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New Hampshire Hospital Association v. Azar

United States Court of Appeals, First Circuit

April 4, 2018

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.


          Tara 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.

          Ann M. 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.

          W. 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, amicus curiae.

          Before Kayatta, Selya, and Lipez, Circuit Judges.

          KAYATTA, Circuit Judge.

         When 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.

         Rather 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, 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 announcement."

         Ruling 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 challenges.


         Medicaid 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 (1990)).

         Once a 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.

         Concerned 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.[1] 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 the year.


         In 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).

         So, in 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"?

         In 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"[2]). 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 dual eligibles.

         The 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.

         In 2010, the Secretary provided further guidance. In a "Frequently Asked Questions" document posted on, [3] 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 and 34.

         Several 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.

         Plaintiffs 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. ยง 706(2)(A). Plaintiffs also argued that Congress itself, by specifying ...

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