were simply discussing
different analyses of different subjects; there is no reason the count of 123 hospitals and the count of 50
hospitals should have matched up.” (Def.’s Reply at 15.) The IFR identified the 123 most egregious
turbo-charging hospitals based on historical FFY 1999 to FFY 2001 data, while the FFY 2004 IPPS Rule
“identified approximately fifty hospitals” for which the Secretary believed outlier payments would likely
be reduced after reconciliation based on future charging practices. See 68 Fed. Reg. at 45476-77. These
two distinct issues do not lend themselves to comparison or trigger any duty for the Secretary to explain
her unspoken rejection of the IFR’s consideration of excluding data from the 123 worst turbo-charging
hospitals.

11
implicit rejection of an exclusion of data from the 123 hospitals is not the type of “reasonably

obvious alternative” for which an agency must explain its rejection. See Nat’l Shooting Sports

Found., 716 F.3d at 215 (“While an agency must consider and explain its rejection of

‘reasonably obvious alternative[s],’ it need not consider every alternative proposed nor respond

to every comment made.” (quoting Natural Res. Def. Council, Inc. v. S.E.C., 606 F.2d 1031,

1053 (D.C. Cir. 1979)); see also Ass’n of Private Sector Colls. & Univs. v. Duncan, 681 F.3d

427, 441 (D.C. Cir. 2012) (“An agency's obligation to respond . . . is not ‘particularly

demanding.’”); City of Brookings Mun. Tel. Co. v. F.C.C., 822 F.2d 1153, 1169 (D.C. Cir. 1987)

(duty to consider reasonable alternatives extends only to “significant and viable” alternatives).

As the Secretary argues, there is nothing talismanic, let alone “reasonably obvious,” about the

number 123 such that the Secretary needed to explain why she did not exclude data from those

123 hospitals. (Def.’s Reply at 17-18; Def.’s Suppl. Mem. at 5.) And the Secretary’s

consideration of excluding data from that particular number of hospitals in a prior rulemaking

that utilized now-outdated data and which was ultimately not adopted in that rulemaking, Outlier

Correction Rule, 68 Fed. Reg. at 34505-06, does not render that alternative so “obvious” that the

Secretary need address it, unprompted by commenters, in a subsequent rulemaking.

Further, although excluding data from those 123 hospitals may have been a reasonable

option for the Secretary to pursue, it does not follow that the Secretary’s decision to include data

from those (or, indeed, any) turbo-charging hospitals necessarily would be unreasonable. The

Secretary’s choice to calculate the charge inflation factor with a dataset including the 123

hospitals most notorious for turbo charging could overstate inflation rates and result in an

excessively high fixed loss threshold. However, regardless of the methodology used, those 123

hospitals continued receiving outlier payments after the Outlier Correction Rule, and failing to

12
account at all for those hospitals could understate the charge inflation factor and result in an

excessively low fixed loss threshold. (See Def.’s Reply at 16-17.) As the D.C. Circuit has

clarified, a decision “to include a suspicious data point because it was relevant” – what the

Secretary did here – and a decision to “exclude a relevant data point because it was suspicious” –

what the Secretary considered in the IFR – are both “rational” choices. Bell Atl. Tel. Cos. v.

F.C.C., 79 F.3d 1195, 1203 (D.C. Cir. 1996); cf. Mt. Diablo Hosp. v. Shalala, 3 F.3d 1226, 1233

(9th Cir. 1993) (“The agency simply chose one imperfect database over another while seeking to

develop data superior to either. This choice was rational.”).

Unable to avoid the fact that the Secretary did not need to address the possibility of

excluding data from the 123 hospitals unless that proposal was a “reasonably obvious

alternative,” Nat’l Shooting Sports Found., 716 F.3d at 216-17, plaintiffs argue more generally

that the Secretary failed to “properly account for the effect of her regulatory changes on hospital

behavior.” (Pls.’ Mot. at 34.)11 In so arguing, plaintiffs cite County of Los Angeles v. Shalala,

192 F.3d 1005 (D.C. Cir. 1999), and Alvarado Community Hospital v. Shalala, 155 F.3d 1115

(9th Cir. 1998). However, those cases provide no support for plaintiffs’ position.

Plaintiffs in County of Los Angeles and Alvarado challenged the fixed loss threshold set

for FFY 1985 on the ground that the Secretary used 1981 MedPAR data, rather than preliminary

and incomplete 1984 MedPAR data, when setting the threshold. Cnty. of Los Angeles, 192 F.3d

at 1020; Alvarado, 155 F.3d at 1121. Both the D.C. and the Ninth Circuits held that the

Secretary failed to provide “adequate explanation for the decision to rely on the 1981 MedPAR

data rather than more recent data that would reflect” recent regulatory changes post-dating the

11
As noted above, the Secretary accounted for the Outlier Correction Rule in the final FFY 2004
fixed loss threshold, resulting in a final threshold she estimated to be $17,000 lower than if she had not
accounted for the Rule. See FFY 2004 IPPS Rule, 68 Fed. Reg. at 45477. Thus, plaintiff’s argument,
more properly stated, is that the Secretary did not sufficiently account for the effect of the Outlier
Correction Rule on hospital behavior.

