United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued December 8, 2023 Decided September 3, 2024

No. 22-5318

LAKE REGION HEALTHCARE CORPORATION,

APPELLANT

v.

XAVIER BECERRA, SECRETARY OF HEALTH AND HUMAN 

SERVICES,

APPELLEE

Appeal from the United States District Court

for the District of Columbia

(No. 1:20-cv-03452)

Sven C. Collins argued the cause and filed the briefs for 

appellant.

Daniel J. Hettich, Rachel M. Wertheimer, and Barbara S. 

Williams were on the brief for amici curiae Hospitals in support 

of appellant.

Leif E. Overvold, Attorney, U.S. Department of Justice, 

argued the cause for appellee. With him on the brief were 

Brian M. Boynton, Principal Deputy Assistant Attorney 

General, Michael S. Raab, Attorney, Samuel R. Bagenstos, 

General Counsel, U.S. Department of Health & Human 
2

Services, Janice L. Hoffman, Associate General Counsel, 

Susan Maxson Lyons, Deputy Associate General Counsel for 

Litigation, and Jonathan C. Brumer, Attorney.

Before: HENDERSON and KATSAS, Circuit Judges, and 

RANDOLPH, Senior Circuit Judge.

Opinion for the Court filed by Circuit Judge KATSAS.

KATSAS, Circuit Judge: Under certain circumstances, 

qualifying hospitals that treat Medicare patients are entitled to 

an extra payment known as a volume-decrease adjustment

(VDA), which must “fully compensate” the hospital for its 

“fixed costs.” 42 U.S.C. § 1395ww(d)(5)(D)(ii). To fully 

compensate for fixed costs, the Secretary of Health and Human 

Services must determine a hospital’s actual fixed costs and then 

must subtract other, baseline payments that reimburse for those 

fixed costs. This appeal turns on how to determine the

reimbursed fixed costs. It is a difficult question because the 

baseline payments for treating Medicare patients do not 

disaggregate between fixed costs, which remain constant no 

matter how many patients are treated, and variable costs, which 

increase with every patient.

In calculating VDA payments, the Secretary used to

attribute the baseline reimbursements entirely to fixed costs. 

Under that approach, a hospital could not receive a VDA 

payment unless its fixed costs exceeded its baseline Medicare 

reimbursements. But the baseline reimbursements, although 

not disaggregated, compensate for both fixed and variable 

costs. 42 U.S.C. § 1395ww(a)(4). We hold that, in calculating 

the VDA, the Secretary may not deem them compensation for 

fixed costs alone.
3

I

A

Medicare pays hospitals for providing inpatient care to the 

elderly and disabled. 42 U.S.C. § 1395c et seq. Although the 

program previously reimbursed all “reasonable costs” incurred 

by hospitals to treat beneficiaries, see Methodist Hosp. of 

Sacramento v. Shalala, 38 F.3d 1225, 1227 (D.C. Cir. 1994)

(cleaned up), Congress established the inpatient prospective 

payment system to give hospitals greater “incentives ... to 

control costs.” Cape Cod Hosp. v. Sebelius, 630 F.3d 203, 205 

(D.C. Cir. 2011).

Under that system, hospitals receive fixed, prospectively 

determined payments keyed to various “diagnosis related 

group[s]” (DRGs). See 42 U.S.C. § 1395ww(d)(3)(D). These

payments reflect the average cost of treating particular 

conditions. See id. § 1395ww(d)(2)(A), (4)(A)–(B). The 

payments must account for “all routine operating costs, 

ancillary service operating costs, and special care unit 

operating costs,” including “the costs of all services for which 

payment may be made.” Id. § 1395ww(a)(4). Although DRG 

payments thus plainly cover both fixed and variable costs, they 

do not disentangle the two categories. Nor do they disentangle 

the “bundle” of “particular items or services” within the DRG 

itself. Appalachian Reg’l Healthcare, Inc. v. Shalala, 131 F.3d 

1050, 1053 (D.C. Cir. 1997).

