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Case number 22-5318, Lake Region Healthcare Corporation, Appellants versus Xavier Becerra, Secretary of Health and Human Services.

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Mr. Collins for the Appellants, Mr. Overbold for the Appellate.

[00:00:14] Speaker 01:
Mr. Collins, good morning.

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Your honor, may it please the court.

[00:00:19] Speaker 02:
I'm Sven Collins.

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I represent Lake Region Healthcare.

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Congress carved out exceptions to the prospective payment system for hospitals like Lake Region that serve isolated rural communities.

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The exception here is intended to provide additional payments to sole community hospitals when their inpatient volume uncontrollably drops by 5% or more, all the while having to maintain the full suite of hospital inpatient services throughout the year, around the clock.

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inpatient volume dropped by over 16%.

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That's nearly one sixth in 2013.

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And thus the statutory protection required the secretary to provide additional payments to fully compensate Lake Region's fixed costs, including the reasonable cost of maintaining its necessary core staff and services around the clock throughout the year.

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The secretary claims he could fulfill that command equally with a payment of zero or with a payment of $2 million.

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Zero if he treats the statutory discharge payments received throughout the year, if they're known as DRG payments, that Lake Region got as having only compensated Lake Region's fixed costs.

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$2 million if he uses a method that he acknowledges the statutory requirement that the discharge payments were also intended as compensation for Lake Region's variable costs.

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The Secretary chose the first approach

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He compared fixed costs to total payments, essentially robbing Lake Region of its variable cost payments to satisfy the obligation to reimburse the unreimbursed fixed costs.

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As we've briefed, there's all sorts of reasons why this apples to oranges method is invalid, but I'd just like to focus on four points.

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Number one, Congress intended the decrease, the volume decrease protection as an exception to prospective payment and an add-on to the prospective payment system.

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The statute specifically says the secretary shall provide such adjustment to the payment amounts.

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Those are the regular DRG rates.

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And the secretary's regulation echoes this in its title, which is additional payments to all community hospitals.

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Yet the Secretary, in his briefs, incorrectly focuses on the ordinary prospective payment system goal of driving efficiency and cost savings, not the intended added protection.

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The second point.

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Can I just ask, statutory scheme requires disaggregation of DRG payments into a fixed cost component, right?

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and statute is silent on how to do that.

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Seems like that's the tough point for you.

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And they have a method for doing it, which says, you know, assume at first the DRG is compensating fixed costs and then for variable.

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Not a great method, but how do we get over the statutory silence?

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Well, you're correct that the statute does not designate how to apportion and the DRG payments were created using average costs for all hospitals.

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That's all 100% understood.

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The problem is, I mean, there's various methods to allocate the DRG payments.

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And there's one method that is clearly

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violates the statute.

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And that's the method that the secretary chose, which is to designate 100% of the payments to the hospital's fixed costs.

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The secretary admits this on page 24 of his brief, that under his apples to oranges method, the entire DRG payment should be considered compensation for the hospital's fixed costs.

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And here, the secretary reallocated 99% of Lake Region's DRG payments to its fixed costs.

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And what that meant is for 99% of the patients that it had treated throughout the year.

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Lake Region got nothing for the costs it incurred for providing necessary drugs, medicine, medical supplies, food, laundry, and similar costs that the contractor deemed variable.

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The statutory scheme could not be read to take away and pay nothing for hospitals' variable costs.

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So the Secretary developed, there's all other methods to allocate the DRG payment, one of which is in the Secretary's regulation from 2017 going forward and similar to the Provider Reimbursement Review Board's method.

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That's a reasonable way to grapple with the statutory scheme and provide an allocation.

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Another reasonable method is the method set forth in the hospital's manual as the secretary repeated in the federal register in its notice to the public about what the method is.

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That's what you call apples, apples, something they call total total.

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Correct.

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I mean, that one seems pretty bad, too.

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That one's going to compensate.

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excuse me, that one's going to compensate for barrier costs as well as fixed.

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Well, Your Honor, the

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And that, I understand that the district court that gave the district court paused.

