United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued December 15, 2017 Decided August 10, 2018

No. 17-5006

BILLINGS CLINIC, ET AL.,

APPELLANTS

v.

ALEX MICHAEL AZAR, II, SECRETARY, U.S. DEPARTMENT OF 

HEALTH AND HUMAN SERVICES,

APPELLEE

Appeal from the United States District Court

for the District of Columbia

(No. 1:13-cv-00643)

Sven C. Collins argued the cause for appellants. With 

him on the briefs was Stephen P. Nash. 

Sydney Foster, Attorney, U.S. Department of Justice, 

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

Jessie K. Liu, U.S. Attorney, and Michael S. Raab, Attorney.

Before: GARLAND, Chief Judge, and SRINIVASAN and 

MILLETT, Circuit Judges.

Opinion for the Court filed by Circuit Judge MILLETT.

MILLETT, Circuit Judge: Several hospitals challenge the 
2

methodology that the Department of Health and Human 

Services used to calculate the “outlier payment” component of 

their Medicare reimbursements for 2008, 2009, 2010, and 

2011. Following this court’s decision in Banner Health v. 

Price, 867 F.3d 1323 (D.C. Cir. 2017) (per curiam)—which 

upheld the challenged methodology at its inception in 2007—

the primary question before us is whether the Department’s

decision to continue with its methodology after the 2007 fiscal

year was arbitrary in light of accumulating data about the 

methodology’s generally sub-par performance. Because the 

Department had, at best, only limited additional data for 2008 

and 2009, and because the 2009 data suggested that hospitals 

were paid more than expected, the Department’s decision to 

wait a bit longer before reevaluating its complex predictive 

model was reasonable. 

On appeal, the Hospitals also challenge the Department’s

failure to publish a proposed, but later abandoned, draft rule 

during the 2003 rulemaking process. As the parties now 

acknowledge, Banner Health decided this issue in favor of the

Department. That prior circuit precedent controls here.

I

A

Congress first established Medicare in 1965 as part of the 

Social Security Act, Pub. L. 89–97, Title XVIII, 79 Stat. 286, 

291 (1965), as a “federally funded medical insurance program 

for the elderly and disabled,” Fischer v. United States, 529 U.S. 

667, 671 (2000). In its early years, Medicare paid its claims 

much like most other insurance providers, reimbursing 

hospitals for the “reasonable costs” of services provided to 

Medicare patients. County of L.A. v. Shalala, 192 F.3d 1005, 

1008 (D.C. Cir. 1999). 
3

But over time, that system broke down. The “reasonable 

cost” payment structure provided little incentive for hospitals 

to husband their costs. The more they spent, the more they 

would receive. County of L.A., 192 F.3d at 1008. So 

healthcare costs rose, driving up the costs of the Medicare 

program. See id.

In 1983, Congress confronted the problem of rising costs. 

To better align the providers’ incentives, it constructed a new 

“prospective” payment system that reimbursed hospitals based 

on the average rate of “operating costs [for] inpatient hospital 

services.” County of L.A., 192 F.3d at 1008. After adopting

this new scheme, the Department of Health and Human 

Services began to reimburse hospitals “at a fixed amount per 

patient, regardless of the actual operating costs they incur in 

rendering [those] services.” Sebelius v. Auburn Reg’l Med. 

Ctr., 568 U.S. 145, 149 (2013). 

Generally speaking, this reimbursement system operates 

as follows:

First, the Secretary of Health and Human Services 

calculates a base payment rate. See 71 Fed. Reg. 47,870, 

47,876 (Aug. 18, 2006) (codified at 42 C.F.R. §§ 412.308, 

412.312). This rate contains both a labor and a non-labor cost 

component. Id. The Secretary then adjusts the labor-related 

component to account for labor costs in the area where the 

hospital is located. Id.

Second, the Secretary develops a list of “diagnosis-related 

groups.” 71 Fed. Reg. at 47,876. These groups encompass 

numerous related medical diagnoses that the Secretary believes 

impose a similar cost on the provider hospital. Id. To reflect 

the average cost of treatment for patients in each diagnosis 

group, the Secretary establishes a unique “relative weight” for 
4

that group. Id. 

Third, the base payment rate is multiplied by the relative 

weight to create a generic payment amount for each diagnosisrelated group. 71 Fed. Reg. at 47,876. That is:

BBBBBBBB PP PPPP PPPP RR × RR RR RRRR WW WWh =

GG ee ee PP PP PP PP PP PPPP PPPP

Fourth, qualifying hospitals can receive various payment 

“add-ons.” For example, if a hospital treats a high proportion

of low-income patients, it receives a percentage increase in 

Medicare payments known as the “disproportionate share 

hospital (DSH) adjustment.” 71 Fed. Reg. at 47,876. 