Special payment rules govern hospitals that are isolated or 

in rural areas. 42 U.S.C. § 1395ww(d)(5)(D), (G). A 

qualifying hospital must receive an additional payment, known

as a volume-decrease adjustment, if the number of its annual 

inpatient cases decreases by more than five percent for reasons

beyond its control. Id. § 1395ww(d)(5)(D)(ii), (G)(iii). This

adjustment, combined with other Medicare reimbursements 
4

received by the hospital, must “fully compensate the hospital 

for the fixed costs it incurs in the period in providing inpatient 

hospital services, including the reasonable cost of maintaining 

necessary core staff and services.” Id. § 1395ww(d)(5)(D)(ii), 

(G)(iii).

B

Over time, HHS has used three different methods to 

calculate the VDA. We refer to them as the “total-total,” 

“fixed-total,” and “fixed-fixed” approaches.

Under the total-total approach, the VDA is the difference 

between the hospital’s total costs for treating Medicare 

beneficiaries and the total DRG payments it has received. HHS 

seemed to endorse this approach in guidance issued in 1990, 

see Provider Reimbursement Manual 15-1, § 2810.1(D), and in 

preambles to later rules fixing annual DRG payments, see 

Medicare Program; Changes to the Hospital Inpatient 

Prospective Payment Systems and Fiscal Year 2007 Rates, 71 

Fed. Reg. 47,870, 48,056 (Aug. 18, 2006); Medicare Program; 

Changes to the Hospital Inpatient Prospective Payment 

Systems and Fiscal Year 2009 Rates, 73 Fed. Reg. 48,434, 

48,631 (Aug. 19, 2008). This approach compensates

qualifying hospitals for their fixed and variable costs.

Under the fixed-total approach, the VDA is the difference 

between the hospital’s fixed costs for treating Medicare 

beneficiaries and the total DRG payments it has received. The 

Centers for Medicare & Medicaid Services, which administers 

Medicare for the Secretary, adopted this approach in 2014. 

Unity Healthcare Muscatine, Iowa v. Blue Cross Blue Shield 

Ass’n/Wisc. Physicians Serv., 2014 WL 5450066, *5 (CMS 

Adm’r Sept. 4, 2014). CMS reasoned that because the totaltotal approach results in compensation for variable costs, it is 

inconsistent with the VDA’s statutory limit to fixed costs. Id. 
5

In contrast, the fixed-total method effectively treats all DRG 

payments as compensation for fixed costs, at least up to the 

amount of the hospital’s total fixed costs. Id. This approach 

ensures that the VDA never compensates for even a penny of

variable costs. See id. at *5–6.

Under the fixed-fixed approach, the VDA is the difference 

between the hospital’s fixed costs for treating Medicare 

beneficiaries and an estimate of what portion of its DRG 

payments afford compensation for those fixed costs. An 

estimate is necessary because HHS does not make available the 

actuarial data that would enable hospitals or administrative 

adjudicators to disaggregate DRG payments into portions 

attributable to fixed and variable costs. By using such an 

estimate, the fixed-fixed method acknowledges that DRG 

payments represent compensation for both kinds of costs.1

The Provider Reimbursement Review Board (PRRB), 

which hears administrative appeals regarding Medicare 

reimbursement decisions, developed the fixed-fixed method in 

a series of adjudications beginning in 2015. It has concluded 

that the fixed-total method used by CMS “takes the portion of 

the DRG payment intended for variable costs and 

impermissibly characterizes it as payment for the hospital’s 

fixed costs.” Lake Region Healthcare Corp. v. Nat’l Gov’t 

Servs., Inc., 2020 WL 13747016, *10 (PRRB Aug. 14, 2020)