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Like, how can what this manual actually says, how can what the federal register actually says, which is the adjustment is the difference between the payments, the entire difference between the payments and the costs, and the hospital receives a lump sum difference, the district courts surmised, well, that must mean some inappropriate payment of variable costs.

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And the answer to that is the manual actually tells you how to the actual the manual has a method that reasonably addresses the variable cost component.

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And that is it defines fixed costs.

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This is a secretary's definition in the manual.

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And also in the original regulation preamble, fixed costs are those over which management has no control.

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And in a hospital setting, many costs are neither perfectly fixed nor variable.

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They're semi-fixed.

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And semi-fixed costs are those for items and services that are essential for the hospital to maintain operation, but also vary somewhat with volume.

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And then the manual goes through two and only two ways in which

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you address, you adjust the total cost figure and in an effort to eliminate costs that are within the hospital's control and outside the secretary's own definition of fixed.

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And the first is elimination of staffing costs that are more than the fixed staff, the core staff that are required.

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Those are netted out and the manual tells contractors precisely what to do in that situation, which is to take them out of the cost report

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rerun for a new total cost figure, which, quote, that is the basis for the payment adjustment.

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And then the second adjustment is a hospital is limited to its lower of last year's costs inflated or the current year's costs.

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And you might ask, why is that?

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Well, the manual explains the reason for this.

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The hospitals assumed to have budgeted in the year in which it had a decrease based on prior utilization and have had insufficient time in that year

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to make significant reductions in costs.

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In other words, the hospital's costs in the reduction year are presumed to be mostly fixed and semi fixed.

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And with those two adjustments, the manual, the secretary's judgment in the manual was that reasonably gets at costs that are

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within the hospital's control and thus, as the secretary defined it, variable costs.

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So in that method, 100% doesn't go to fix, I'm sorry, variable costs.

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Some portion goes to variable costs, but it at least is an effort to grapple with it.

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In contrast, the secretary's apples to orange method makes no effort to account for the fact that the DRG payments are supposed to pay variable costs.

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The second

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thing I wanted to bring up is that here, the secretary says that two methods are equally reasonable, zero or two million.

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Well, actually, they're mutually incompatible.

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The same exact cost figures, fixed variable, the same exact payments yield radically different outcomes.

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$2 million, and if $2 million is necessary to compensate and does not overcompensate Lake Region, then zero necessarily undercompensates.

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And

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Beyond Lake Region here, the point we were discussing a moment ago about taking all of the payments for fixed costs, providing zero for variable costs.

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The hospitals, many other hospitals, it was 99% Lake Region case, but in many other hospitals case, it was zero, literally zero.

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Many of the Mickey hospitals and the hospital in the Unity Healthcare case.

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Another point that I want to just make, hopefully make clear, it's hopefully made clear by the materials the secretary published, the manual does not just set a cap.

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The manual tells you precisely how to set a method.

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And the secretary changed the method, and the apples to oranges method is a change from the regulation.

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It imposes a lower cap, not fixed, not total costs and DRG payments, fixed costs and DRG payments.

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So the secretary has clearly changed the regulatory text without notice and comment.

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And regardless of whether the secretary is correct or not in terms of the manual, did it set a clear policy and dictate how to be calculated?

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The secretary admits that it had no definition, no formula until 2017.

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And that means the secretary could not either establish, and no court analyzed, establish or change the method.

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And the secretary, it first established the apples to oranges method in a adjudication, not notice and comment rulemaking.

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So that violates notice and comment.

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I say I'm out of time.

[00:11:16] Speaker 04:
Before you sit down, can you tell me, your client is Lake Region Healthcare?

[00:11:23] Speaker 04:
Yes, Your Honor.

[00:11:24] Speaker 04:
What's the, is that related to Lakes Regional Healthcare?

[00:11:30] Speaker 02:
It is not, Your Honor.

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They're two separate corporations?

[00:11:33] Speaker 02:
Yes, there's a lot of lakes in the upper Midwest.

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But yeah, that's the inferiors fall Minnesota and it's not not the same entity or related at all.

[00:11:45] Speaker 01:
We'll give you a couple minutes to reply.

[00:11:47] Speaker 02:
Thank you.

[00:11:50] Speaker 01:
Thank you.