13
1981 data. Alvarado, 155 F.3d at 1122; see also Cnty. of Los Angeles, 192 F.3d at 1021

(agreeing with Alvarado). Notably, however, neither court concluded that the Secretary failed to

adequately account for regulatory changes when setting the fixed loss threshold; rather, those

courts faulted the Secretary on the narrow ground that she failed to explain why she did not

calculate the threshold using more recent and available (even if incomplete) data that should

have reflected hospitals’ behavioral changes in response to the new regulatory regime.12 In this

case, there is no evidence in the administrative record that at the time of the FFY IPPS 2004

Rulemaking the Secretary had available any analogous and more recent data that could have

been used to more accurately account for the changes in hospital behavior brought about by the

Outlier Correction Rule.13 Without such data, County of Los Angeles and Alvarado are

12
Indeed, the D.C. Circuit did not conclude that using the 1981 MedPAR data necessarily was
per se unreasonable, but rather remanded the issue back to the Secretary for further explanation. See
Cnty. of Los Angeles, 192 F.3d at 1023 (remanding to Secretary to recalculate of outlier threshold “or to
offer a reasonable explanation for refusing to use the 1984 data in setting outlier thresholds during those
years”). The D.C. Circuit’s decision to remand for further agency explanation only further highlights that
the decision focused, first and foremost, on the data considered and not, as plaintiffs suggest, on a general
(and incurable) failure to account for regulatory changes.
13
For this same reason, plaintiffs’ related argument that the Secretary did not use the “best
available data” for estimating future charges (Pls.’ Mot. at 35-36) also fails. Plaintiffs cannot succeed on
a “best available data” claim based on vague and generalized assertions that better data existed at the time
of the decision without pointing to evidence that such data actually existed. Cf. Sw. Ctr. for Biological
Diversity v. Babbitt, 215 F.3d 58, 61 (D.C. Cir. 2000) (holding that, where agency was under a duty to
make statutory determinations “on the basis of the best available data,” the district court erred in imposing
“an obligation upon the [agency] to find better data”); Baystate Med. Ctr. v. Leavitt, 545 F. Supp. 2d 20,
49 n.31 (D.D.C. 2008) (“Of course, a court cannot require an agency to develop data that does not
presently exist.”). To the extent plaintiffs purport to argue that the “best available data” are that which
excludes data from the 123 turbo-charging hospitals, the Court rejects this argument for the same reasons
as noted above. See Mt. Diablo Hosp., 3 F.3d at 1233. And to the extent plaintiffs suggest that the
Secretary should have used more recent partial-year data to calculate the charge inflation factor, as she
did in the FFY 2005 IPPS Rulemaking, see Medicare Program; Changes to the Hospital Inpatient
Prospective Payment Systems and Fiscal Year 2005 Rates (“FFY 2005 IPPS Rule”), 69 Fed. Reg. 48916,
49277 (Aug. 11, 2004), there is no evidence that such partial-year data existed or was available to the
Secretary at the time of the FFY 2004 IPPS Rulemaking. In any event, plaintiffs cannot use changes
adopted in a later rulemakings to question the reasonableness of earlier rulemakings. See Alvin Lou
Media, Inc. v. F.C.C., 571 F.3d 1, 12 (D.C. Cir. 2009) (noting that a proposed change in FCC policy that
brought auction procedures in line with those long-proposed by commenters does not affect the
reasonableness “is of no moment” to whether prior procedures were reasonable when adopted); see also

14
inapposite and the Court concludes that the Secretary acted reasonably when she calculated the

charge inflation factor for the FFY 2004 IPPS Rule by using data from all participating hospitals.

B. COST-TO-CHARGE RATIOS

Although plaintiffs concede that the Secretary attempted to calculate more accurate cost-

to-charge ratios in the wake of the Outlier Correction Rule by relying on the latest tentatively

settled cost reports, rather than the latest settled cost reports (see Pls.’ Mot. at 21-22), they argue

that the Secretary did not go far enough to compensate fully for predictable changes in hospital

behavior. In particular, plaintiffs make three arguments: (1) that using the “latest tentatively

settled cost report” still resulted in cost-to-charge ratios based on data that was outdated and

inadequately reflective of the Outlier Correction Rule (id. at 38-40); (2) that the Secretary failed

to account for the Outlier Correction Rule’s termination of defaulting certain hospitals’ cost-to-

charge ratios to the statewide average (id. at 41); and (3) that the Secretary failed to account for

the Outlier Correction Rule’s post-payment reconciliation mechanism, which would lower the