1

 The fixed-fixed approach caps the VDA at the amount 

calculated under the total-total approach. The cap rests on a 

regulation making hospitals ineligible for the adjustment in years 

when they make a profit treating Medicare patients. See Medicare 

Program; Changes to the Inpatient Hospital Prospective Payment 

System and Fiscal Year 1988 Rates, 52 Fed. Reg. 22,080, 22,091 

(June 10, 1987). In other words, the VDA may not “exceed the 

difference between the hospital’s Medicare inpatient operating costs 

and total [DRG] payments.” Id. The cap is not at issue here.
6

(Lake Region I). To implement the fixed-fixed method, the 

PRRB uses a hospital’s own ratio of fixed costs to total costs 

for Medicare patients to estimate the percentage of DRG 

payments that compensate for fixed costs. Id. The PRRB has 

consistently applied the fixed-fixed method in reviewing 

hospital reimbursement decisions. See id. at *6 & n.45. And 

CMS, which may review decisions of the PRRB, has 

consistently reversed those decisions in favor of its fixed-total 

approach. See id.

In 2017, HHS changed course and adopted the fixed-fixed 

approach by rule. 82 Fed. Reg. 37,990, 38,180 (Aug. 14, 2017)

(2017 Rule).

2

 HHS continued to defend the lawfulness of its 

fixed-total approach but acknowledged that hospitals wanted it 

to “make an effort, in some way,” to disaggregate the fixedcost and variable-cost components of DRG payments. Id. To 

estimate the percentage of DRG payments that compensate for

fixed costs, the 2017 Rule uses the hospital’s own ratio of 

“fixed inpatient operating costs” to “total inpatient operating 

costs” for treating all of its patients, Medicare and nonMedicare alike. 42 C.F.R. § 412.92(e)(3). HHS imposed this 

new approach only prospectively, for cost-reporting periods 

after October 1, 2017. See id.

2

 The actual name of the rule is a mouthful: Medicare Program; 

Hospital Inpatient Prospective Payment Systems for Acute Care 

Hospitals and the Long-Term Care Hospital Prospective Payment 

System and Policy Changes and Fiscal Year 2018 Rates; Quality 

Reporting Requirements for Specific Providers; Medicare and 

Medicaid Electronic Health Record (EHR) Incentive Program 

Requirements for Eligible Hospitals, Critical Access Hospitals, and 

Eligible Professionals; Provider-Based Status of Indian Health 

Service and Tribal Facilities and Organizations; Costs Reporting and 

Provider Requirements; Agreement Termination Notices.
7

II

Lake Region Healthcare Corporation operates a hospital in 

Fergus Falls, Minnesota. In 2013, it experienced a decrease in 

Medicare inpatient discharges that qualified it for a VDA. 

Lake Region sought an adjustment of $1,947,967, which it 

calculated using the PRRB’s variant of the fixed-fixed 

approach. J.A. 41. A Medicare contractor denied Lake Region 

any adjustment. Applying the fixed-total approach, the 

contractor concluded that no adjustment was permissible 

because Lake Region’s fixed costs for the year for treating 

Medicare patients were less than its total DRG payments for 

the year. Id. at 59.

On administrative review, the PRRB and CMS continued 

their duel. The PRRB adhered to its fixed-fixed approach,

reversed the contractor’s decision, and awarded Lake Region 

the full amount of its requested adjustment. Lake Region I, 

2020 WL 13747016, at *10–11. In turn, CMS adhered to its 

fixed-total approach, reversed the PRRB’s decision, and 

reinstated the decision of the contractor. Lake Region 

Healthcare Corp. v. Nat’l Gov’t Servs., Inc., 2020 CMS Adm’r

Decision LEXIS 11, at *37 (Sept. 29, 2020) (Lake Region II). 

Somewhat curiously, CMS asserted that the PRRB’s fixedfixed approach—a close variant of the approach that HHS now 

requires—“is in direct contradiction” with the Medicare 

statute, regulations, and agency guidance. See id. at *34–35.

Lake Region then sought judicial review. In the district 

court, it urged application of the total-total method or, in the 

alternative, the fixed-fixed method. The government defended 

CMS’s application of the fixed-total method.

On cross-motions for summary judgment, the district court 

ruled for the government. Lake Region Healthcare Corp. v. 