[00:11:50] Speaker 01:
Over.

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Over both.

[00:12:08] Speaker 05:
Thank you, Your Honor.

[00:12:09] Speaker 05:
May I please support life overall on behalf of the Secretary of Health and Human Services.

[00:12:14] Speaker 05:
I'd like to start with the disaggregation question that my friends started with.

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The hospital in this case did not allocate the DRG payments that Lake Region received to its fixed costs.

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It just treated them the same way that the statutory scheme does, as undifferentiated payments that a participating hospital receives for providing inpatient care to Medicare patients.

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That's entirely consistent with the governing statutory scheme, as well as the regulation in place at the time of the fiscal year for which this volume decrease adjustment was made.

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For all these hospitals getting zero, your method treats the DRG payments as being 100% for fixed costs.

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How can that be?

[00:13:00] Speaker 05:
It doesn't allocate them to fixed costs or variable costs.

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It just treats them as the payment the hospital receives for providing patient care.

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For fixed costs.

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Under a statute that requires disaggregation of for fixed costs of the basic amount already received through the provider payment system.

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and the unreimbursed amount.

[00:13:27] Speaker 05:
Your Honor, the statute does not require disaggregation.

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Nothing in the statute talks about disaggregating the payments.

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The statute says you have to fully compensate the hospital for fixed costs.

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For fixed costs and it also provides the

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Payment the hospital receives is this DRG payment, which is not calculated on the basis of fixed cost or variable cost.

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It's calculated based on these historic average operating costs from the 1980s, which wasn't calculated in the first instance on the basis of some portion is fixed, some portion is variable.

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And in the same way that this court addressed an appellation original.

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The adjustment payment just reflects

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Arithmetic subtraction, right?

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You start with the hospital's fixed costs, and then you subtract out, you have to figure out unreimbursed fixed costs, and you do that through the DRG payment, right?

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But it's in order to determine unreimbursed fixed costs.

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So you have to figure out how much of the DRG payment is attributable to fixed and how much is attributable to variable.

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And that's unavoidable.

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And your method just says, we'll treat it as compensating for fixed.

[00:14:50] Speaker 05:
Well, nothing about the statute requires this sort of disaggregation.

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I mean, this scheme was adopted in the 80s to move away from this sort of dollar for dollar reimbursement statute.

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The statute requires calculation of unreimbursed fixed costs.

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It requires such adjustment as may be necessary to fully compensate for fixed costs.

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does not provide a basis for disaggregating the drg payments it's a little more it's it's you have to figure out unreimbursed right because there are two payments there's the drg payment on the front end and then there's the adjustment you have to conclude whether an adjustment is necessary that's what it says as may be necessary to fully compensate for fixed costs

[00:15:31] Speaker 05:
And if you're provided an undifferentiated payment, but again, like in Appalachian Regional, it's not broken down into particular services, particular cost categories.

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It's reasonable to treat it as compensation for fixed costs.

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The statutory provision at issue, it doesn't mention variable costs anywhere.

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Fixed cost has only mentioned this adjustment provision.

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The DRG scheme is supposed to compensate hospitals.

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A reasonably efficient hospital is supposed to get

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whatever they're supposed to get, right?

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It builds in what you would expect.

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It's a fixed cost to treat a patient or a particular ailment, right?

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Comes in with the heart attack and you get whatever, $10,000 for treating the heart attack.

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It's a fixed payment generally based on historic average operating costs and then with this sort of adjustment.

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And you think it's reasonable to view that payment as not compensating for any of the variable costs?

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Any.

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The hospital incurs treating the guy who comes in with the heart attack?

[00:16:38] Speaker 05:
It's reasonable for the agency not to sort of affect an allocation that the statute does not direct.

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And the one point I want to make, the plaintiff argues that the agency has changed its position in this regard.

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But no one is arguing that there was this previous practice of disaggregating the DRG payments into fixed and variable cost categories and that change.

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I mean, going back to the 1987 regulation, when it's talking about the cap, what you're subtracting in that is the entirety of the DRG payments.

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It wasn't until this series of review board decisions in 2014, where they started looking to the proxy of a hospital's own fixed cost ratio, that any sort of effort was made to disaggregate the DRG payments in that way.