cost-to-charge ratios for some reconciled hospitals. (Id. at 41-43).14

James Madison Ltd. v. Ludwig, 82 F.3d 1085, 1095 (D.C. Cir. 1996) (limiting review of administrative
decision to the administrative record “before the agency at the time the decision was made” (internal
quotation marks omitted)).
14
In their complaint, plaintiffs alleged that “the Secretary failed to consider use of the ‘cost
methodology,’ rather than the ‘charge methodology,’ in setting outlier thresholds, despite the fact that the
cost methodology had been more accurate in predicting outlier payments in prior years.” (Compl., Jan.
19, 2011 [Dkt. No. 1] at 33.) Plaintiffs now limit their discussion of the “cost” versus “charge”
methodologies to a single footnote, stating only that “[i]n response to the FFY 2004, 2005, and 2006
proposed rules, several hospitals submitted comments to the Secretary asking her to return to cost
methodology for calculation of the inflation adjustment factor.” (Pls.’ Mot. at 38 n. 36.) Because
plaintiffs fail to provide any argument for why the Secretary’s choice to use a “charge methodology” for
FFYs 2004-2006 is arbitrary and capricious, the Court considers this allegation to have been abandoned.
In any event, the Court finds the Secretary adequately explained her reasonable choice to continue using a
“charge methodology” to set fixed loss thresholds for FFYs 2004-2006. See FFY 2004 IPPS Rule, 68
Fed. Reg. at 45476 (adopting rationale of FFY 2003 IPPS Rule); FFY 2005 IPPS Rule, 69 Fed. Reg. at
49277 (“[W]e believe the use of charge inflation is more appropriate than our previous methodology of
cost inflation because charges tend to increase at a much faster rate than costs.”); Medicare Program;
Changes to the Hospital Inpatient Prospective Payment Systems and Fiscal Year 2006 Rates (“FFY 2006

15
 1. Latest tentatively settled cost reports

Before the Outlier Correction Rule, fiscal intermediaries calculated cost-to-charge ratios

using the latest settled cost reports. See Outlier Correction Rule, 68 Fed. Reg. at 34497.

Because the cost reports had to be fully settled before they could be used, there existed a time lag

between a hospital’s charges and those charges’ reflection in a settled cost report used by fiscal

intermediaries. For instance, cost-to-charge ratios calculated and used to set the FFY 2003 fixed

loss threshold were based on “cost reports that began in FY 2000 or, in some cases, FY 1999 or

even earlier.” Id. Hospitals took advantage of this several-year time lag by turbo charging:

hospitals’ dramatic increases of charges at a greater rate than costs during the time lag, while

fiscal intermediaries applied higher historical cost-to-charge ratios, caused overestimated

hospital costs and resulted in overpayments to the turbo-charging hospitals. Id.; see also supra

note 9.

In response, the Outlier Correction Rule’s first step to address turbo charging was to

allow fiscal intermediaries to use the latest tentatively settled cost reports to calculate cost-to-

charge ratios. See id. at 34497-98. Providing this alternative data source for fiscal

intermediaries significantly reduced the time lag in the IPPS process:

Hospitals must submit their cost reports within 5 months after the end of their
fiscal year. CMS makes a decision to accept a cost report within 30 days. Once
the report is accepted, CMS makes a tentative settlement of the cost report within
60 days. . . . After the cost report is tentatively settled, it can take 12 to 24
months, depending on the type of review or audit, before the cost is final-settled.
Thus, using cost-to-charge ratios from tentative settled cost reports . . . reduces
the time lag for updating cost-to-charge ratios by a year or more.

IPPS Rule”), 70 Fed. Reg. 47278, 47495 (Aug. 12, 2005) (continuing to use charge methodology because,
inter alia, it “more closely captures how actual outlier payments are calculated”).

16
Id. at 34497.15 As described above, for the FFY 2004 IPPS Rule, the Secretary had to

“approximate[]” the latest tentatively settled cost reports. See FFY 2004 IPPS Rule, 68 Fed.

Reg. at 45476.

Plaintiffs challenge the Secretary’s use of approximated tentatively settled cost reports on

two grounds. First, plaintiffs argue that the Secretary failed to adequately explain how she

“approximated” the tentatively settled cost reports for FFY 2004. (Pls.’ Mot. at 39-40.) While

the Secretary’s description of her “approximation” process, see FFY 2004 IPPS Rule, 68 Fed.

Reg. at 45476, may not be a paragon of clarity, it is not so unclear as to be unreasonable. For “a

court is not to substitute its judgment for that of the agency, and should uphold a decision of less

than ideal clarity if the agency’s path may reasonably be discerned.” F.C.C. v. Fox Television

Stations, Inc., 556 U.S. 502, 513-14 (2009) (internal quotation marks and citations omitted).

Here, it is reasonably discernable that the Secretary used provider-specific data from the most

recent cost reporting year to approximate, in a logical manner, what the latest tentatively settled

cost reports would have provided, if available. See FFY 2004 IPPS Rule, 68 Fed. Reg. at 45476.

This is sufficient under the APA.

Second, and more fundamentally, plaintiffs argue that the Secretary’s use of latest

tentatively settled cost reports (even approximated ones) was unreasonable because the data

underlying the reports were outdated and failed to reflect the continuing trend in declining cost-

to-charge ratios. (Pls.’ Mot. at 38-39; Pls.’ Suppl. Mem. at 4, 9.) And because the latest

tentatively settled cost reports for FFY 2004 would be based on data from, depending on the

15
The Secretary noted that, notwithstanding the use of the tentatively settled cost reports, in some
instances “there would still be a lag of 1 to 2 years during which a hospital’s charges may still increase
faster than costs,” providing hospitals the opportunity to turbo charge. See Outlier Correction Rule, 68
Fed. Reg. at 34497. To address this possibility, the Secretary promulgated her reconciliation provision,
discussed infra. See id. at 34497-98.

