NEW HAMPSHIRE HOSPITAL ASSOCIATION; MARY HITCHCOCK MEMORIAL HOSPITAL; LRGHEALTHCARE; SPEARE MEMORIAL HOSPITAL; VALLEY REGIONAL HOSPITAL, INC., Plaintiffs, Appellees,
ALEX AZAR, United States Secretary of Health and Human Services;[*] CENTERS FOR MEDICARE AND MEDICAID SERVICES; SEEMA VERMA, in her official capacity as Administrator, Centers for Medicare and Medicaid Services, Defendants, Appellants.
FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW
HAMPSHIRE [Hon. Landya B. McCafferty, U.S. District Judge]
S. Morrissey, Attorney, Appellate Staff, Civil Division, U.S.
Department of Justice, with whom Chad A. Readler, Acting
Assistant Attorney General, Civil Division, U.S. Department
of Justice, John J. Farley, Acting U.S. Attorney, Mark B.
Stern, Attorney, Appellate Staff, Civil Division, U.S.
Department of Justice, Heather Flick, Acting General Counsel,
Centers for Medicare and Medicaid Services Division, U.S.
Department of Health and Human Services, Janice L. Hoffman,
Associate General Counsel, Centers for Medicare and Medicaid
Services Division, U.S. Department of Health and Human
Services, Susan M. Lyons, Deputy Associate General Counsel
for Litigation, Centers for Medicare and Medicaid Services
Division, U.S. Department of Health and Human Services, David
L. Hoskins, Attorney, Office of the General Counsel, Centers
for Medicare and Medicaid Services Division, U.S. Department
of Health and Human Services, and Lindsay S. Goldberg,
Attorney, Office of the General Counsel, Centers for Medicare
and Medicaid Services Division, U.S. Department of Health and
Human Services, were on brief, for appellants.
Rice, Deputy Attorney General, Civil Bureau, State of New
Hampshire, and Nancy J. Smith, Senior Assistant Attorney
General, Civil Bureau, State of New Hampshire, on brief for
State of New Hampshire, Department of Health and Human
Services, amicus curiae.
Scott O'Connell, with whom Morgan C. Nighan and Nixon
Peabody LLP were on brief, for appellees.
Geraldine E. Edens, Christopher H. Marraro, Baker &
Hostetler LLP, Susan Feign Harris, and Morgan Lewis &
Bockius LLP on brief for Children's Hospital Association,
Kayatta, Selya, and Lipez, Circuit Judges.
KAYATTA, Circuit Judge.
hospitals treat Medicaid patients, the Medicaid payments
received from the government often do not cover the full
costs of care. In 1981, Congress authorized the payment of
additional sums to lessen the burden on hospitals that treat
a high number of indigent patients. Years later, concerned
that this payment adjustment overshot the mark in some
instances, Congress passed another law seeking to cap such
payments at each hospital's "costs incurred."
Of particular relevance to this litigation is to what extent
"costs incurred" equals the total costs of service,
rather than the costs net of payments from other sources,
namely, Medicare and private insurance. This question arises
because some patients qualify for coverage under both
Medicaid and either Medicare or private insurance.
than specifying expressly the full extent to which
"costs incurred" are limited to costs net of other
sources of payment, Congress identified two specific sources
of payment that must be offset against total costs, but
otherwise simply stated that "costs incurred" are
"as determined by the Secretary" of the United
States Department of Health and Human Services. In 2008, the
Secretary promulgated a regulation. But the regulatory text,
like the statute, contained no express direction on the
question at issue. Then, in 2010, the Secretary announced, in
the form of answers to "Frequently Asked Questions"
posted on medicaid.gov, that the payments to be offset
against total costs in calculating "costs incurred"
also included reimbursements received from Medicare and
private insurance. For ease of reference, we will call this
pronouncement "the FAQs" or "the FAQs
in favor of the plaintiff hospitals and their association,
the district court found that the set-off rule announced in
the FAQs represented a substantive policy decision that could
not be adopted without notice and comment. For the following
reasons, we affirm the district court's ruling on this
same ground, without reaching the plaintiffs' other
is a cooperative federal-state health insurance program that
enables states to provide medical assistance to the disabled,
the elderly, and families with dependent children,
"whose income and resources are insufficient to meet the
costs of necessary medical services." 42 U.S.C. §
1396-1. The program is funded by both the federal and state
governments, but is administered by the states. 42 C.F.R.