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And it's entirely reasonable when the agency is first presented with a sort of rough proxy, which I think everyone agrees, this is not reflective of the actual fixed and variable cost categories that might have gone into the historical calculation of the DRG payments in the 1980s.

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This is just hospitals own fixed cost ratios, which might or might not be representative.

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It's reasonable for the agency not to sort of adopt that

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in the first instance, absent sort of a statutory or regulatory basis for doing so.

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And instead, again, treating the payments as the statute does, as it is undifferentiated compensation to a participating hospital for providing inpatient care.

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Am I correct if I

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If I understand this, that the higher in the old system, not the one that's in place now, that the higher the variable cost would be, the more likely the hospital would receive this compensatory payment, and the higher the payment would be.

[00:18:22] Speaker 05:
I think, Judge Randolph, it would be the opposite.

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I believe that the higher a hospital's fixed costs are, the more likely those fixed costs might exceed its DRG payments.

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And to the extent it has not sort of.

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No, I'm not talking about the system where you're disaggregating.

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I'm talking about the system where you take a look at the DRG payments, and you take a look at what the fixed costs were.

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this aggregate, the higher the variable cost would be, then the fixed cost would not necessarily be taken or compensated for.

[00:19:07] Speaker 05:
Well, under the method the administrator employed here, the fixed costs, which are about 72%, and in this case, it does include all the hospitals, semi-fixed costs as well.

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To the extent a hospital can show they're fixed or semi-fixed, then they're eligible for compensation.

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So the higher that number is, I think the more likely it is that that exceeds the DRG payments that a hospital has received.

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That would mean the lower the variable costs would be.

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I think that's the percentage of the total payments.

[00:19:39] Speaker 05:
I think that's right.

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The lower the variable costs as a percentage, the more likely you might receive an adjustment.

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I mean, it depends on what the DRG payments are, what the total number is.

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Whereas under this system, you have to use the hospital's own fixed cost ratio as the proxy for sort of calculating it.

[00:20:00] Speaker 05:
the hospital that does have higher variable costs for whatever reason, that results in more of the DRG payments being treated as allocated to variable costs, even though that doesn't actually track how the DRG payment was calculated in the first instance.

[00:20:15] Speaker 03:
Let me give you a numeric example.

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I hope this doesn't get too complicated, but I'll try to do it slowly.

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So let's say there's a hospital

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Perfectly efficient.

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They're well-run.

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They're average, you know, what CMS expects in every respect.

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And they have total cost of $100, fixed or $80, variable or $20.

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They're right on target.

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And so their DRG payment for the year is $100, okay?

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Next year, they have a 20% volume decrease.

[00:20:58] Speaker 03:
Pretty significant, right?

[00:21:00] Speaker 03:
If not catastrophic, it's four times the trigger.

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Fixed costs are fixed, so they remain at 80.

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Variable 20% decrease, they go down from 20 to 16.

[00:21:17] Speaker 03:
So their total costs are 96, if I had my math right, but only 80 are fixed.

[00:21:26] Speaker 03:
The DRG is gonna go down, DRG is gonna go down 20%, right, from 100 to 80.

[00:21:36] Speaker 03:
Under the secretary's method, their new DRG is 80.

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their fixed costs are still 80.

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They're gonna get zero compensation, notwithstanding a 20% decrease in volume.

[00:21:52] Speaker 03:
It just seems hard to square in a scheme that is designed to deal with this problem of these rural hospitals and they're subject to these volume swings and they have these high fixed costs and that's the problem Congress is addressing.

[00:22:10] Speaker 05:
I mean, I think the example generally tracks one that the amicus brief offered.

[00:22:14] Speaker 05:
And I think they presented an even third method for determining whether, essentially, the hospital had appropriately reduced its variable costs proportionate to the share.

[00:22:25] Speaker 05:
And that might be reasonable.

[00:22:26] Speaker 05:
And going forward from 2017, the secretary adopted another reasonable approach to remove any possibility.

[00:22:33] Speaker 05:
It's fixed.

