Opinion ID: 2801751
Heading Depth: 2
Heading Rank: 3

Heading: setting the outlier thresholds

Text: DHP contends that the Secretary acted arbitrarily and capriciously by setting the outlier thresholds too high in 2004, 2005 and 2006. Because the Secretary dealt with different considerations in each rulemaking, we discuss them separately.
The Secretary established that the 2004 outlier threshold was the applicable DRG rate “plus $31,000.” 68 Fed. Reg. at 45,477. As discussed above, the Secretary selected this number by first simulating 2004 outlier payments using data from 2002. Id. at 45,476. She inflated the 2002 data using “the 2-year average annual rate of change in charges per case” between 2000 and 2002, which calculation was made from all hospitals’ “cost-to-charge ratios.” Id. And she accounted for the effects of reconciliation by identifying “approximately 50 [turbo-charging] hospitals” that were likely to be reconciled. Id. For each of the 50 hospitals, the Secretary sought to 20 project its “cost-to-charge ratio based on its rate of increase in charges per case” in 2002. 6 Id. at 45,477. DHP argues that the Secretary, in calculating the charge inflation factor, should have excluded the data from the 123 turbo-charging hospitals identified in the NPRM. The Secretary excluded them in the OMB draft rule and DHP faults the Secretary for not explaining why she changed course in the 2004 rulemaking and opted to include turbo-chargers’ data. But, as already noted, HHS abandoned the OMB draft rule and never published it in the Federal Register. Relying on the OMB draft rule to impugn the 2004 rulemaking, then, presents a problem. The Supreme Court recently iterated that “federal courts ordinarily are empowered to review only an agency’s final action.” Nat’l Ass’n of Home Builders v. Defenders of Wildlife, 551 U.S. 644, 659 (2007). Deviations from a 6 At oral argument, counsel for DHP intimated that the charge inflation factor and cost-to-charge ratios come from two different datasets. Oral Arg. Tr. at 11–12, 14–15, 38. Because this data is separate, DHP asserted, the Secretary could make adjustments to one group but not the other. We do not believe the intimation is supported by the record. In each rulemaking, the Secretary specified that she derived the charge inflation factor from the cost-to-charge ratios for individual hospitals. See 70 Fed. Reg. at 47,494 (Secretary calculated “a charge inflation factor of 14.94 percent . . . us[ing] updated cost-to-charge ratios from the March 2005 update” of hospital files); 69 Fed. Reg. at 49,277 (“[t]he 1-year average annual rate of change in charges per case . . . was 8.9772 percent, or 18.76 percent over 2 years. As discussed above, as we have done in the past, we used hospital cost-to-charge ratios” from hospital files (emphasis added)); 68 Fed. Reg. at 45,476 (charge inflation factor is derived from “the 2-year average annual rate of change in charges per case” and is based on “cost-to-charge ratios” from hospital files). Accordingly, any adjustment to cost-to-charge ratios is reflected in the charge inflation factor. 21 “preliminary determination” that was subsequently “overruled at a higher level . . . does not render the decisionmaking process arbitrary and capricious.” Id. It is true, of course, that an agency cannot “depart from a prior policy sub silentio or simply disregard rules that are still on the books.” FCC v. Fox Television Stations, Inc., 556 U.S. 502, 515 (2009). But this principle is inapplicable here—the OMB draft was never “on the books” in the first place. Id. We held as much in Kennecott Utah Copper Corp. v. DOI, 88 F.3d 1191 (D.C. Cir. 1996). That case involved, among other things, draft regulations that were sent by a Department of Interior (Interior) official to the Office of the Federal Register (OFR) for publication. Id. at 1200. Before they were published, however, Interior switched course and withdrew the draft from publication. Id. at 1200–01. Interior then proposed and eventually published a new set of regulations. Id. at 1201. Certain Kennecott petitioners challenged the published regulations because they supposedly “repealed and modified” the never-published draft regulations without a new round of notice and comment. Id. at 1207. We