Hays Medical Center v. Azar, 956 F.3d 1247

Background

Medicare Part A reimburses inpatient hospital services under the inpatient prospective payment system (fixed payments per discharge based on a DRG weight × payment rate).
DRG weights are recalibrated periodically from a recent-patient dataset; the Secretary normalizes weights so average post-recalibration weight equals pre-recalibration average.
Congress requires recalibration be done so aggregate Medicare payments remain budget neutral; the Secretary therefore also applies a budget-neutrality adjustment (a multiplier) to payment rates to achieve systemwide neutrality.
When Congress adds a new statutory base year for a hospital-specific rate, the Secretary uses a four-step formula: (1) target amount ÷ discharges; (2) ÷ normalized average DRG weight; (3) apply update factors; (4) apply cumulative budget-neutrality adjustment to the resulting rate.
The Hospitals (sole-community and Medicare-dependent rural hospitals) sued, arguing the Secretary’s methodology is arbitrary and capricious—principally because the cumulative budget-neutrality adjustment is effectively applied twice (in step 2 via inflated normalized weights and again in step 4), and because the method can yield payments below 100% of base-year costs. The district court upheld the Secretary; the Tenth Circuit affirmed.

Issues

Issue	Plaintiff's Argument	Defendant's Argument	Held
Whether applying the cumulative budget-neutrality adjustment to a new base-year hospital-specific rate results in a double application (once via the divisor using normalized DRG weights and again via the rate multiplier).	The normalized DRG weights are "artificially high" post-recalibration so dividing by them reduces the rate by the same amount later applied again as a budget-neutrality multiplier.	Normalization keeps average DRG weight unchanged from pre-recalibration; the cumulative budget-neutrality multiplier corrects for other payment adjustments (wage index, IME, etc.), not to offset normalized weights, so there is no double-counting.	Held for Defendant: no double application; Hospitals’ premise that normalized weights are inflated is incorrect.
Whether the Secretary must apply budget-neutrality adjustments to DRG weights instead of to payment rates because that would produce the same payments.	The adjustment’s sole purpose is to budget-neutralize the DRG weights, so different placement that yields different payments is unlawful.	Statute requires aggregate payment neutrality, not neutrality of weights; Secretary has discretion how to achieve that and may apply adjustments to rates.	Held for Defendant: Secretary’s method satisfies statutory mandate and his choice of method is not arbitrary.
Whether the statute’s phrase "amount based on 100 percent of the hospital’s target amount" requires paying 100% of base-year costs (i.e., no downward adjustment when calculating a base-year hospital-specific rate).	"Based on 100 percent" requires full reimbursement of base-year allowable operating costs; method that yields less is arbitrary.	The prospective payment system prescribes fixed rates; "based on 100 percent" signals the starting point for calculation, not entitlement to full base-year reimbursement; cumulative adjustments may reduce the computed rate.	Held for Defendant: "based on 100 percent" denotes the starting point; Secretary’s methodology is permissible and not arbitrary.

Key Cases Cited

Sebelius v. Auburn Regional Medical Center, 568 U.S. 145 (Supreme Court) (describing inpatient prospective payment system as fixed per-patient payments)
Adirondack Medical Center v. Sebelius, 740 F.3d 692 (D.C. Cir. 2014) (discussing DRG weight recalibration and special rural-hospital rules)
Adirondack Medical Center v. Burwell, 782 F.3d 707 (D.C. Cir. 2015) (examining Secretary’s discretion in implementing Medicare budget-neutrality rules)
County of Los Angeles v. Shalala, 192 F.3d 1005 (D.C. Cir. 1999) (DRG weights reflect relative resource use; recalibration purpose)
Rush University Medical Center v. Burwell, 763 F.3d 754 (7th Cir. 2014) (IMEs and special payment adjustments for teaching hospitals)
Henry Ford Health System v. Department of Health & Human Services, 654 F.3d 660 (6th Cir. 2011) (teaching hospital payment adjustments under Medicare)
Thomas Jefferson University v. Shalala, 512 U.S. 504 (1994) (APA review in Medicare reimbursement context)
Motor Vehicle Manufacturers Association v. State Farm, 463 U.S. 29 (1983) (arbitrary-and-capricious standard)
Department of Commerce v. New York, 139 S. Ct. 2551 (2019) (review focuses on agency contemporaneous explanation; narrow exception for bad faith)