Huntington Hosp. v. Thompson, 01-6095(L).

• Decision Date: 09 October 2002
• Docket Number: No. 01-6097(CON).,No. 01-6095(L).,01-6095(L).,01-6097(CON).
• Citation: 319 F.3d 74
• Parties: HUNTINGTON HOSPITAL, Long Island College Hospital, Nassau County Medical Center, New York Methodist Hospital, Northern Westchester Hospital Center, Phelps Memorial Hospital Center, St. Vincent's Hospital, Sound Shore Medical Center, f/k/a New Rochelle Hospital, Southampton Hospital, Staten Island Hospital, f/k/a Richmond Memorial Hospital, Plaintiffs-Appellants, v. Tommy THOMPSON, in his official capacity as Secretary of the United States Department of Health and Human Services, and Empire Blue Cross and Blue Shield, Defendants-Appellees.
• Court: U.S. Court of Appeals — Second Circuit

319 F.3d 74

HUNTINGTON HOSPITAL, Long Island College Hospital, Nassau County Medical Center, New York Methodist Hospital, Northern Westchester Hospital Center, Phelps Memorial Hospital Center, St. Vincent's Hospital, Sound Shore Medical Center, f/k/a New Rochelle Hospital, Southampton Hospital, Staten Island Hospital, f/k/a Richmond Memorial Hospital, Plaintiffs-Appellants, v. Tommy THOMPSON, in his official capacity as Secretary of the United States Department of Health and Human Services, and Empire Blue Cross and Blue Shield, Defendants-Appellees.

No. 01-6095(L).

No. 01-6097(CON).

United States Court of Appeals, Second Circuit.

Argued: February 20, 2002.

Decided: October 9, 2002.

Amended: January 13, 2003.

Roy W. Breitenbach (Garfunkel Wild & Travis, Great Neck, NY) for Plaintiffs-Appellants.

Paul Kaufman, Assistant United States Attorney, (Alan Vinegrad, United States Attorney for the Eastern District of New York; Deborah B. Zwany and Kathleen A. Mahoney, Assistant United States Attorneys, of counsel) for Defendants-Appellees.

Before: VAN GRAAFEILAND and KATZMANN, Circuit Judges, and KORMAN, District Judge.^*

KORMAN, District Judge.

This appeal involves the application of an established principle of administrative law to an exceedingly complex legislative and administrative scheme for Medicare reimbursement of hospitals. Because the principle is easier to explain than the scheme, and because it will be helpful in following our explanation of the scheme, we begin first with a simple statement of the manner in which the principle applies in this case.

The law is clear that an administrative agency that promulgates inconsistent regulations interpreting an act of Congress "must supply a reasoned analysis." Motor Vehicle Mfrs. Ass'n of the U.S., Inc. v. State Farm Mutual Auto. Ins. Co., 463 U.S. 29, 57, 103 S.Ct. 2856, 77 L.Ed.2d 443 (1983) (quoting Greater Boston Television Corp. v. F.C.C., 444 F.2d 841, 852 (D.C. Cir.1970)). The Secretary of Health and Human Services ignored this rule here. More than that, this is not simply a case in which an administrative agency changed a regulation that it had previously adopted. Instead, it involves two separate regulations construing the same act of Congress in a totally inconsistent manner. Such administrative rulemaking cannot stand. As Judge Sentelle aptly observed: "The treatment of cases A and B, where the two cases are functionally indistinguishable, must be consistent. That is the very meaning of the arbitrary and capricious standard." Independent Petroleum Ass'n of America v. Babbitt, 92 F.3d 1248, 1260 (D.C.Cir.1996).

Background

Medicare, the federally funded health insurance program for the elderly and disabled, is governed by Title XVIII of the Social Security Act, 42 U.S.C. §§ 1395 to 1395ggg. See 42 U.S.C. §§ 1395c, 1395d, 1395j, 1395k (2000). This case concerns reimbursement under Part A of the Medicare program, which provides elderly and disabled persons with "basic protection against the costs of hospital, related post-hospital, home health services, and hospice care." 42 U.S.C. § 1395c.

Plaintiffs are New York hospitals that accepted assignment of payments from Medicare beneficiaries for in-patient hospital services. Because they were participants in a Medicare demonstration project, for which New York State received approval, they were exempted from Medicare reimbursement rules from January 1, 1983 until December 31, 1985. During this period, Congress made two significant changes in Medicare reimbursement rules, which up until then provided reimbursement through a retrospective reasonable cost system. Under that prevailing reasonable cost system, hospitals reported the total costs for which they sought reimbursement at the end of each year. They were entitled to be reimbursed for those costs that the Secretary determined were reasonable and necessary. 42 U.S.C. § 1395 f(b)(1) (1988). Congress concluded that this scheme did not provide hospitals with sufficient incentive to be efficient. See generally Rye Psychiatric Hosp. Ctr., Inc. v. Shalala, 52 F.3d 1163, 1166 (2d Cir.1995).