disagreed and held that the published regulations did not “repeal or modify” anything because the draft “never became a binding rule requiring repeal or modification.” Id. at 1208. The APA requires notice and comment only when “formulating, amending, or repealing a rule,” 5 U.S.C. § 551(5), and the “agency was in no sense ‘formulating’ a rule” by “discarding” the earlier draft, Kennecott, 88 F.3d at 1209. Nevertheless—and without regard to the OMB draft—we believe that the Secretary’s promulgation of the 2004 outlier threshold violated the APA. In the NPRM—a formal agency document that was published in the Federal Register—the Secretary identified 123 turbo-charging hospitals. 68 Fed. Reg. at 10,423–24. The 123 hospitals reported adjusted 22 charges that “increased at a rate at or above the 95th percentile rate of charge increase for all hospitals” between 1999 and 2001. Id. at 10,423. The Secretary also noted that the 123 hospitals were the principal beneficiaries of the outlier payment system: Their “mean rate of increase in charges was 70 percent” for that two-year period while their cost-to-charge ratios “declined by only 2 percent.” Id. at 10,424. The 123 hospitals are nowhere to be found in the 2004 rulemaking. Granted, the Secretary identified 50 hospitals “that have been consistently overpaid recently for outliers.” 68 Fed. Reg. at 45,476. But she did not explain how the 50 hospitals differed from the 123 she identified in the NPRM. This unexplained inconsistency is significant because factoring in the outlier correction rule “resulted in a substantial reduction in the outlier threshold from the proposed level.” Id. at 45,477 (emphasis added). The changes, in fact, caused the actual 2004 fixed loss threshold to fall from $50,200 in the proposed rule to $31,000 in the final rule. Id. Had the Secretary accounted for more turbo-charging hospitals in the 2004 rule, perhaps the 2004 outlier threshold would have been even lower. Or perhaps not. Either way, we have no way to know for sure because there was scarcely a word about the 123 turbo-chargers in the 2004 rule. 7 7 Although the NPRM was not technically part of the 2004 rulemaking record, it was sufficiently similar to, and contemporaneous with, the 2004 rulemaking as to require the Secretary to explain inconsistencies in the data. See Portland Cement Ass’n v. EPA, 665 F.3d 177, 187 (D.C. Cir. 2011) (agency must account for and explain changes that affect “a contemporaneous and closely related rulemaking”); Ala. Power Co. v. FCC, 773 F.2d 362, 371 (D.C. Cir. 1985) (noting that agency adopted “inconsistent” principles in different but related orders and 23 Our conclusion follows naturally from the Supreme Court’s holding in State Farm. There, the Court stated that an agency “must examine the relevant data and articulate a satisfactory explanation for its action including a rational connection between the facts found and the choice made.” 463 U.S. at 43 (emphases added; quotation mark omitted). The Secretary failed to do so here. She identified only 50 turbo-charging hospitals despite that figure being “counter to the evidence” before her, id., namely the 123 hospitals in the NPRM. The inconsistency went unresolved in the 2004 rulemaking because the Secretary never discussed it. We have often declined to affirm an agency decision if there are unexplained inconsistencies in the final rule. See, e.g., Engine Mfrs. Ass’n v. EPA, 20 F.3d 1177, 1182 (D.C. Cir. 1994) (noting that “unexplained inconsistency” in final rule was “not reasonable”); Gulf Power Co. v. FERC, 983 F.2d 1095, 1101 (D.C. Cir. 1993) (“[W]hen an agency takes inconsistent positions . . . it must explain its reasoning.”); General Chem. Corp. v. United States, 817 F.2d 844, 846 (D.C. Cir. 1987) (agency action was arbitrary and capricious because its analysis was “internally inconsistent and inadequately explained”). Nor do we uphold agency action if it fails to consider “significant and viable and obvious alternatives.” Nat’l Shooting Sports Found., Inc. v. Jones, 716 F.3d 200, 215 (D.C. Cir. 2013) (quotation marks omitted). The analysis of the 123 turbo-charging hospitals identified in the NPRM was a significant and obvious alternative to the 50 hospitals the Secretary ultimately considered in the 2004 final rule. The Secretary maintains that she had no obligation to explain the inconsistency given our holding in Bell Atlantic Telephone Cos. v. FCC, 79 F.3d 1195 (D.C. Cir. 1996). But remanding to agency for further explanation “[i]n light of this unexplained inconsistency”). 