17
hospital, FFYs 2001 or 20002, the reports would not be reflective at all of hospitals’ behavioral

changes caused by the Outlier Correction Rule.16 (Pls.’ Mot. at 38-39.) Plaintiffs suggest that

the Secretary should have accounted for the “predictable decrease” in cost-to-charge ratios that

occurred during the time lag between the data underlying the latest tentatively settled cost report

and when costs were incurred during FFY 2004. (Id. at 38.)

Notably, however, plaintiffs offer no specific suggestions as to how the Secretary should

have accounted for a trend in decreasing cost-to-charge ratios. And, considering that the

Secretary’s application of an (approximated) latest tentatively settled cost report (and other

provisions of the Outlier Correction Rule) resulted in a significant decrease in cost-to-charge

ratios and, in effect, the fixed loss threshold from the FFY 2004 IPPS Proposed Rule, see 68 Fed.

Reg. at 45477, it is apparent that a significant decrease in applicable cost-to-charge ratios already

was captured by the new methodologies inherent in the Outlier Correction Rule. Any additional

consideration of decreasing cost-to-charge ratios would require projections of changes in hospital

behavior (and thus cost-to-charge ratios) at the expense of the use of historical data. Given the

deferential standard that the Court is to apply, see West Virginia, 362 F.3d at 868, it will not

invalidate the Secretary’s decision to use actual historical data when setting the fixed loss

threshold.

2. Defaulting to statewide averages

Prior to the Outlier Correction Rule, the Secretary would apply statewide average cost-to-

charge ratios to those hospitals whose cost-to-charge ratios fell “below the range considered

reasonable under regulations.” Outlier Correction Rule, 68 Fed. Reg. at 34499. The Outlier

16
Although the Secretary intended the Outlier Correction Rule to eliminate turbo charging (which
itself caused decreasing cost-to-charge ratios), the rule predictably would cause lower cost-to-charge
ratios, at least in the short term, by utilizing more recent data reflective of the turbo charging that had
occurred prior to rule’s promulgation.

18
Correction Rule identified this default to statewide averages as a “vulnerability” of which certain

hospitals had taken advantage “to maximize their outlier payments,” id. at 34496, by increasing

their “charges at extreme rates.” Id. at 34499. By defaulting to statewide averages, the Secretary

found that forty-three turbo-charging hospitals were receiving higher outlier payments than they

would have if their actual cost-to-charge ratios were applied. Id.

The Outlier Correction Rule terminated the practice of defaulting to statewide averages

when hospitals’ cost-to-charge ratios fall below the prior-defined reasonableness threshold. See

id. at 34499-500. Because the hospitals that had previously defaulted to statewide averages

would now have their actual (and very low) cost-to-charge ratios applied, this change in policy

would result in (all other things being equal) a decline in the fixed loss threshold. As a result,

during the FFY 2004 IPPS Rulemaking at least one commenter recommended that the Secretary

take into account the elimination of the use of statewide averages when calculating the fixed loss

threshold. (See FFY 2004 AR 2240 (comment of Fed’n of Am. Hosps.)

Plaintiffs assert that the Secretary “never addressed in the Rulemakings how she

accounted for the change in policy regarding default to statewide averages.” (Pls.’ Mot. at 41.)

Although plaintiffs are correct that the Secretary did not directly address how she accounted for

the elimination of the statewide averages, she clearly accounted for the change in policy. See

FFY 2004 IPPS Rule, 68 Fed. Reg. at 45476 (“To calculate the FY 2004 outlier thresholds, we

simulated payments by applying FY 2004 rates and policies using cases from the FY 2002

MedPAR file (emphasis added); see also id. at 45477 (“As described above, we are reflecting the

changes made to outliers from the [Outlier Correction Rule]. These changes have resulted in a

substantial reduction in the outlier threshold from the proposed level.”); id. at 45661-63 & tbl. I

col. 2 & n.2 (regulatory impact analysis showing that policies of Outlier Correction Rule

19
amounted to a lower fixed loss threshold for FFY 2004). Further, the Court notes that

elimination of the use of statewide averages seems to account for itself in the fixed loss threshold

calculation. Because the statewide average policy substituted statewide averages for actual (very

low) cost-to-charge ratios, the policy’s discontinuance merely defaulted back to the exclusive use

of actual cost-to-charge ratios when calculating the fixed loss threshold. Cf. id. at 45476.