Likewise, if the hospital serves as an approved teaching 

hospital, it can receive a percentage add-on payment, known as 

the indirect medical education adjustment. Id. Hospitals

also can receive additional payments for cases involving the

use of new technologies. Id.

Fifth, even with those add-ons, Congress recognized that 

healthcare providers would encounter patients with needs well 

outside the norm. Country of L.A., 192 F.3d at 1009. To 

account for those abnormally costly cases and to protect against

large financial losses for hospitals, the statute permits hospitals 

to request additional “outlier payments.” See 42 U.S.C. 

§ 1395ww(d)(5)(A)(ii). Hospitals may seek such payments

where “charges, adjusted to cost, * * * exceed the sum of the 

applicable [diagnosis-related group] prospective payment rate 

plus any amounts payable under [the payment adjustment 

provisions] plus a fixed dollar amount determined by the 

Secretary.” Id. In other words, hospitals are eligible for 

outlier payments where:
5

CCh ,AAAAAAAA AA CC > (GG PP PP PP PP PP PPPP PPPP +

AA PP PPPP PPPP AAAAAAAA +

AAAAAA BB BBBBBB AA AA ( bb h SS ))

Any cost-adjusted charges above the applicable threshold 

are eligible for outlier compensation. Charges below the 

threshold are not. For that reason, the latter half of the above 

formula—the generic prospective payment, adjustments, and 

additional buffer (or “outlier threshold”)—is collectively 

referred to as the “fixed-loss cost threshold.” 72 Fed. Reg. 

47,130, 47,417 (Aug. 22, 2007) (codified at 42 C.F.R. pt. 412). 

The Department can control the threshold (and thus the number 

of cases eligible for outlier payments) by adjusting the 

additional buffer amount up or down at the start of the year.

The first figure in the formula, “charges, adjusted to cost,” 

represents the estimated cost of care for the patient at issue. 

Since the Department will not know the hospital’s actual cost 

of care at the time of payment, it can only estimate the 

hospital’s costs using historical information about the 

hospital’s past costs in relation to its prior charges. 1 The 

 1 Unlike other payments, outlier payments are typically made 

based on the data available at the time the Department processes the 

hospital’s claim. 68 Fed. Reg. 34,494, 34,500 (June 9, 2003) 

(codified at 42 C.F.R. pt. 412). As noted below, due to systemic 

abuse of this payment structure, the Department now retains the right 

to adjust payments in certain cases through a process known as 

“reconciliation,” which relies on later-acquired cost information. 

Id. at 34,500–34,502. In the mine-run case, however, the 

Department will not adjust the payment based on subsequently 

obtained information. See 72 Fed. Reg. at 47,419. Instead, the 

hospital will receive an outlier payment, if any, based on the 

Department’s predicted cost of care for the patient in question given 

the hospital’s actual charges for that patient.
6

Department estimates costs as follows:

CCh , AAAAAAAA AA CC = AA AA CCh ×

HHHHHHHHHHHHHHHHHHHH CC

HHHHHHHHHHHHHHHHHHHH CCh aaaa

See 53 Fed. Reg. 38,476, 38,503 (Sept. 30, 1988).

The final piece of this formula—historical costs/historical

charges—is known as the hospital’s “cost-to-charge ratio.” It 

reflects the percentage of that hospital’s charges attributable to 

actual costs. To illustrate: If a hospital submits a bill for 

$1,000, the Department will look to see whether the hospital’s 

estimated costs(or, as the Department refers to them, “charges, 

adjusted to cost”) exceed the fixed-loss cost threshold. To do 

so, it will first need to know the costs embedded in that $1,000 

charge. That is where the cost-to-charge ratio enters in. If 

the hospital charged $500 for this procedure in prior years, and 

its costs were $375, the hospital would have a cost-to-charge

ratio of $375/$500 or .75. Put another way, in the past, 75% 

of the hospital’s charges reflected its costs of care. Knowing 

that, the current costs of care can be estimated as follows:

$1,000 × .75 = $750

In this instance, the hospital’s “charges, adjusted to costs” 

would be $750, and that number can be weighed against the

fixed-loss cost threshold for that patient’s diagnosis-related 

group to determine whether the hospital should receive an 

outlier payment. 

Finally, the statute provides that the total outlier payment 

for a given hospital “shall be determined by the Secretary and 

shall * * * approximate the marginal cost of care beyond the 

[applicable] cutoff point.” 42 U.S.C § 1395ww(d)(5)(A)(iii). 

To implement this objective, the Department currently pays 

80% of all costs above the applicable threshold. 42 C.F.R. 
7

§ 412.84(k).

Continuing the previous example: If the fixed-loss cost 

threshold was $500, but the estimated cost of a patient’s care 

was $750, the hospital would be eligible for an outlier payment 

of $200 (or 80% of $250, the amount falling above the $500 

threshold). If, however, the threshold was $1,000, the hospital 

would receive no payment at all.