24 our holding there is off point. In Bell Atlantic, the FCC was required by regulations to set a price cap for telephone carriers that included an offset based on “productivity growth” in the telecommunications industry. Id. at 1198. In a 1990 order, the Commission included data from a controversial study and arrived at a productivity offset that was relatively low. See id. at 1200. Then, in 1995, the Commission reversed course and excluded the data from that same study, which led to a higher productivity offset. Id. at 1200–01. We held that it was reasonable for “[o]ne Commission . . . to include a suspicious data point because it was relevant, [and] a later Commission . . . to exclude a relevant data point because it was suspicious.” Id. at 1203 (first alteration in original). Neither decision should “be viewed as more rational” than the other. Id. The same circumstances do not exist here. In Bell Atlantic, the later Commission acknowledged the inclusion of suspect data in the past and explained why it decided to exclude that information in calculating the 1995 price cap. Id. at 1200–03. In the 2004 rulemaking, however, the Secretary never even acknowledged the possibility of excluding the 123 turbo-charging hospitals from the dataset. Her muteness makes Bell Atlantic inapposite. Indeed, as we explained in that case: “Everyone agrees that an agency’s change of mind does not itself render the agency’s action arbitrary. What matters is the Commission’s explanation for its decision.” Id. at 1202 (emphasis added; citations omitted). The Secretary also claims that our deferential standard of review tilts in favor of upholding the 2004 outlier threshold. We have stated that “in framing the scope of review, the court takes special note of the tremendous complexity of the Medicare statute. That complexity adds to the deference which is due to the Secretary’s decision.” Methodist Hosp. of Sacramento v. Shalala, 38 F.3d 1225, 1229 (D.C. Cir. 1994). 25 We do not retreat from that statement. The Secretary’s task of collecting and analyzing hospital charge data remains challenging. And when agency decisions “involve complex judgments about sampling methodology and data analysis that are within the agency’s technical expertise,” they receive “an extreme degree of deference.” Alaska Airlines, Inc. v. TSA, 588 F.3d 1116, 1120 (D.C. Cir. 2009). But our deference “is not unlimited” and we will remand to the agency if it fails to apply its “expertise in a reasoned manner.” Cape Cod Hosp., 630 F.3d at 206. Having decided that the Secretary’s explanation is insufficient, the question becomes one of remedy. “If the record before the agency does not support the agency action . . . the proper course, except in rare circumstances, is to remand to the agency for additional investigation or explanation.” Fla. Power & Light Co. v. Lorion, 470 U.S. 729, 744 (1985). We have likewise held that “bedrock principles of administrative law preclude us from declaring definitively that [the Secretary’s] decision was arbitrary and capricious without first affording her an opportunity to articulate, if possible, a better explanation.” Cnty. of L.A., 192 F.3d at 1023; see also New York v. Reilly, 969 F.2d 1147, 1153 (D.C. Cir. 1992) (remanding “for more reasoned decisionmaking” because agency failed to “adequately explain” its final rule). We follow that well-worn path here and remand to the Secretary for additional explanation. On remand, the Secretary should explain why she corrected for only 50 turbo-charging hospitals in the 2004 rulemaking rather than for the 123 she had identified in the NPRM. She should also explain what additional measures (if any) were taken to account for the distorting effect that turbo-charging hospitals had on the dataset for the 2004 rulemaking. And if she decides that it is appropriate to recalculate the 2004 outlier threshold, she should also decide what effect (if any) the 26 recalculation has on the 2005 and 2006 outlier and fixed loss thresholds.