Becerra, No. 1:20-cv-03452, 2022 WL 9936856 (D.D.C. Oct. 
8

17, 2022) (Lake Region III). First, the court ruled out use of 

the total-total method as “contradict[ing] the clear statutory 

directive that the VDA compensate only fixed costs.” Id. at *8. 

Then, the court concluded that both the fixed-total and fixedfixed methods “fall within the range of permissible 

interpretations” of the governing statute. Id. Citing Chevron 

U.S.A. Inc. v. NRDC, 467 U.S. 837 (1984), the court reasoned 

that because the statute did not “specify” how HHS should 

calculate the VDA, Congress had “delegated” that question to 

HHS “[t]hrough its silence.” Lake Region III, 2022 WL 

9936856, at *8. Moreover, it reasoned, payments for each 

DRG consist of a “single, undifferentiated number” that is not 

easily separated into its “fixed and variable components.” Id.

at *9. The court thus endorsed CMS’s reading of the statue as 

“reasonable, even if it might not be the best.” Id.3

III

When the district court reviews a PRRB or CMS order, we 

review its decision de novo. Forsyth Mem’l Hosp., Inc. v. 

Sebelius, 639 F.3d 534, 537 (D.C. Cir. 2011). Like the district 

court, we apply the judicial-review provisions of the 

Administrative Procedure Act. See 42 U.S.C. § 1395oo(f)(1). 

So we must independently “decide all relevant questions of 

law.” Loper Bright Enters. v. Raimondo, 144 S. Ct. 2244, 2272

(2024) (cleaned up); see 5 U.S.C. § 706(2).

This case turns on a question of statutory construction—

whether CMS’s total-fixed method for calculating volume3

 The district court further concluded that CMS’s approach was 

consistent with HHS regulations and did not represent a break from 

prior agency precedent. Lake Region III, 2022 WL 9936856 at *5–

7, *10–11. Because we resolve this case on statutory grounds, we 

need not consider these rulings.
9

decrease adjustments is consistent with the statutory command 

to “fully compensate” qualifying hospitals for their “fixed 

costs.” 42 U.S.C. § 1395ww(d)(5)(D)(ii). The district court 

deferred to HHS’s reading of the statute under Chevron. See 

Lake Region III, 2022 WL 9936856, at *9–10. Other courts 

have done the same. See, e.g., Unity HealthCare v. Azar, 918 

F.3d 571, 577–78 (8th Cir. 2019); Stephens Cnty. Hosp. v. 

Becerra, No. 19-cv-3020, 2021 WL 4502068, *9–10 (D.D.C. 

Sept. 30, 2021). But Chevron has now been overruled, so we 

must “exercise independent judgment” in construing the 

Medicare statute. Loper Bright, 144 S. Ct. at 2262.

We hold that HHS’s fixed-total approach does not afford 

the requisite full compensation for fixed costs. We recognize, 

as other courts have emphasized, that the statute does not 

specify exactly how HHS should calculate the VDA. But it 

does require attention to unreimbursed fixed costs—those a 

hospital has actually incurred minus those for which it has 

already been reimbursed. DRG payments cannot fairly be 

understood as compensation only for fixed costs. As noted

above, they are keyed to the average cost of treating particular 

conditions within the DRG. 42 U.S.C. § 1395ww(d)(3)(A); see 

also 42 C.F.R. §§ 412.2(c), 412.64(a). And they cover “all

routine operating costs, ancillary service operating costs, and 

special care unit operating costs,” including “the costs of all

services for which payment may be made.” 42 U.S.C. 

§ 1395ww(a)(4) (emphases added). DRG payments thus 

unambiguously compensate for variable as well as fixed costs. 

By attributing the payments solely to fixed costs, the fixed-total 

method overstates the amount of a hospital’s reimbursed fixed 

costs and thus understates the amount of its unreimbursed fixed 

costs, shortchanging the hospitals.