B

Over the years, the Department has taken various 

approaches to the cost-to-charge ratio data used to calculate the 

cost-adjusted charges in this formula. Originally, it employed 

a nationwide ratio for all hospitals. In the late 1980s, it shifted 

to hospital-specific ratios that more accurately reflected the 

costs at a given facility. 53 Fed. Reg. at 38,503, 38,507–

38,509 (codified at 42 C.F.R. pts. 405, 412, 413 & 419). But 

even after making that change, the Department had difficulties 

aligning its projections with actual costs of care. Prior to 

2003, it used cost and charge data from the “latest available 

settled cost report” without any forward projections. 68 Fed. 

Reg. 34,494, 34,495 (June 9, 2003) (codified at 42 C.F.R. pt. 

412).

2

 But cost reports take several years to settle. And that

time lag generated opportunities for abuse. Hospitals could 

manipulate their outlier payments by inflating current charges 

so that the historic cost-to-charge ratio employed to calculate 

outlier payments did not reflect the hospital’s true costs. In 

those situations, the hospital’s cost-to-charge ratio would 

 2 A “cost report” is an annual report submitted by each hospital

that details the hospital’s costs for treating Medicare patients during

the prior fiscal year. The Department uses these reports to 

“determine total allowable inpatient Medicare costs” as well as to 

calculate the hospital’s cost-to-charge ratio. 68 Fed. Reg. at 10,423.
8

overstate actual costs, resulting in an inflated cost estimate for 

the current year’s claims. Id. at 34,496. 

To use another example: If a hospital charged $2,000 for 

a certain procedure ($1,500 of which reflected the hospital’s 

costs), it would have a historic cost-to-charge ratio of 75%. If 

the hospital wanted to increase its chances of obtaining an 

outlier payment, it could simply increase the charge for that 

procedure to $4,000. Using the now outdated cost-to-charge

ratio, the Department would calculate the hospital’s estimated 

costs as $3,000 ($4,000 * .75), though, in reality, the costs were

likely much closer to the original $1,500. 

To make matters worse, prior to 2003, if a hospital’s costto-charge ratio fell outside a specified window, the Department

would substitute a statewide cost-to-charge ratio in lieu of the 

hospital-specific ratio. 68 Fed. Reg. 10,420, 10,424 (March 5, 

2003). That compounded the benefit of charge inflation 

because hospitals could reap the rewards of inflated charges in 

the short term without feeling the effects of a deflated cost-tocharge ratio in subsequent payment periods.

Unsurprisingly, this approach led to rampant inflation in 

hospital charges, a problem that came to be known as “turbocharging.” Banner Health, 867 F.3d at 1333. The 

Department later identified 123 hospitals that had engaged in 

the practice of turbo-charging starting in the 1990s. 68 Fed. 

Reg. at 10,423. 

In 2003, when the turbo-charging problem came to light, 

the Department issued a regulation that addressed the problem 

in two key ways. First, the Department sought to close the gap 

between cost-to-charge ratios and current costs by using more 

recent data—specifically by permitting the use of “either the 

most recent settled or the most recent tentative settled cost 
9

report, whichever is from the later cost reporting period.” 68 

Fed. Reg. at 34,499. Second, the Department reserved the 

right to recalculate a hospital’s eligibility using actual cost data 

at the time of settlement. Id. at 34,501. Through this 

process, known as reconciliation, the agency could claw-back 

undue outlier payments. Id.

At that same time, the Department also considered 

immediately adjusting the 2003 outlier threshold, which had 

been set at the beginning of the year, to account for the effect 

of the reforms on 2003 outlier payments. To that end, the 

Department drafted a rule proposing to decrease the existing 

outlier threshold for the remainder of the 2003 fiscal year.

The Department ultimately abandoned that effort, opting 

instead to maintain the existing threshold until the year’s end

to allow rates to settle. 68 Fed. Reg. at 34,506. So the draft 

rule was never published. The Hospitals later obtained a copy 

of the draft through a Freedom of Information Act request.

C

To add complexity to the complexity, the Medicare 

statute also limits the total amount of all outlier payments the 

Department can make in a given fiscal year—setting both a 

floor and a ceiling. Under the Act, the “total amount of” 

outlier payments made in a fiscal year “may not be less than 5 

percent nor more than 6 percent of the total payments projected 

or estimated to be made based on [diagnosis-related group]

prospective payment rates for discharges in that year.” 42 

U.S.C. § 1395ww(d)(5)(A)(iv). Of course, that requires the 

Department to estimate certain numbers at the start of the year 

before it has actual claims information. Because the statutory 

target is tied to “projected or estimated,” not actual, payments, 

id., the Department has interpreted the statutory directive to 

mean that the fixed loss threshold must be set at a level that, 
10

“when tested against historical data, will likely produce 

aggregate outlier payments totaling between five and six 

percent of projected or estimated [diagnosis-related group]

payments.” County of L.A., 192 F.3d at 1013 (emphasis 

added); see e.g., 50 Fed. Reg. 35,646, 35,710 (Sept. 3, 1985). 