Finally, to the extent that plaintiffs suggest that the Secretary should have (by some

undefined means) attempted to project how the elimination of the statewide average policy

(which applied to only forty-three hospitals in FFY 2003) would affect hospital behavior and

thus cost-to-charge ratios more generally, the Court defers to the Secretary’s decision not to

undertaking the task of modeling the undoubtedly complex and attenuated effects of the policy

on hospital behavior. See West Virginia, 362 F.3d at 868.17

3. Reconciliation

In the Outlier Correction Rule, the Secretary also attempted to address the threat that,

notwithstanding other actions intended to end turbo charging, a hospital could still “dramatically

increase its charges by far above the rate-of-increase in costs during any given year” and

therefore take advantage of the inherent time lag in the IPPS process to “manipulate the system

to maximize outlier payments.” Outlier Correction Rule, 68 Fed. Reg. at 34503; see also id. at

34501. The Secretary therefore adopted a cost report reconciliation process whereby fiscal

intermediaries would reconcile outlier payments on “a limited basis” when a hospital’s actual

cost-to-charge ratios were found to be substantially different from those ratios (from the

tentatively settled cost reports) used to make the initial outlier payments. See id. at 34501-03.

17
It is unclear whether plaintiffs challenge the FFYs 2005 and 2006 IPPS Rules on any grounds
related to the Outlier Correction Rule’s changes in statewide average policy. To the extent they do, the
Court declines to reach the merits because plaintiffs have not identified comments which raised the issue
before the agency during either rulemaking. See Nat’l Wildlife Fed’n, 286 F.3d at 562.

20
For those hospitals, the reconciled outlier payments “would be based on the relationship between

the hospital’s costs and charges at the time a discharge occurred” such that the payments “would

reflect an accurate assessment of the actual cost the hospital incurred,” rather than a projection of

cost based on cost-to-charge ratios calculated using hospitals’ most recent tentatively settled cost

report at the time of initial outlier payment. See id. at 34501.

Plaintiffs argue that reconciliation, even on a limited basis, “punishes hospitals if their

[cost-to-charge] ratios are too high” and was thus intended “to lower [cost-to-charge] ratios that

are too high.” (Pls.’ Mot. at 41.) According to plaintiffs, including cost-to-charge ratios from

hospitals potentially subject to reconciliation when calculating the fixed loss threshold

overestimates costs and overstates the fixed loss threshold. (Id.; see also, e.g., FFY 2004 AR at

2200.75-.76 (comment of Am. Hosp. Assoc.).) Plaintiffs accordingly assert that the Secretary

acted arbitrarily and capriciously by not accounting for the effect of reconciliation on the fixed

loss threshold calculation.18 (Pls.’ Mot. at 41.)

Although the Secretary did not adjust her overall methodology for calculating the fixed

loss threshold to account for potential reconciliations, the Secretary did not ignore the issue.

Instead, the Secretary explained that it was impossible to predict the full effects of reconciliation

in advance because

it is difficult to project which hospitals will be subject to reconciliation of their
outlier payments using available data. For example, for most hospitals, the latest
available cost data are from FY 2000. In addition, the amount of fiscal
intermediary resources necessary to undertake reconciliation will ultimately

18
Plaintiffs also assert that the Secretary addressed reconciliation in the IFR “by excluding data
from the 123 turbo-charging hospitals, which are the hospitals most likely to be subject to reconciliation,”
and thus suggests she should have done so for the FFY 2004 IPPS Rule. (Pls.’ Mot. at 41.) However, the
IFR at no point states that its proposed exclusion of data from 123 turbo-charging hospitals is meant to
address the effects of reconciliation on the fixed loss threshold calculation. (See FFY 2004 AR 2264-68.)
Indeed, as noted supra note 10, the issues of charge inflation and reconciliation, although related, are
distinct.

21
 influence the number of hospitals reconciled. Without actual experience with the
reconciliation process, it is difficult to predict the number of hospitals that will be
reconciled.

FFY 2004 IPPS Rule, 68 Fed. Reg. at 45476. Nevertheless, for those hospitals the Secretary

projected face reconciliation, the Secretary did “attempt[] to project each hospital’s [reconciled]

cost-to-charge ratio based on its rate of increase in charges per case based on FY 2002 charges,

compared to costs.” Id. at 45476-77. The Court finds the Secretary’s decision, which implicates

her predictive expertise as applied to a complex and newly implemented procedure, to be

reasonable and adequately responsive to plaintiffs’ (and commenters’) concerns. See

Cablevision Sys. Corp., 649 F.3d at 714.19

III. FFY 2005 FIXED LOSS THRESHOLD DETERMINATION

In the FFY 2005 IPPS Rulemaking, the Secretary explained that “[d]ue to the limited

time from the publication of the [Outlier Correction Rule] to the publication of the IPPS final

rule for FY 2004,” she had “insufficient data to determine the full impact” the Outlier Correction

Rule “would have on hospital charges” when the FFY 2004 IPPS Rule was finalized. FFY 2005

IPPS Rule, 69 Fed. Reg. at 49277. However, the Secretary had “more recent data reflecting the

impact of the [Outlier Correction Rule] upon hospital charges” during the FFY 2005 IPPS

Rulemaking. Id. Thus, after initially proposing a $35,085 fixed loss threshold for FFY 2005, id.

at 49276, the Secretary “revised [her] methodology” for calculating the fixed loss threshold “to

address both the changes to the outlier payment methodology [from the Outlier Correction Rule]

and the exceptionally high rate of hospital charge inflation that is reflected in the data for FYs

2001, 2002, and 2003.” Id. at 49277. As a result of these changes in methodology, the Secretary

established a fixed loss threshold of $25,800 for FFY 2005. Id. at 49278.