CMS offers several responses: The statute does not 

prescribe any particular method for calculating the VDA. DRG 
10

payments are lump-sum amounts covering both fixed and 

variable costs. And disentangling them into fixed-cost and 

variable-cost components would be difficult if not impossible. 

The courts deferring to CMS under Chevron have embraced 

these arguments. See, e.g., Lake Region III, 2022 WL 

9936856, at *8–9; Unity HealthCare, 918 F.3d at 577; Stephens 

Cnty. Hosp., 2021 WL 4502068, at *8–9.

We are unpersuaded. Accountants and auditors routinely 

break down business costs into fixed and variable components. 

HHS itself must consider fixed and variable costs in setting the 

annual DRG payments. In some contexts, it must determine 

the portion of DRG payments attributable to particular kinds of 

costs. For example, to account for wage differences in different 

areas, the Medicare statute requires adjustments for the portion 

of DRG payments “attributable to wages and wage-related 

costs.” 42 U.S.C. § 1395ww(d)(3)(E)(i). And in making those 

adjustments, CMS “determines the proportion of the [DRG 

payment] that is attributable to wages and labor-related costs.” 

42 C.F.R. § 412.64(h), (h)(2). For these reasons, HHS’s 

arguments about the prohibitive difficulty of disentangling 

DRG payments fall flat.

HHS does not release the data that it uses to calculate the 

DRG payments, which would enable a more precise calculation 

of the fixed- and variable-cost components of the DRGs using 

industry averages. But the agency cannot use the unavailability 

of that data to justify a demonstrably false working assumption 

that DRG payments compensate only for fixed costs. When

HHS does not release the best available data, hospitals, 

contractors, and the PRRB must resort to proxies. See Pomona 

Valley Hosp. Med. Ctr. v. Becerra, 82 F.4th 1252, 1261 (D.C. 

Cir. 2023). And here, there are reasonable proxies for

disentangling DRG payments into their fixed and variable 

components. As noted above, the PRRB has long used a 
11

hospital’s own ratio of fixed costs to total costs for treating 

Medicare patients to determine the ratio of its DRG payments 

reflecting compensation for its fixed costs. Lake Region I, 

2020 WL 13747016, at *6 & n.45. And HHS itself, for 

payment years after 2017, mandates using the hospital’s own 

ratio of fixed costs to total costs for treating all patients to 

determine the ratio of its DRG payments reflecting 

compensation for its fixed costs. 42 C.F.R. § 412.92(e)(3). We 

recognize that the regulation, which has only prospective 

application, is not directly controlling here. But it confirms our 

view that HHS can at least attempt to estimate how much 

compensation a hospital has already received for its fixed costs. 

The total-fixed approach does not even do that much.

Like the district court in Stephens County Hospital, we 

recognize that no method for calculating the VDA is perfect. 

2021 WL 4502068, at *9. Nonetheless, a method that ignores

all compensation for variable costs is not one that reasonably

approximates full compensation for fixed costs. Moreover, 

while DRG payments are keyed to average costs, the VDA, 

which requires the Secretary to “fully compensate the hospital 

for the fixed costs it incurs,” 42 U.S.C. § 1395ww(d)(5)(D)(ii)

(emphasis added), is keyed to the actual fixed costs of 

individual hospitals. So, in determining how much of a DRG 

payment compensates a hospital for its fixed costs, using the 

fixed-to-total cost ratio of the individual hospital may in fact 

be a more precise method—as opposed to a flawed “proxy,” 

Stephens Cnty. Hosp., 2021 WL 4502068, at *10 (cleaned 

up)—than using the industry-wide, fixed-to-total cost ratios 

that HHS declines to release. Regardless, all we hold today is 

that the fixed-total method used by CMS did not “fully 

compensate” Lake Region for its “fixed costs” in 2013.
12

IV

We reverse the grant of summary judgment to HHS, 

reverse the denial of summary judgment to Lake Region, and 

remand with instructions to set aside CMS’s decision and then 

remand to the agency for further proceedings consistent with 

the opinion.

So ordered.