For every year since 1989, the Department has aimed to set the 

fixed-loss cost threshold so that the total outlier payments will 

be 5.1% of all Medicare payments, or: 

TT OO PP PPPP PPPP =

5.1% (TT PP PP PP MM PP PPPP PPPP ) 

But, alas, this is a predictive enterprise. The Department 

must set the outlier threshold at the start of each year before it 

knows how many hospitals will actually have outlier patients. 

In other words, the agency must estimate the number of outlier 

cases for the upcoming year and set a threshold that it believes 

will result in outlier payments of 5.1%. 

As a result, to compute an appropriate outlier threshold, 

the Department must estimate the total outlier costs for all 

hospitals for the upcoming year. In practice, the Department 

uses a formula similar to the one it uses to calculate actual 

outlier payments, inputting projected and historical cost and 

charge information to fill in the gaps. More specifically, the 

agency takes historical charges and projects them forward to 

reflect the upcoming year’s charges. The Department then 

takes the historical cost-to-charge ratio from the most recent 

year available and projects those figures forward to predict 

current cost-to-charge ratios. 3 The basic formula is as 

 3 In reality, the agency calculates operating and capital ratios 

separately. For simplicity, we treat this as a single-track 

calculation.
11

follows:

TT CCh , AAAAAAAA AA CC = PP PP PP CCh ×

PP PP PP CC RR RR

In 2007, the Department refined its methodology for 

projecting historical cost-to-charge ratios forward to the 

current year. 71 Fed. Reg. at 48,149. In the aftermath of the 

2003 turbo-charging reforms, cost-to-charge ratios had fallen. 

As a result, the Department’s efforts to hit its 5.1% target had 

begun to land consistently short. Commenters, including 

many hospital providers, asked the Department to adopt an 

“adjustment factor” to update the cost-to-charge ratio formula 

based on the current downward trend in hospital costs. Id. at 

48,150. The Department agreed. It proposed the following 

formula to estimate costs for purposes of determining the 

outlier threshold: 

TT CCh ,AAAAAAAA AA CC =

(HH CCh × CCh II FF ) ×

� HH CC

HH CCh ×

CC II FF

CCh II FF �

See id. at 48,149.

This refined formula relied upon two critical metrics to 

predict future costs and charges from the available historical 

information: the cost inflation factor and the charge inflation 

factor. 

The latter was relatively simple. The agency would 

update historical charge data using the average annualized rate 

of change in charges per case. In other words:

CCh II FF =
12

AA RR AA AA CCh CCh CC

71 Fed. Reg. at 48,149.

The cost inflation factor, however, was more complex. It 

factored in both hospital-specific cost inflation and general 

inflation as measured by the change in a standard market basket 

of goods and services. At the highest level, the formula is as 

follows:

Cost Inflation Factor =

(Average Annual Hospital Cost Inflation for three years prior × 

Annual Inflation of Market Basket for the most recent year available)

And within this formula:

AA AA HH CC II =

AAAAAAAA CCh aaaa CC pp DD h aaaa

AAAAAAAA MM MM BB II

To put this all together in a more concrete setting, the 

Department would calculate the cost inflation factor for 

purposes of the 2008 threshold using historical data as follows:

2008 CC II FF =
13

⎝

⎜

⎜

⎜

⎜

⎜

⎜

⎜

⎜

⎜

⎜

⎛

⎝

⎜

⎜

⎜

⎛

2004 2005 CCh CC DD h

2005 MM MM BBBBBB BB II +

2003 2004 CCh CC DD h

2004 MM MM BBBBBB BB II +

2002 2003 CCh CC DD h

2003 MM MM BBBBBB BB II ⎠

⎟

⎟

⎟

⎞

3

⎠

⎟

⎟

⎟

⎟

⎟

⎟

⎟

⎟

⎟

⎟

⎞

× 2006 MM MM BBBBBB BB II

See 71 Fed. Reg. at 48,150 (outlining this process for the 2007 

threshold).

Once the agency calculates both the cost inflation and 

charge inflation factors, it then divides the cost inflation factor 

by the charge inflation factor to obtain the “adjustment factor.” 

This adjustment factor is then multiplied by the historical costto-charge ratio to obtain an updated, or projected, cost-tocharge ratio for that year. 