The Secretary set the 2005 outlier threshold as the applicable DRG rate “plus $25,800.” 69 Fed. Reg. at 49,278. In arriving at this number, she considered the suggestions of numerous commenters and ultimately adopted a methodology in the final rule that was different from that in the proposed rule. Id. at 49,277. The Secretary said that she had to use more recent data to address both the outlier correction rule and the “exceptionally high rate of hospital charge inflation that is reflected in the data for [fiscal years] 2001, 2002, and 2003.” Id. Although the data in the revised methodology was more recent, it still had to be inflated to accurately predict charges for 2005. Id. Instead of using the “2-year average annual rate of change in charges per case,” the Secretary took “the unprecedented step of using the first half-year of data from [fiscal year] 2003 and comparing this data to the first half year of data for [fiscal year] 2004.” Id. The Secretary’s methodology in the 2005 rulemaking obviated any need to eliminate the turbo-charging hospitals from her dataset. She opted to use the most recent cost-to-charge ratios in calculating the 2005 charge inflation factor, half of which were from the “first half year of data for [fiscal year] 2004.” Id. This data came after the effective date of the outlier correction rule; it was not infected by turbo-charging because the outlier correction rule had by then corrected the flaw in the outlier payment system that created the opportunity—and incentive—to turbo-charge. See id. at 49,278; see also supra pp. 7–8. The ratios were therefore based on “either the most recent settled cost report or the most recent tentative settled cost report, whichever is from the latest 27 cost reporting period.” 42 C.F.R. § 412.84(i)(2). This data was “more recent” than previous data used by the Secretary. 69 Fed. Reg. at 49,278. Her revised methodology, she believed, would “account for the[] changes” resulting from the outlier correction rule. Id. at 49,277. It is true that the data from the “first half-year” of 2003 was affected by turbo-charging. Id. But it makes little sense to remove turbo-charging hospitals from this half of the dataset without making similar adjustments to the other half of the dataset (i.e., the first half-year of data from fiscal year 2004). As discussed, there was no need to modify the 2004 data because that information was collected while the outlier correction rule was in effect. With no need to change the 2004 data, the Secretary reasonably left both halves unaltered. See id. (stating that it is “optimal to employ comparable periods in determining the rate of change from one year to the next”). Indeed, if the Secretary had removed turbo-chargers from the 2003 dataset, she would have had to project how that decision affected the 2004 dataset. If that projection indicated significant effects, she would have had to undertake further statistical adjustments and perhaps remove hospitals from the 2004 dataset. The Secretary sensibly opted for a simpler approach that did not entail piling projections atop projections. See id. (noting her preference “to employ actual data rather than projections in estimating the outlier threshold because we employ actual data in updating charges[] themselves”); see also Ashland Exploration, Inc. v. FERC, 631 F.2d 817, 822 (D.C. Cir. 1980) (agencies “may rationally turn to simplicity . . . and administrative convenience”). Moreover, even if this dataset was less than perfect, imperfection alone does not amount to arbitrary decision-making. See, e.g., White Stallion Energy Ctr., LLC v. EPA, 748 F.3d 1222, 1248 (D.C. Cir. 2014) (agency’s 28 “data-collection process was reasonable, even if it may not have resulted in a perfect dataset”); In re Polar Bear ESA Listing, 709 F.3d 1, 13 (D.C. Cir. 2013) (“That a model is limited or imperfect is not, in itself, a reason to remand agency decisions based upon it.”); Allied Local and Reg’l Mfrs. Caucus v. EPA, 215 F.3d 61, 71 (D.C. Cir. 2000) (“[w]e generally defer to an agency’s decision to proceed on the basis of imperfect scientific information”); North Carolina v. FERC, 112 F.3d 1175, 1190 (D.C. Cir. 1997) (“The mere fact that the Commission relied on necessarily imperfect information . . . does not render [its decision] arbitrary.”); Chemical Mfrs. Ass’n v. EPA, 28 F.3d 1259, 1265 (D.C. Cir. 1994) (agency may nonetheless use model “even when faced with data indicating that it is not a perfect fit”). This precedent further supports the Secretary’s conclusion that removing turbo-charging hospitals from both datasets in the 2005 rulemaking was not a “significant and viable and obvious alternative[].” Nat’l Shooting Sports Found., 716 F.3d at 215 (quotation marks omitted). DHP claims that our holding in County of Los Angeles supports its argument. We disagree. In pertinent part, we held there that the Secretary’s 1985 and 1986 outlier thresholds were arbitrary and capricious. 