19
The Court also finds reasonable the Secretary’s implicit decision not to attempt to predict how
reconciliation might influence future hospital behavior and cost-to-charge ratios for the purposes of
setting the FFY 2004 fixed loss threshold. See West Virginia, 362 F.3d at 868.

22
 Relevant to this case, the Secretary changed her methodology for calculating the charge

inflation factor for FFY 2005. Id. at 49277. “Instead of using the 2-year average annual rate of

change in charges per case from FY 2001 to FY 2002 and FY 2002 to FY 2003,” as she had in

prior years, the Secretary used “more recent data to determine the annual rate of change in

charges for the FY 2005 outlier threshold.” Id. Specifically, the Secretary began utilizing the

“first half-year of data from FY 2003 and comparing this data to the first half year of data for FY

2004.” Id. The Secretary explained that this comparison, using the “most recent charge data

available” would “result in a more accurate determination of the rate of change in charges per

case between FY 2003 and FY 2005” than a comparison of charge increases from FFYs 2001 to

2002 and FFYs 2002 to 2003. Id.

In contrast, the Secretary did not change her methodology for calculating cost-to-charge

ratios. As in FFY 2004, the Secretary “used hospital cost-to-charge ratios from the most recent

Provider Specific File, in this case the April 2004 update.” Id. The Secretary did not believe

that it was necessary to make an adjustment to her methodology for computing cost-to-charge

ratios to account for any decline in cost-to-charge ratios brought about by the Outlier Correction

Rule. Id. In support of her position, the Secretary explained that, in the FFY 2004 IPPS

Rulemaking, she had “already taken into account the most significant factor in the decline in

cost-to-charge ratios, specifically, the change from using the most recent final settled cost report

to the most recent tentatively settled cost report.” Id. Moreover, the Secretary expressed a

“strong[]” preference to utilize “actual data rather than projections in estimating the outlier

threshold because [she] employ[s] actual data in updating charges, themselves.” Id. at 49277-78.

Although plaintiffs’ challenges to the FFY 2005 IPPS Rule are far from clear, plaintiffs

seem to attack the Secretary’s methodologies for calculating both the charge inflation factor and

23
cost-to-charge ratios. (Pls.’ Mot. at 23-24; Pls.’ Reply at 11-12.) As with the FFY 2004 IPPS

Rule, plaintiffs assert that her methodological decisions once again “overstated the outlier

threshold, resulting in a significant payment reduction to hospitals.” (Pls.’ Mot. at 24.)

A. CHARGE INFLATION FACTOR

Plaintiffs seem to challenge the FFY 2005 IPPS Rule’s charge inflation factor

methodology on grounds similar to those relied on with regard to the FFY 2004 IPPS Rule – i.e.,

that the Secretary used data including the 123 turbo-charging hospitals. (See Pls.’ Reply at 11-

12.) Although this argument would fail for the same reasons already discussed, it also fails for

the more basic reason that there is no evidence that a proposal to exclude data from those 123

hospitals was before the Secretary during the FFY 2005 IPPS Rulemaking. The IFR is not part

of the Administrative Record for the FFY 2005 IPPS Rule. (See 9/19/13 Mem. Op. & Order at

21-22 & n.13.) And, plaintiffs have not pointed to any comments that raise the issue of

excluding data from any (let alone 123) turbo-charging hospitals when calculating the charge

inflation factor. “It is well established that issues not raised in comments before the agency are

waived and this Court will not consider them.” Nat’l Wildlife Fed’n v. E.P.A., 286 F.3d 554, 562

(D.C. Cir. 2002). Accordingly, plaintiffs are barred from challenging the FFY 2005 IPPS Rule

on this ground.

B. COST-TO-CHARGE RATIOS

Plaintiffs challenge the reasonableness of the FFY 2005 IPPS Rule on two grounds

relating to cost-to-charge ratios. First, plaintiffs argue that, even by FFY 2005, the use of “latest

tentatively settled cost report” would still provide outdated cost-to-charge ratios based on pre-

Outlier Correction Rule data. (See Pls.’ Mot. at 38-41.) Second, plaintiffs again argue that the

24
Secretary arbitrarily failed to account for reconciliation of certain hospitals’ cost-to-charge ratios

when calculating the fixed loss threshold. (See id. at 41-42.)