HH CC

HH CCh ×

CC II FF

CCh II FF

= PP PP PP CC RR RR

D

Many providers supported the downward adjustment in 

the cost-to-charge ratios, but not the “magnitude of that 

adjustment.” Banner Health, 867 F.3d at 1355. Several 

hospitals then challenged the 2007 outlier payment

methodology. This court rejected those claims, holding that 

the Department’s new formula was not arbitrary or capricious 
14

in light of the information available to the Department. Id. at 

1355–1356 (finding “many non-arbitrary reasons for 

predicting that costs and charges * * * will not continue on their 

current trajectories”).

The following year, the Department used the same 

methodology to calculate the 2008 outlier threshold. See 72 

Fed. Reg. at 47,417. The result was a proposed fixed loss 

threshold of the prospective payment rate plus any cost 

adjustments plus $23,015. Id.

Several commenters thought that the buffer amount was 

too high. They noted that outlier payments had been, by their 

calculation, only 4.63% of overall 2007 payments. They 

urged the Department to adopt a simplified cost inflation factor 

based on the actual rate of change in hospital costs—the same 

method already being used to estimate projected charges. 

Commenters also faulted the agency for not using more recent 

cost-to-charge ratio data, and suggested applying the cost-tocharge ratio adjustment factor over different periods of time 

(longer or shorter than one year) based on individual hospital’s 

fiscal calendars. Others simply urged the Department to 

lower the threshold without providing an alternative approach.

The Department rejected all of those proposals. 72 Fed. 

Reg. at 47,418. By the time of the final rule, the Department

estimated that outlier payments for 2007 had been 4.6% of

overall payments. Id. at 47,420. That fell far short of the 

5.1% payment target. But because cost reports had not been 

settled for 2007, 4.6% was still just an estimate of what the 

actual 2007 percentage would be. Id. (“This estimate is based 

on simulations[.]”). For that reason, the Department declined 

to alter its methodology, reasoning that its chosen cost inflation 

factor was “more accurate and stable than the commenter’s * * 

* because it takes into account the costs per discharge and the 
15

market basket percentage increase[.]” Id. at 47,418. As it 

had in prior years, the Department also determined that its 

methodology would not account for any potential payment 

claw-backs made during the reconciliation process because 

those would be too “difficult to predict” and because the 

amounts are generally too small to materially affect the 

predictive assumptions. Id. at 47,419. The Department, 

however, did update the data for its final rule, a change that 

resulted in a lower buffer amount of $22,635. Id.

That process was largely repeated in 2009. See 73 Fed. 

Reg. at 48,763. The Department proposed a fixed loss 

threshold of the prospective payment rate plus any cost 

adjustments plus $21,025, and ended with an updated, final 

buffer of $20,185. 73 Fed. Reg. 23,528, 23,711 (April 30, 

2008); 73 Fed. Reg. at 48,766.

Once more, commenters challenged the cost inflation 

factor, calling it “unnecessarily complicated.” 73 Fed. Reg. at 

48,764. They again urged the agency (i) to use more recent, 

historical, and industry-wide rates of change; (ii) to vary the 

cost-to-charge ratio adjustment factor to more or less than one 

year; and (iii) to apply more recent hospital data to its 

calculations. Id. 

As before, the Department rejected the suggestions,

largely reiterating the reasons it had provided in 2008. See 73 

Fed. Reg. at 48,763. The Department now estimated 2007 

outlier payments as 4.6% of final payments, and it projected 

2008 payments to be 4.7%. Despite widely missing the 5.1% 

mark again, the Department maintained its approach to cost 

inflation, asserting that the use of “the market basket in 

conjunction with the cost per discharge takes into account two 

sources [of] potential cost inflation and ensures a more accurate 

and stable cost adjustment factor.” Id. at 48,764.
16

For 2010, the agency again employed the same formula. 

74 Fed. Reg. at 44,007. Using that methodology, the agency

proposed a fixed loss threshold of the prospective payment rate 

plus any adjustments plus $24,240, a 21% increase from the 

previous fiscal year. With updated data, the Department later 

arrived at a final buffer of $23,140. 

This time, the Department’s estimates appeared slightly 

more promising. By the final rulemaking, the Department 

estimated that 2008 outlier payments had been 4.8% of final 

payments, but 2009 outlier payments had been 5.4% of final 

payments—meeting and even exceeding the 5.1% target. 

Nevertheless, the proposed increase in the buffer amount 

prompted renewed protest. See 74 Fed. Reg. at 44,007. 

Commenters could not understand why—when the agency had 

met its target in 2009—there should be any change to the 

threshold amount. Id. at 44,009. Others accused the agency 

of purposefully erring on the low end of the 5% to 6% target. 

Id. Another asked the agency to make a mid-year adjustment 

if it appeared that the existing threshold would not result in 

payments in the 5% to 6% range. Id. Still others repeated the 

requests to use more recent data in the final rule and to account 

for reconciliation. Id. at 44,009–44,010.