The first of the two changes relevant here was enacted as part of the Tax Equity and Fiscal Responsibility Act of 1982 and is commonly referred to as the TEFRA reimbursement scheme. Under this scheme, a base year would be selected from which the cost of providing hospital services would be calculated. Each subsequent year, the base would be adjusted by multiplying the figure for the base year by legislatively determined percentages that are intended to reflect primarily cost increases attributable to inflation. Rye Psychiatric, 52 F.3d at 1166 & n. 3.

In 1983, only one year later, Congress replaced the TEFRA scheme with a Prospective Payment System ("PPS"). The PPS marked a major departure in Medicare reimbursement policy. It established a number of Diagnostically Related Groups ("DRGs"), which describe particular classes of patients and treatments, and the amount Medicare will pay for each. DRG cost schedules are generated from anticipated national and regional average costs for the treatment of particular illnesses. 42 U.S.C. § 1395ww(d)(2)(D) (2000). This system differs substantially from TEFRA. It focuses on national and regional averages for the cost of treating particular illnesses and is not based on the cost to any particular hospital of treating particular DRG-classified illnesses. See Rye Psychiatric, 52 F.3d at 1167. "When a hospital's actual operating costs exceed its federally prescribed limit for the given DRG, the hospital must absorb the difference. Conversely, if a hospital's costs are lower than the federal rates, the hospital retains the difference." Sacred Heart Med. Ctr. v. Sullivan, 958 F.2d 537, 541 (3d Cir.1992).

TEFRA remained applicable only to those hospitals and units that were specifically exempted from PPS; it was also applicable to the formula Congress established for the four-year transitional period from TEFRA to PPS. The formula for reimbursement during the transition provided for a portion of the reimbursement to be calculated by using the TEFRA base year and a portion to be calculated by using the PPS scheme. The TEFRA portion decreased proportionally each year until it was phased out completely. See 42 U.S.C. § 1395ww(d)(1)(A)(i)-(ii) (2000).

The two categories of cases to which TEFRA continued to apply required the calculation of a base year that was subject to the inflation adjusted multiplier. The significance of an accurate determination of the base year was succinctly summarized by Judge Kaplan as follows:

The initial step in fixing a TEFRA hospital's entitlement to reimbursement, generally speaking, is to determine its total "allowable costs" for a base year. 42 C.F.R. § 413.40(b)(1) (1993); Tucson Medical Center [v. Sullivan], 947 F.2d [971] at 975 [(D.C.Cir.1991)]. Reimbursements in subsequent years, however, do not depend on total or allowable costs incurred in those subsequent years. Rather, a maximum permissible reimbursement, or "target amount," for each subsequent period is established by multiplying the figure for the base year by a legislatively determined percentage. 42 U.S.C. § 1395ww(b)(3) (1988); 42 C.F.R. § 413.40 (1993). If a hospital expends more than its target amount, or ceiling, it is reimbursed only up to the amount of the ceiling. If its costs are less than its ceiling, it is given a bonus payment of half the difference between its costs and the ceiling. 42 U.S.C. § 1395ww(b)(1)(A) (1988); 42 C.F.R. § 413.40 (1993); see generally Connecticut Hospital Association v. Weicker, 46 F.3d 211, 214-15 (2d Cir.1995).... How fully a TEFRA hospital is reimbursed from year to year thus depends on (1) how representative its base period is of its actual total costs in the relevant year, and (2) how closely the Congressionally fixed percentage increase mirrors any increase in the hospital's costs. If a hospital's actual total costs equal its costs in the base period plus the statutory increase, it will be fully reimbursed. If a TEFRA hospital's actual total costs in any given year differ from the costs in the base period plus the statutory increase, however, its reimbursement may either fall short of or exceed its actual total costs.

Rye Psychiatric, 52 F.3d at 1166 (footnote omitted).

The determination of the base year for the TEFRA reimbursement scheme for New York hospitals is at the heart of the dispute here. The parties agree that Congress expressly provided that the same base year used when it adopted the TEFRA scheme, 42 U.S.C. § 1395ww(b)(3)(A), was also to be used to calculate the TEFRA base year component of the reasonable cost calculation for the PPS transition period, 42 U.S.C. § 1395ww(d)(1)(A). The Secretary, however, did not comply with this directive. Instead, the Secretary promulgated two regulations that differed in their definitions of the base year. Specifically, the applicable TEFRA statute, 42 U.S.C. § 1395ww(b)(3)(A)(i), specifies that the base year is the twelve-month cost reporting period preceding that for which the TEFRA scheme is in effect. Since TEFRA took effect in 1983, the base year could reasonably be construed as 1982, as it was for most hospitals in the United States. On the other hand, it would not have been altogether unreasonable to conclude that the first year TEFRA took effect as to the New York hospitals was 1986, because the Medicare reimbursement rules were not applicable to them until 1986. The base year would then have been 1985.

In 1986, the regulation defining the TEFRA base year, 42 C.F.R § 405.463(b)(1) (1982) (renumbered as 42 C.F.R. § 413.40(b)(1), 51 Fed.Reg. 34790, 34790 (September 30, 1986)), was construed in part and amended in part to permit the latter result for those hospitals that were exempt from the PPS scheme. In explaining this action, the Secretary first described the existing regulation and then discussed the changes in interpretation and...