On August 13, 2019, the U.S. Court of Appeals for the District of Columbia Circuit overturned a district court ruling that CMS’s 2017 final rule on the Medicaid DSH program limit calculation violates the Medicaid Act, 42 U.S.C. § 1396 et seq. The D.C. Circuit Court reinstated the 2017 final rule, which requires hospitals to exclude additional payments they receive from their calculation of their “costs incurred” in serving a disproportionate number of low-income patients under the DSH program.

In Children’s Hospital Association of Texas, et al. v. Azar, four children’s hospitals and a children’s hospital association (the Plaintiffs) successfully argued before the district court that the regulatory definition of “costs incurred” was inconsistent with the Medicaid Act. The district court vacated the 2017 final rule. The D.C. Circuit’s three-judge panel unanimously reversed that decision, ruling that, when a hospital calculates its “costs incurred” in serving these populations in the DSH program, the hospital must also deduct payments it receives from Medicare and private insurers. This calculation will effectively lower the cap on a hospital’s DSH payment and potentially reduce reimbursements to some hospitals.

At issue in Children’s Hospital was the proper methodology to calculate the limit of government reimbursement a hospital can receive under the Medicaid DSH program, otherwise known as the “hospital-specific limit.” Under the program, a hospital may not receive DSH payments that exceed the hospital’s “costs incurred” during the year for providing hospital services to Medicaid-eligible and uninsured patients. To calculate the limit, hospitals report cost data for these populations to their state Medicaid agencies which, in turn, use that information to determine the hospital’s final Medicaid DSH payments. The Medicaid statute also requires the hospital-specific limit to be calculated net of payments received from Medicaid as well as payments received from uninsured patients. Therefore, hospitals report that information as well to their state Medicaid agencies. In Children’s Hospital, the D.C. Circuit addressed the question of whether the Medicaid statute allows CMS to require hospitals to report payments they receive from other sources—specifically Medicare payments and payments from private insurers—to be subtracted from the hospital’s “costs incurred,” thereby lowering each hospital’s Medicaid DSH limit.

This issue has been brewing for a number of years. In 2008, CMS promulgated a final rule related to Medicaid DSH payments that was silent as to whether payments from Medicare or private insurers should be included in calculating the amount of a hospital’s “total Medicaid uncompensated care.”

In 2010, CMS posted a “Frequently Asked Questions” document on its website that for the first time required hospitals to report payments from Medicare and private insurers when providing cost data to their state Medicaid agencies for purposes of calculating the hospital-specific limit. Several lawsuits were filed, challenging the FAQs as either inconsistent with the Medicaid Act or a violation of the Administrative Procedure Act because they were adopted without notice and comment. Various courts of appeals have agreed that the FAQs could not be enforced because they were not adopted through notice and comment.

In response to these lawsuits, CMS promulgated through notice and comment a final rule in 2017 that serves as the basis of the Children’s Hospital Association case (the 2017 Final Rule). The 2017 Final Rule states that a hospital’s costs for providing care to Medicaid and uninsured patients are to be determined “net of third-party payments, including, but not limited to, payments by Medicare and private insurance,” and that a hospital’s DSH “limit calculation [should] reflect only the costs for Medicaid eligible individuals for which the hospital has not received payment from any source.” In other words, the 2017 Final Rule established that hospitals should also net out payments from Medicare and private insurers when calculating their DSH limit.

The Plaintiffs in Children’s Hospital argued that the 2017 Final Rule violates the Administrative Procedure Act (APA) by exceeding the Secretary’s authority under the Medicaid Act and that the 2017 Final Rule’s reasoning is arbitrary and capricious. The district court agreed with the Plaintiffs that the 2017 Final Rule violates the APA because its language is inconsistent with the language of the Medicaid Act, explaining that the Act “nowhere mentions subtracting other third-party payments made on behalf of Medicaid-eligible patients from the [hospital’s] total costs incurred.”

The D.C. Circuit disagreed, finding that the Medicaid Act’s language was not exclusive, stating, “Although the statute establishes that payments by Medicaid and the uninsured must be considered, it nowhere states that those are the only payments that may be considered.” The Court found sufficient reason to believe that Congress “did not intend to exclude Medicare and private insurance payments from” consideration of which reimbursements should be subtracted from a hospital’s costs incurred.

The D.C. Circuit concluded that, when reporting their total costs incurred under the Medicaid DSH program, hospitals should not only subtract payments from Medicaid and uninsured patients, but also subtract Medicare and private insurers’ payments. The D.C. Circuit opinion credited the so-called “double dipping” concern, reasoning that hospitals should not be permitted to receive DSH payments while receiving compensation from Medicare or private insurers for the dual-eligible patients they treat. The Court wrote, “[b]y requiring the inclusion of payments by Medicare and private insurers, the 2017 Final Rule ensures that DSH payments will go to hospitals that have been compensated least and are thus most in need.”

Before the D.C. Circuit Court’s ruling, the Medicaid.gov website noted, “[h]ospital services furnished after June 2, 2017 are covered by [the 2017 Rule] clarifying the treatment of third party payers in determining the hospital-specific Medicaid DSH payment limit. In light of the [district court’s decision in Children’s Hospital], CMS will not be enforcing the 2017 rule” as long as the ruling remains valid. Now that the D.C. Circuit has reversed the district court’s ruling, this language is expected to change.

The D.C. Circuit Court’s decision comes on the heels of recent Medicare (as opposed to Medicaid) DSH rulings that largely favored hospitals. In July 2019, the U.S. District Court for the District of Columbia ruled in favor several hospitals challenging the calculation of their Medicare DSH payments. Click here for a discussion of this case. The Fifth Circuit also ruled in July that hospitals’ Medicare DSH payments had been understated because CMS improperly calculated the Medicaid fraction of the hospitals’ disproportionate patient percentage. Click here for a discussion of this case.

In June, the Supreme Court vacated a policy posted by HHS requiring DSH program hospitals to include Medicare Part C enrollees in their Medicare fraction for fiscal year (FY) 2012. In that case, Azar v. Allina Health Services, the Supreme Court ruled that HHS enacted the policy without going through the Medicare Act’s notice and comment period required for such a substantive legal change.

The full opinion in Children’s Hospital Association of Texas, et al. v. Azar, No. 18-5135 (D.C. Cir. 2019), can be found here, and the District Court decision can be found here.