§ 430.0. Although participation in Medicaid is
voluntary, a state that elects to participate must comply
with the requirements imposed by federal statute and
regulations promulgated by the Secretary. See Stowell v.
Ives, 976 F.2d 65, 68 (1st Cir. 1992) (quoting
Wilder v. Va. Hosp. Ass'n, 496 U.S. 498, 502
participating state establishes a state plan that complies
with the Medicaid Act, the federal government reimburses the
state for certain patient care costs. See 42 U.S.C.
§§ 1396a, 1396b. The state, in turn, reimburses the
medical facilities that provided the care. These Medicaid
reimbursements often do not cover the hospitals' full
costs of treating Medicaid-eligible individuals.
about the financial burden thus placed on hospitals that
treat largely indigent communities, Congress amended the
Medicaid statute in 1981 to "take into account the
situation of hospitals which serve a disproportionate number
of low income patients with special needs." Omnibus
Budget Reconciliation Act of 1981, Pub. L. No. 97-35, §
2173, 95 Stat. 357 (codified as amended at 42 U.S.C. §
1396a(a)(13)(A)(iv)). Giving practical effect to its intent,
Congress provided a "payment adjustment" for
hospitals deemed "disproportionate share hospitals"
("DSH"). See 42 U.S.C. § 1396r-4(c).
Several years later, Congress became aware of reports that
certain types of hospitals had received payment adjustments
"that exceed the net costs, and in some instances the
total costs, of operating the facilities." H.R. Rep. No.
103-111, at 211 (1993). According to these reports, the
excess funds were then being redirected to finance other
state government projects, such as road construction and
maintenance. Id. at 211-12. In 1993, Congress
responded to this unintended consequence by imposing a cap on
the DSH payment adjustment ("the DSH cap").
See Omnibus Budget Reconciliation Act of 1993, Pub.
L. No. 103-66, § 13621, 107 Stat. 312 (codified at 42
U.S.C. § 1396r-4(g)). This hospital-specific DSH cap
limited the payment adjustment to the "costs
incurred" in treating Medicaid-eligible individuals,
less Medicaid payments received. 42 U.S.C. §
1396r-4(g)(1)(A). The provision now states, in relevant part:
A payment adjustment during a fiscal year shall not . . .
exceed the costs incurred during the year of furnishing
hospital services (as determined by the Secretary and net of
payments under this subchapter, other than under this
section, and by uninsured patients) by the hospital to
individuals who either are eligible for medical assistance
under the State plan or have no health insurance (or other
source of third party coverage) for services provided during
2003, Congress made a further amendment to the Medicaid
statute. This time, Congress expanded the government's
enforcement mechanism by requiring states, as a condition of
receiving DSH payments, to submit both an annual report and
an annual audit of their qualifying hospitals' expenses
and received DSH payments. See Medicare Prescription
Drug, Improvement, and Modernization Act of 2003, Pub. L. No.
108-173, § 1001(d), 117 Stat. 2066 (codified at 42
U.S.C. § 1396r-4(j)). The reporting provision of this
act requires states to identify each hospital within the
state that received a payment adjustment and the amount of
that adjustment, as well as "[s]uch other information as
the Secretary determines necessary to ensure the
appropriateness of the payment adjustments made under this
section." 42 U.S.C. § 1396r-4(j)(1)(B). In turn,
the audit requirement in the 2003 legislation requires the
state to "verif[y], " by "independent
certified audit, " that, among other things, the payment
adjustment complied with the statutory cap and that
"[o]nly the uncompensated care costs of providing
inpatient hospital and outpatient hospital services to
individuals described in [42 U.S.C. § 1396r-4(g)(1)(A)]
are included in the calculation of the hospital-specific
limits." Id. § 1396r-4(j)(2)(B)-(C).
three steps, Congress provided for additional payments to
certain hospitals, imposed a limit on those payments, and
then created a mechanism for verifying compliance with the
limit. No party claims that this statutory scheme in so many
words expressly addresses the underlying question that gives
rise to this case: how to treat, in determining Medicaid
payment adjustments, costs associated with individuals
eligible for both Medicaid and other health coverage, namely,
Medicare or private insurance. For these individuals -- to
whom the parties refer as "dual eligibles" or those
with "dual coverage" -- the additional coverage may
kick in to reimburse hospital costs before Medicaid does, as
Medicaid is often the "payer of last resort."