For its part, the Department insisted that it had “use[d] the 

most recent data available to set the outlier threshold.” 74

Fed. Reg. at 44,009. It rejected the mid-year course correction

because such adjustments would be “extremely difficult or 

impracticable (if not impossible) to administer.” Id.

(incorporating 70 Fed. Reg. 47,278, 47,495 (Aug. 12, 2005), 

the Department’s response to a similar request made in the 

2006 rate proposal). And it denied all other suggestions for 

the same reasons given in prior rulemakings. See id. at 

44,010. 
17

Fiscal year 2011—the last at issue in this case—proved no 

different. See 75 Fed. Reg. 50,042, 50,427 (Aug. 16, 2010). 

The Department proposed a buffer of $23,970. 75 Fed. Reg. 

at 24,069. And it ultimately settled on $23,075 as the final 

amount. 75 Fed. Reg. at 50,430. The complaints from 

hospitals and the answers from the Department were repeated. 

In addition, using updated data, the Department calculated 

2009 outlier payments to be 5.3% of final payments, and 2010 

outlier payments to be 4.7% of final payments. Commenters 

took issue with the Department’s 2009 estimate, arguing that 

its calculations indicated outlier payments of only 4.9% for the 

2009 year. 

The following chart summarizes the key data points from 

each rulemaking:
18

2008 2009 2010 2011

Proposed FixedLoss Threshold

$23,015 $21,025 $24,240 $23,075

Final Fixed-Loss 

Threshold

$22,635 $20,185 $23,140 $23,075

Agency’s Target 5.1% 5.1% 5.1% 5.1%

Agency’s 

Reported 

Estimate 

4.8% 5.3% 4.7% 4.8%

Hospitals’ 

Estimate 

4.6% 4.9% N/A N/A

Shortfall 

(Agency 

Estimate )

-0.3% +0.2% -0.4% -0.3%

Shortfall 

(Hospital 

Reported 

Estimate)

-0.5% -0.2% N/A N/A

E

There is yet one final piece of this byzantine process that 

bears a bit of explanation. When a hospital seeks Medicare 

payments from the Department, it must first submit its request 

to a fiscal intermediary—that is, a contracted entity to which 

the Department has delegated payment determinations. See

42 U.S.C. §§ 1395kk-1, 1395oo(a). If the hospital is 

unsatisfied with the intermediary’s final determination, it may 

appeal the decision to the Provider Reimbursement Review 

Board. Id. In the normal course, the Board would review the 

claim, and the hospital would retain the right to seek “judicial 

review of any final decision of the Board.” 42 U.S.C. 

§ 1395oo(f)(1).

However, if the hospital’s claim “involves a question of 
19

law or regulations relevant to the matters in controversy * * *

[that the Board] is without authority to decide,” the hospital can 

ask the Board to allow it go directly to district court. 42 

U.S.C. § 1395oo(f)(1); 42 C.F.R. § 405.1842. If the Board 

agrees, it will certify the question for immediate judicial 

review. Id. Only the hospital can challenge the Board’s 

certification determination. See Allina Health Servs. v. Price, 

863 F.3d 937, 941–942 (D.C. Cir. 2017).

F

Several acute care hospitals have challenged the outlier 

payments received in 2008, 2009, 2010, and 2011. They 

allege that the Department’s methodology for determining the 

outlier threshold during this period was arbitrary and 

capricious, pointing in particular to the consistent 

underpayments in each of the relevant years and the failure to 

account for the possibility of reconciliation. They also object 

to the Department’s failure to publish the proposed but 

ultimately not-adopted 2003 draft rule, which, in their view, 

contains much-needed ammunition to show that the 

Department should have updated its methodology in these later 

years. 

Because the Hospitals challenged the legality of the 

applicable outlier thresholds, they requested expedited access 

to judicial review from the Board. The Board granted many 

of those certification requests, either initially or on 

reconsideration. With respect to some Hospitals, however, 

the Board concluded that it lacked jurisdiction to grant 

expedited review because those Hospitals had failed to comply 

with the required procedures for filing their cost reports. See 

e.g., Ex. 1 PRRB Decisions, Lee Mem’l Hosp. v. Sebelius, No. 

1:13-cv-00643 (D.D.C. Jan. 10, 2014), ECF No. 22-1 (citing 

42 C.F.R. § 405.1835(a)(1)(ii) (2013)). For that subset of 
20

Hospitals, the Board dismissed the cases for lack of jurisdiction 

without deciding the certification question. 

Both the dismissed and certified Hospitals filed suit in 

district court. The government conceded that the Board erred 

in dismissing some of the cases for lack of jurisdiction. In 

light of that concession, the district court held that the Board 

had jurisdiction, and that the court could likewise exercise its

own jurisdiction under 42 U.S.C. § 1395oo(f)(1). 