[00:22:34] Speaker 05:
Well, it's a version of finding a way to disaggregate these ZOG payments that the statute does not provide, that the regulations before 2017 did not provide a basis to doing so.

[00:22:45] Speaker 05:
There are reasonable ways to further ensure that there's no possibility of any possibility of lack of full compensation, as the 2017 rule explains.

[00:22:57] Speaker 05:
But it's also reasonable for the

[00:23:00] Speaker 05:
the administrator to look at a hospital that has fully received payments that fully total its fixed costs under a scheme in which the drg payments are not necessarily are expressly not designed to uh mirror the dollar for dollar reimbursement of the old scheme and a statutory direction to make sure that fixed costs are compensated obviously implies that there's no similar requirement for variable costs when a hospital has received payments totaling its fixed costs it is reasonable for the agency to conclude that the statutory directive is met in that situation

[00:23:30] Speaker 03:
when CMS prospectively sets the D R G s. Do they consider variable costs?

[00:23:39] Speaker 03:
Well, I mean, this gets this sort of question.

[00:23:42] Speaker 05:
It's a historical.

[00:23:43] Speaker 03:
It's a historical note.

[00:23:46] Speaker 05:
I don't think there's any way in which, at least I'm not aware, that in setting these based on these historical 1980s costs, that certainly costs that a hospital would have treated as variable go into that calculation.

[00:24:00] Speaker 03:
Setting the amount designed to compensate a well-run hospital for all the costs they have to incur to treat patients.

[00:24:08] Speaker 03:
You don't think they're accounting for variable costs.

[00:24:11] Speaker 05:
Certainly, there's no direction that the variable costs and the fixed costs both have to go into the DRD payment.

[00:24:17] Speaker 05:
Again, the variable cost is not mentioned anywhere in this provision.

[00:24:19] Speaker 05:
And even then, if you have some aspect of the payment,

[00:24:25] Speaker 05:
historically included something that that hospital would have treated as variable.

[00:24:29] Speaker 05:
I mean, variable costs vary across hospitals.

[00:24:31] Speaker 05:
They can vary for a particular hospital across time.

[00:24:34] Speaker 05:
That doesn't provide a basis for sort of disentangling this payment that this court has recognized is extremely difficult to disentangle, given the move away from a dollar for dollar reimbursement scheme to this average payment that is expressly intended to have hospitals eat the excess when they don't provide

[00:24:53] Speaker 05:
where they provide an inpatient care and their costs exceed the average amount.

[00:24:59] Speaker 05:
Thank you.

[00:25:01] Speaker 01:
Mr. Collins, why don't you take two minutes?

[00:25:17] Speaker 02:
Congress clearly included variable costs in the DRG payments.

[00:25:21] Speaker 02:
There's no question there.

[00:25:23] Speaker 02:
It's all costs, all operating costs.

[00:25:26] Speaker 02:
That is baked into the payment structure.

[00:25:28] Speaker 02:
And counsel's mistaken when he says that

[00:25:33] Speaker 02:
This is completely different than the reasonable cost, dollar for dollar.

[00:25:37] Speaker 02:
This is prospective payment.

[00:25:38] Speaker 02:
It's a new era.

[00:25:40] Speaker 02:
It's all efficiency.

[00:25:41] Speaker 02:
You get one payment.

[00:25:42] Speaker 02:
Your individual circumstances don't matter.

[00:25:44] Speaker 02:
The statute on its face says, including the reasonable cost of maintaining necessary core staff and services.

[00:25:51] Speaker 02:
Now, the question of, so that's inconsistent with the secretary's interpretation here.

[00:25:59] Speaker 02:
The statute,

[00:26:01] Speaker 02:
obviously doesn't direct how to apportion.

[00:26:05] Speaker 02:
And the secretary has characterized it as a rough proxy, the method adopted in 2017 and what the board did.

[00:26:12] Speaker 02:
But the secretary, of course, could have adopted a different proxy, but it needs to be something that addresses the reality that fixed costs, the variable costs are part of the DRG payment and simply can't fully compensate if you don't.

[00:26:32] Speaker 02:
And council mentioned the Appalachian case and Appalachian was dealing with specifically cost cutting measures.