1. Latest tentatively settled cost reports

Several commenters during the FFY 2005 IPPS Rulemaking suggested that the Secretary

compensate for the predicted decline in cost-to-charge ratios following the Outlier Correction

Rule by reducing historical cost-to-charge ratios based on some reduction factor. (See, e.g., FY

2005 AR at 1979.82, .85 (comment of the Fed’n of Am. Hosp.); id. at 2123.41796, .41799

(comment of the Cal. Hosp. Ass’n.).)20 The Secretary summarized these comments in the FFY

2005 IPPS Rule. See 69 Fed. Reg. at 49276 (“The [commenters’] data analysis . . . accounted for

the fact that hospitals’ CCRs are expected to decline throughout the fiscal year as a result of the

use of more current data reflecting changes in hospital charging practices after the [Outlier

Correction Rule]”.) The Secretary responded that:

We do not believe it is necessary to make a specific adjustment to our
methodology for computing the outlier threshold to account for any decline in
cost-to-charge ratios in FY 2005, as the commenter has requested. We have
already taken into account the most significant factor in the decline in cost-to-
charge ratios, specifically, the change from using the most recent final settled cost
report to the most recent tentatively settled cost report. Furthermore, we strongly
prefer to employ actual data rather than projections in estimating the outlier
threshold because we employ actual data in updating charges, themselves.
However, we will continue to monitor the experience and evaluate whether
further requirements to our methodology are warranted.

Id. at 49277-78.

The Secretary’s reasoned determination “to employ actual data rather than projections in

estimating the outlier threshold,” id., is a “prediction resting on the agency’s evaluation of past

performance and its expert judgment how the measures it implemented” – here, the Outlier

20
As the with FFY 2004 IPPS Rulemaking, data underlying the latest tentatively settled cost
reports used to set the FFY 2005 fixed loss threshold pre-dated the Outlier Correction Rule. (Pls.’ Mot. at
39.)

25
Correction Rule – “will operate in the future.” Oceana, Inc. v. Gutierrez, 488 F.3d 1020, 1025

(D.C. Cir. 2007). Because the use of actual data rather than projections in this situation is, as it

was for FFY 2004, “within the bounds of reason,” id., this Court will not disturb the Secretary’s

determination. See also North Carolina v. F.E.R.C., 112 F.3d 1175, 1190 (D.C. Cir. 1997)

(concluding that the fact that a particular population estimates was “less ‘reasonable’” than other

options does not render those estimates unreasonable or arbitrary).

2. Reconciliation

For FFY 2005, the Secretary determined she would “not includ[e] in the calculation of

the outlier threshold the possibility that hospitals’ cost-to-charge ratios may be reconciled upon

cost report settlement.” FFY 2005 IPPS Rule, 69 Fed. Reg. at 49278. This decision represented

a change from the FFY 2004 IPPS Rule, where the Secretary had attempted to project hospitals’

reconciled cost-to-charge ratios when calculating the fixed loss threshold. See FFY 2004 IPPS

Rule, 68 Fed. Reg. at 45476-77.

Commenters for the FFY 2005 IPPS Rule urged the Secretary to take into account the

effects of the Outlier Correction Rule, including reconciliation, when setting the fixed loss

threshold.21 (See, e.g., FFY 2005 AR 1764 (comment of Catholic Healthcare W.).) Plaintiffs

argue that the Secretary’s decision not to account for the potential of reconciliation in FFY 2005

is “inconsistent” with her position in the FFY 2004 IPPS Rule and is therefore is arbitrary and

capricious. (Pls.’ Mot. at 42.)

21
More specifically, the commenters suggested that because overall outlier payments had
decreased following the Outlier Correction Rule (of which reconciliation was a part), that the fixed loss
threshold should be reduced in response. (See, e.g., FFY 2005 AR 1753 (comment of Neb. Hosp. Ass’n);
id. at 1764 (comment of Catholic Healthcare W.); id. at 1837 (comment of N.J. Hosp. Ass’n); id. at 1905
(comment of Tenn. Hosp. Ass’n).) However, none of the comments provided any suggestions on how to
project the future effects of reconciliation in particular. Indeed, one commenter that did propose an
alternative methodology for calculating the fixed loss threshold specifically did “not take into account the
potential impact of outlier reconciliation.” (Id. at 2123.41788 (comment of Cal. Healthcare Ass’n).)

26
 However, the Secretary explained in the FFY 2005 IPPS Rule why she did not factor the

possibility of reconciliation into her fixed loss threshold calculation:

[W]e believe that due to changes in hospital charging practices following
implementation of the [Outlier Correction 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. Furthermore, it is difficult to predict
which specific hospitals may be subject to reconciliation in any given year. As a
result, we believe it is appropriate to omit reconciliation from the outlier threshold
calculation.

69 Fed. Reg. at 49278. That hospitals were less likely to face reconciliation in FFY 2005 than in

FFY 2004, combined with the continued difficulty of predicting which hospitals would face

reconciliation, compels the Court to conclude that it was reasonable for the Secretary to decide,

in contrast to her decision in FFY 2004, not to factor the reconciliation process into the fixed loss

threshold calculation for FFY 2005.

IV. FFY 2006 FIXED LOSS THRESHOLD DETERMINATION

The Secretary retained the same methodology for calculating the fixed loss threshold in

FFY 2006 as she had used for the FFY 2005 IPPS Rule. See FFY 2006 IPPS Rule, 70 Fed. Reg.

at 47494. She used part-year data from FFYs 2004 and 2005 to calculate the inflation factor, id.,

and once again used the latest tentatively settled cost reports to calculate cost-to-charge ratios.