Massachusetts v. Sebelius, 638 F.3d 24, 26 (1st Cir.
2011) (citation omitted). So, the question arose: In
calculating the DSH cap, should states deduct Medicare and
private insurance payments for those with dual coverage when
determining the hospitals' "costs incurred"?
2008, the Secretary promulgated a rule following notice and
comment. But in so doing, the Secretary exercised authority
not under section 1396r-4(g)(1)(A) (which established the DSH
cap), but rather under the Secretary's delegated
authority to define the scope of information necessary to
satisfy the 2003 Modernization Act's reporting
requirement. See Disproportionate Share Hospital
Payments, 73 Fed. Reg. 77, 904, 77, 904 (Dec. 19, 2008)
(stating that the rule "implement[s] the reporting
requirement in Section 1923(j)(1) of the
Act"). This regulation requires states, as a
condition of receiving DSH payments, to report eighteen
categories of information to the Centers for Medicare and
Medicaid Services ("CMS") -- the arm of the United
States Department of Health and Human Services responsible
for administering the Medicaid program -- including
"Total Medicaid Uncompensated Care." Id.
at 77, 950-51. But here too, the regulatory text is silent on
the proper treatment of costs and revenues associated with
regulation's preamble, on the other hand, does address
the issue, albeit only to the extent of adding Medicare
payments as a type of reimbursement that need be offset from
the associated costs. Responding to a comment, the preamble
instructs that, "in calculating th[e] uncompensated care
costs" of treating dual eligibles, "it is necessary
to take into account both the Medicare and Medicaid payments
made." Id. at 77, 912.
2010, the Secretary provided further guidance. In a
"Frequently Asked Questions" document posted on
medicaid.gov,  but issued without notice and comment, the
Secretary stated that both Medicare payments and private
insurance payments associated with individuals also eligible
for Medicaid should be deducted in calculating the DSH cap.
The relevant statements appear in the responses to FAQs 33
New Hampshire hospitals and the New Hampshire Hospital
Association (collectively, "plaintiffs")
subsequently filed this challenge to the procedural propriety
of the two FAQs as well as to the substance of the policy
articulated in the FAQs. The conflict arose in 2014, when the
New Hampshire Department of Health and Human Services
retained an independent accounting firm to conduct its
statutorily required audit of DSH payments made to New
Hampshire hospitals for fiscal year 2011. The auditor's
report followed the Secretary's guidance articulated in
the FAQs. In calculating the DSH cap, it thus reduced the
total "costs incurred" by the plaintiff hospitals
by the amount of payments received from both Medicare and
private insurance in connection with treating
Medicaid-eligible patients. According to this calculation,
the plaintiff hospitals had received a significant
overpayment in fiscal year 2011. The regulatory scheme
requires the state to recover this sum. See 42
C.F.R. § 433.312.
first petitioned CMS to withdraw the FAQs. CMS denied their
petition. Plaintiffs then brought a challenge in federal
district court under the Administrative Procedure Act,
seeking declaratory and injunctive relief. They alleged that
because the rule articulated in the FAQs effected a
substantive regulatory change, it was procedurally improper
for having been issued without the notice-and-comment
procedures prescribed by the APA. This impropriety, according
to plaintiffs, rendered the agency's action invalid as
both being taken "without observance of procedure
required by law, " 5 U.S.C. § 706(2)(D), as well as
being "arbitrary, capricious, an abuse of discretion, or
otherwise not in accordance with law, " id.
§ 706(2)(A). Plaintiffs also argued that Congress
itself, by specifying ...