[00:26:40] Speaker 02:
And Medicare shouldn't double pay the DRG payment plus something that was already paid by a third party.

[00:26:49] Speaker 02:
So that's

[00:26:51] Speaker 02:
The court construed there that that was consistent with the PPS structure.

[00:26:57] Speaker 02:
We're not going to give hospitals an out when they receive a payment for a discrete item.

[00:27:03] Speaker 02:
That's part of the payment that comes to us.

[00:27:06] Speaker 02:
Here, we're dealing with an exception intended to provide more money.

[00:27:10] Speaker 02:
So I don't think appellation is good, other than the fact that it has the language about the DRG payments and the nature of them.

[00:27:17] Speaker 02:
You know, it's not a good source of not good support for the secretary.

[00:27:21] Speaker 02:
I mean, at the end of the day here, the question is, can.

[00:27:30] Speaker 02:
the secretary reasonably take money that it has already paid hospitals throughout the year for all of its discharges, money that was intended to pay for blood products, for medicine, for other costs the secretary calls as reasonable and necessary to care, take that money and say, oh, here you go.

[00:27:50] Speaker 02:
Here it is again.

[00:27:52] Speaker 02:
That's your fixed cost payment.

[00:27:54] Speaker 02:
We submit it isn't both for substantive and procedural reasons.

[00:27:58] Speaker 02:
So we asked the court

[00:28:00] Speaker 02:
versus the district court.

[00:28:02] Speaker 02:
Thank you.

[00:28:03] Speaker 01:
Mr. Collins, I didn't want to take your time, but I do have a question about the impact of travelers.

[00:28:09] Speaker 01:
Are they considered, how are they considered as cost?

[00:28:17] Speaker 01:
They must be very cost and how, and if you know, that's an ax used by these small hospitals.

[00:28:26] Speaker 02:
Yeah, particularly during the pandemic, a lot of hospitals had to hire nurses, traveling nurses, to fill in gaps, to provide additional care.

[00:28:38] Speaker 02:
And I'm not an accounting expert.

[00:28:42] Speaker 02:
I would think that those would be potentially deemed variable costs of a hospital because they can vary with utilization if they're brought on.

[00:28:52] Speaker 02:
to increase utilization, they could also fall in the category of necessary core staff if the hospital is lacking some of its core staff.

[00:29:01] Speaker 02:
But those are potentially the types of costs that the secretary's method simply wouldn't pay.

[00:29:05] Speaker 02:
And it's no, you know, it's no

[00:29:09] Speaker 02:
coincidence that a lot of the volume adjustment payments that in the Amikis cases and their records in our case are all during in the aftermath of the great financial meltdown when rural hospitals were struggling everywhere.

[00:29:25] Speaker 02:
And when the secretary is supposed to provide that protection, the secretary instead comes up with a new method that provides them nothing.

[00:29:35] Speaker 04:
Rural hospital is defined as

[00:29:40] Speaker 04:
with a hospital that doesn't have another hospital within 30 miles.

[00:29:46] Speaker 04:
Yes, your honor.

[00:29:47] Speaker 02:
It's rough.

[00:29:47] Speaker 02:
I think it's 35 miles and 30 road.

[00:29:53] Speaker 02:
Yes, there's no other.

[00:29:54] Speaker 02:
There's no other hospital essentially within the geographic area to service Medicare beneficiaries.

[00:30:03] Speaker 04:
It's not necessarily a small hospital.

[00:30:05] Speaker 04:
It could be a very, very large house, right?

[00:30:08] Speaker 02:
Well, they can vary in size.

[00:30:12] Speaker 02:
But typically, they tend to be much smaller than hospitals that are located in urban areas under the prospective payment system.

[00:30:20] Speaker 02:
Their bed size is usually in the 100 range versus the 5, 600 range.

[00:30:25] Speaker 02:
So they tend to be much smaller.

[00:30:28] Speaker 02:
And they also, these hospitals are basically cornerstones of their communities.

[00:30:33] Speaker 02:
There is absolutely vital to the economic viability to promote rural areas as well.

[00:30:39] Speaker 01:
Okay, thank you.

[00:30:42] Speaker 01:
Thank you.