The district court subsequently granted summary 

judgment for the Department, concluding that its approach to 

calculating the outlier threshold was not arbitrary or capricious. 

The Hospitals moved for reconsideration, and the district court 

denied the motion. The Hospitals now appeal.

II

A

We start, as we must, with jurisdiction. The Medicare 

Act specifies that “[n]o findings of fact or decision of the 

[Secretary] shall be reviewed by any person, tribunal, or 

governmental agency” except as the Medicare Act itself 

provides jurisdiction. 42 U.S.C. § 405(h). The relevant 

source of jurisdiction in this case is 42 U.S.C. § 1395oo(f). 

That provision allows providers to seek review of a final 

decision of the Provider Reimbursement Review Board and to 

seek expedited judicial review where the Board lacks 

“authority to decide” a question of law relevant to the matter at 

hand. Id. 

As noted, for the majority of the plaintiff Hospitals, the 

Board granted expedited review on the ground that it lacked 

authority to override the outlier regulations. The district court 
21

properly exercised jurisdiction over those claims. See Allina 

Health Servs., 863 F.3d at 941–942.

As for the plaintiff Hospitals over which the Board

declined to exercise jurisdiction, the question is more 

complicated. While the Secretary has since disavowed the 

Board’s procedural objection to the claims in that case, that 

leaves unanswered whether the district court could proceed 

without first remanding for either a final decision or 

certification for expedited review from the Board. 

We need not resolve that jurisdictional quandary because 

there are Hospitals with valid Board certifications of expedited 

review for each of the years at issue, and only nonindividualized injunctive relief is sought. We accordingly

proceed to the merits on a clean jurisdictional slate.

B

Under the Administrative Procedure Act, we may only set 

aside agency action if it is “arbitrary, capricious, an abuse of 

discretion, or otherwise not in accordance with law.” 5 U.S.C. 

§ 706(2)(A). In making that assessment, we must ensure that 

the agency has “examine[d] the relevant data and articulate[d] 

a satisfactory explanation for its action including a rational 

connection between the facts found and the choices made.” 

Motor Vehicle Mfrs. Ass’n v. State Farm Mutual Auto. Ins. Co., 

463 U.S. 29, 43 (1983) (citation and internal quotation marks 

omitted).

The Hospitals argue that the cost-projection methodology

used by the Department to set the annual outlier thresholds is 

arbitrary and capricious for three reasons. First, they object to 

the Department’s failure to publish the 2003 draft rule, which 

they allege deprived them of useful information in the 
22

subsequent rulemakings. Second, they challenge the 

Department’s failure to account for the possibility of 

reconciliation claw-backs in setting the 2008, 2009, 2010, and 

2011 thresholds. Third, they object to the Department’s

continued use of its cost-inflation methodology in the face of 

repeated underpayments and the availability of a simpler 

formula, which the Department was already using to calculate 

inflation in hospital charges. 

The first two challenges are foreclosed by circuit

precedent. See Banner Health, 867 F.3d at 1337, 1356. As 

for the third, while the Hospitals’ frustration with the 

Department’s frequently off-target calculations is 

understandable, the methodology has not sunk to the level of 

arbitrary or capricious agency action. 

1

Our decision in Banner Health, which involved a similar 

challenge to the 1997 through 2007 outlier payment rates, 

disposes of the Hospitals’ procedural challenge regarding the 

Department’s unpublished draft rule. There, this court held 

that the Department did not err in failing to disclose the 2003 

draft rule because it had not relied on it in crafting its final rule. 

Banner Health, 867 F.3d at 1337.

4

 4 Because Banner Health controls disposition of this claim, we 

need not address the Department’s alternative standing argument. 

See Ruhrgas AG v. Marathon Oil Co., 526 U.S. 574, 584–585 (1999) 

(“It is hardly novel for a federal court to choose among threshold 

grounds for denying audience to a case on the merits.”). In any 

event, the Department’s concerns speak more to the merits of the 

Hospitals’ ability to obtain their desired relief with the aid of the 

2003 draft rule—a question not relevant to a threshold standing 

inquiry.
23

Banner Health also largely answers the Hospitals’ 

argument that the Department had to factor reconciliation 

claw-backs into its threshold predictions. Banner Health 

rejected that exact same challenge to the 2005 outlier 

thresholds. 867 F.3d at 1351–1352, 1356. We held that the 

Department “was under no obligation” to “account for the 

possibility of reconciliation in setting the fixed-loss threshold.” 

Id. at 1356; see also District Hosp. Partners, L.P. v. Burwell, 

786 F.3d 46, 61 (D.C. Cir. 2015) (concluding that the 2003 

reforms “corrected the flaw in the outlier payment system that 

created the opportunity—and incentive—to turbo-charge,” and 

thus the need for large reconciliations).