Id. at 47495. Although she initially proposed a fixed loss threshold of $26,675, the Secretary set

the fixed loss threshold for FFY 2006 at $23,600. Id. at 47494. Plaintiffs once again seem to

challenge the Secretary’s methodologies for calculating the charge inflation factor and cost-to-

charge ratios for FFY 2006. (See Pls.’ Mot. at 24; Pls.’ Reply at 11-12.)

A. CHARGE INFLATION FACTOR

Plaintiffs appear to fault the FFY 2006 IPPS Rule’s charge inflation factor methodology

based on the same rationale which they challenged the FFYs 2004 and 2005 IPPS Rules –

27
because the Secretary used data from the 123 turbo-charging hospitals mentioned in the IFR.

(See Pls.’ Reply at 11-12.) As was the case with the FFY 2005 IPPS Rulemaking, the IFR is not

part of the FFY 2006 IPPS Rule administrative record, and plaintiffs cannot point to any

comments suggesting the Secretary should have excluded data from any turbo-charging hospitals

when calculating the FFY 2006 charge inflation factor. Accordingly, plaintiffs are barred from

challenging the FFY 2006 IPPS Rule on this ground. See Nat’l Wildlife Fed’n, 286 F.3d at 562.

B. COST-TO-CHARGE RATIO

As to cost-to-charge ratios, plaintiffs challenge the reasonableness of the FFY 2006 IPPS

Rule on the same grounds that they challenged the FFY 2005 IPPS Rule: (1) that even by FFY

2006, the use of the latest tentatively settled cost reports would still provide cost-to-charge ratios

that, at most, reflected only five months of post-Outlier Correction Rule data (see Pls.’ Mot. at

39-41); and (2) that the Secretary failed to account for reconciliation of certain hospitals’ cost-to-

charge ratios when calculating the fixed loss threshold. (See id. at 41-42.)

1. Latest tentatively settled cost reports

During the FFY 2006 IPPS Rulemaking, commenters again implored the Secretary to

adjust the latest tentative settled cost reports’ cost-to-charge ratios downward to reflect the

continued projected decreases in cost-to-charge ratios. (See FY2006 AR 1288 (comment of Am.

Hosp. Ass’n); id. at 1398 (comment of Fed’n of Am. Hosp.).) The Secretary squarely addressed

the comments “suggesting that [she] . . . adjust the cost-to-charge ratios that are used in setting

the outlier thresholds.” FFY 2006 IPPS Rule, 70 Fed. Reg. 47495. The Secretary, again

rejecting the commenters’ recommendation, explained

We believe it is necessary to inflate the charges from the FY 2004 MedPAR file
to project charge levels for FY 2006, but we do not believe it is also necessary to
adjust cost-to-charge ratios from the March 2005 Provider-Specific File. . . . We

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 likely would greatly underestimate payments if we did not inflate the MedPAR
charge data.

On the other hand, the cost-to-charge ratios from the March 2005 Provider-
Specific File reflect much more recent hospital-specific data than the case-specific
data in the FY 2005 MedPAR file. The March 2005 Provider-Specific File
includes the cost-to-charge ratios from the hospitals’ most recent tentatively-
settled cost report. In many cases, for part of FY 2006, fiscal intermediaries will
determine actual outlier payment amounts using the same cost-to-charge ratios
that are in the March 2005 Provider-Specific File. Fiscal intermediaries will
begin using an updated cost-to-charge ratio to calculate the outlier payments for a
hospital only after a more recent cost report of the hospital has been tentatively
settled.

Id.

Although the Secretary’s rationale in FFY 2006 was distinct from that given in FFY

2005, it is no less reasonable. Indeed, the fact that the cost-to-charge ratios used to calculate the

fixed loss threshold are actually used, for some portion of the fiscal year, to calculate outlier

payments, is a strong reason to not adjust the cost-to-charge ratios downward based on

speculation regarding the continued downward trend in cost-to-charge ratios. Accordingly, the

Secretary acted reasonably when deciding to continue utilizing actual data from the latest

tentatively settled cost reports when calculating the fixed loss threshold for FFY 2006.

2. Reconciliation

As in the FFY 2005 IPPS Rulemaking, the Secretary “did not make any adjustment for

the possibility that hospitals’ cost-to-charge ratios and outlier payments may be reconciled upon

cost report settlement.” FFY 2006 IPPS Rulemaking, 70 Fed. Reg. 47495. The Secretary again

explained that, due to the Outlier Correction Rule, “few hospitals, if any, will actually have these

ratios reconciled” and that it would be difficult to predict ex ante “which specific hospitals will

have cost-to-charge ratios and outlier payments reconciled in any given year.” Id. For the same

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reasons (and in response to the same challenges) as indicated above with regard to the FFY 2005

IPPS Rule, the Court finds the Secretary’s decision to be reasonable.

CONCLUSION

For the foregoing reasons, the Court concludes that the Secretary acted reasonably when

setting the fixed loss thresholds for FFYs 2004-2006. Accordingly, the Secretary’s motion for

summary judgment will be granted, and plaintiffs’ cross-motion will be denied. An Order

consistent with this Memorandum Opinion will also be issued this date.

/s/
ELLEN SEGAL HUVELLE
United States District Judge

Date: January 6, 2014

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