192 F.3d at 1021–23. To set the thresholds, the Secretary used data that was collected when hospitals were still reimbursed based on the reasonable cost of their services rather than the average cost of treatment. Id. at 1020. She did so even though she had a wealth of readily available data collected under the new average-cost-of-treatment regime. Id. at 1021. The more recent data, unlike the older numbers, also accounted for a downward “trend” in outlier payments that was caused by the new reimbursement scheme. Id. The Secretary nevertheless concluded that “there [was] no evidence to suggest that total outlier payments” decreased under the new system. Id. We 29 held that her failure to account for the contrary evidence in the record—as well as her refusal to use more recent data—were arbitrary and capricious actions. Id. at 1023. Here, by contrast, the Secretary did not reject a more recent dataset; she stated time and again that the revised methodology “use[d] the most recent charge data available.” 69 Fed. Reg. at 49,277. She also stated that the revised methodology for calculating the 2005 outlier threshold “address[ed] both the changes to the outlier payment methodology and the exceptionally high rate of hospital charge inflation” between 2001 and 2003. Id. Thus, unlike in County of Los Angeles, the Secretary here used the most recent data that accounted for the outlier correction rule’s effects. Accordingly, we reject DHP’s APA challenge to the 2005 outlier threshold.
We need not linger with this rulemaking because the 2006 outlier threshold was plainly reasonable. The Secretary set it at the applicable DRG rate “plus $23,600.” 70 Fed. Reg. at 47,494. She settled on $23,600 by simulating 2006 payments using a charge inflation factor. Id. The data used to compute this factor was taken—as in the earlier rules—from “updated cost-to-charge ratios” included in “the most recent tentatively settled cost reports of hospitals.” Id. With this data in hand, the Secretary compared charges from the “first six months of [fiscal year] 2005 relative to [the] same period for [fiscal year] 2004.” Id. Importantly, the Secretary noted that the entire period (i.e., both six-month sets) occurred while the outlier correction rule was in effect. Id. Because all of the charge data for the 2006 rule was collected with the outlier correction rule in effect, the specter of turbo-charging was nil. Indeed, the Secretary noted in the 30 2006 rulemaking that the outlier correction rule worked as predicted: “The actual rate of charge inflation subsided significantly in [fiscal year] 2004 after we made significant changes to our outlier policy.” Id. In other words, “hospitals changed their charging practices as a result” of the outlier correction rule. Id. The Secretary reasonably weighed the evidence and concluded that there was no need to account for turbo-chargers because turbo-charging was no longer occurring. See El Conejo Americano of Texas, Inc. v. DOT, 278 F.3d 17, 20 (D.C. Cir. 2002) (courts do not “reweigh the evidence” if agency’s “conclusion was reasonable”). And, to state the obvious, excluding data from those hospitals was neither a significant nor an obvious alternative the Secretary had to consider. See Nat’l Shooting Sports Found., 716 F.3d at 215–16. We are perplexed by DHP’s objection to the 2006 outlier threshold. DHP cites favorably a comment submitted during the 2006 rulemaking that advocated a fixed loss threshold of $24,050, using the methodology the Secretary in fact employed. Moreover, at oral argument, DHP’s counsel suggested that the fixed loss threshold for 2006 should have been in the “low twenties.” Oral Arg. Tr. at 35–36. That is exactly where it ended up: $23,600. 70 Fed. Reg. at 47,494. Accordingly, we conclude that the Secretary’s calculation of the 2006 fixed loss threshold was neither arbitrary nor capricious. For the foregoing reasons, we affirm the district court’s partial supplementation of the 2004 rulemaking record and its rejection of the APA challenges to the 2005 and 2006 outlier thresholds. We reverse its ruling upholding the 2004 outlier threshold because that threshold is inadequately explained and remand to the district court with instructions to remand the 31 2004 rule to the Secretary for further proceedings consistent with this opinion. So ordered.