That conclusion applies with equal force to the 2008 

through 2011 outlier thresholds. As in Banner Health, the 

Department reasonably concluded “that [the] charging 

practices would not fluctuate significantly enough to justify 

accounting for reconciliation[.]” 867 F.3d at 1352 

(alterations, citation, and internal quotation marks omitted); 

see e.g., 72 Fed. Reg. at 47,419 (rejecting the need to consider 

reconciliation for the 2008 threshold for these same reasons). 

Nothing in the current record supports a different answer here.

The Office of the Inspector General’s 2012 Report, to which 

the Hospitals direct us, does not indicate that these payments 

occur with more regularity now than the Department suggested 

at the time of Banner Health.

Finally, Banner Health sanctioned the agency’s 2007 

methodology for calculating cost inflation, at least to the extent 

that the Hospitals challenge its facial validity. See 867 F.3d at 

1356 (“[T]he Hospitals have provided no reason to doubt that 

the market basket percentage increase correlated reasonably 

well with cost-per-case inflation.”). On top of that, just as 

Banner Health recognized, there is good reason to believe that

a model that accounts for macro-level change may better 
24

predict future costs than one that does not. Id.

The Hospitals’ proposal of a simpler method does not 

make the Department’s method arbitrary. “A model’s 

complexity, by itself, reveals little about its rationality.” 

Banner Health, 867 F.3d at 1356. In the wake of the turbocharging scandal and persistent cost containment problems, it 

was not unreasonable for the Department to be wary of an 

industry-specific inflation metric. Plus, as the Department 

explained, a method accounting for general inflation “is more 

accurate and stable” than the industry-specific alternative. 72 

Fed. Reg. at 47,418.

5

2

That leaves one final question: Did the Department act

arbitrarily in maintaining its cost inflation methodology after 

the 2007 fiscal year in the face of numerous underpayments? 

In light of the short pattern of missed targets, the limited and 

inconsistent data available to the Department at the time of its 

rulemakings, and the lengthy time lag in finally determining 

the actual payments made for a preceding year, we conclude 

that it did not.

To be sure, a methodology used for prediction “can look 

 5 The Hospitals also argue that the Department acted arbitrarily 

in treating under- and over-payments differently. Specifically, they 

claim that the agency responded to underpayments that fell short of 

the 5.1% target with indifference, but promptly increased the outlier 

threshold in 2010 after what it believed was an overshoot of the 5.1% 

target. That argument misunderstands what happened in 2010. 

The Department did not change its methodology after it hit what it 

believed to be a 5.3% mark. It employed the same methodology it 

had been using since 2007. That methodology simply produced a 

higher threshold for the 2010 fiscal year.
25

more arbitrary the longer it is applied.” American Petroleum 

Inst. v. EPA, 706 F.3d 474, 477 (D.C. Cir. 2013). But that line 

was not crossed for the years at issue here. In 2008, the 

Department had only one year’s worth of yet unsettled data to 

test the validity of its new model. By the time the Department 

had to develop its 2008 outlier payment amount, it had not 

definitively settled on the 2007 results, a cost-resolution 

process that can take several years. The tentative 2007 results 

were not so far off base as to suggest the need for immediate 

abandonment of the newly adopted system. Even by 2009, the 

Department had only a slightly more settled 2007 estimate and 

a tentative number for 2008. The time-lag inherent in 

obtaining accurate payment data underscores the 

reasonableness of the Department’s deliberative and cautious 

approach to evaluating the operation and accuracy of its 

methodology. 

Putting some proof in the pudding, the Department’s

calculations indicated that it not only met, but exceeded, the 

5.1% mark in 2009, resulting in payments to the Hospitals that 

exceeded the Department’s 5.1% target. Even considering the 

Hospitals’ contrary estimation of 4.9%, the 2009 payments 

nearly reached the Department’s intended target. For that 

reason, we cannot conclude that the Department acted 

arbitrarily in continuing to employ its predictive model for the 

next two years while accumulating additional data points. 

* * * * *

For all its complexity and labyrinthine mathematical 

formulae, this case turns on a simple concept: Some things 

take a bit of time to sort out. The Department’s efforts to 

predict Medicare costs for patients across the Nation each fiscal 

year is fraught with variables, estimates, and uncertainties. 

The Medicare statute recognizes that difficulty by requiring the 
26

Department to model results that fall between 5% and 6% of 

total projected payments, without mandating that the 

Department actually hit the bullseye each year. See 42 U.S.C. 

§ 1395ww(d)(5)(A)(iv). Though the Department has an 

obligation to act reasonably and to account for the actual results 

of its decisions, the need for time both to study the results and 

to determine how to improve accuracy must inform any 

evaluation of the appropriateness of the Department’s actions 

in these years.

For those reasons, we affirm the judgment of the district 

court.

So ordered.