Nazareth Hospital v. Secretary United States Department of Health & Human Services, 747 F.3d 172

Background

Medicare DSH payments adjust hospital prospective reimbursement based on number of patient days for Medicaid-eligible patients; Secretary may include days from Section 1115 Medicaid demonstration (waiver) projects.
CMS clarified in 1999–2000 that State general assistance (GA) and charity care days are excluded from Medicare DSH, but Section 1115 waiver days may be included; Congress later ratified that rule in the Deficit Reduction Act of 2005.
Pennsylvania did not obtain a Section 1115 waiver; it operated a state-funded GA program (SPA 94-08) that the state used in distributing Medicaid DSH funds to hospitals.
Two Pennsylvania hospitals (Nazareth and St. Agnes) included GA patient days in their 2002 Medicare cost reports; CMS excluded those days, and administrative and agency reviews upheld the exclusion.
The hospitals sued in district court asserting (1) the exclusion was arbitrary and capricious under the APA because it treated GA and Section 1115 days alike, and (2) the disparate treatment violated equal protection; the district court agreed and ordered relief.
The Third Circuit reversed, holding the Secretary had rational bases to include Section 1115 waiver days while excluding Pennsylvania GA days.

Issues

Issue	Plaintiff's Argument	Defendant's Argument	Held
Whether CMS acted arbitrarily/capriciously by excluding GA days while including Section 1115 waiver days in Medicare DSH calculations	Excluding GA days but including Section 1115 days is arbitrary because patient populations and services are effectively the same	CMS reasonably distinguished waiver days (federally approved, tied to Medicaid objectives, subject to federal conditions) from state-only GA days	Not arbitrary/capricious — CMS articulated rational distinctions in purpose and federal control
Whether the Secretary had statutory authority to include Section 1115 waiver days and exclude GA days	GA inclusion required because state described GA in its Medicaid plan and used Medicaid DSH funds for GA-related hospitals	Statute (and DRA ratification) permits inclusion of Section 1115 days and exclusion of state-only GA/charity days	Statutory scheme permits CMS discretion; DRA ratified the interim rule including Section 1115 days
Whether CMS failed to respond adequately to rulemaking comments	CMS ignored or inadequately addressed significant comments urging GA inclusion	CMS responded during rulemaking and provided further explanation on remand; responses were adequate under APA	CMS sufficiently considered and answered comments; no remand required
Whether disparate treatment violated Equal Protection (rational basis review)	Disparate treatment lacks rational basis given similarity of patients/services	Rational basis exists because of different purposes and federal oversight of waivers	No Equal Protection violation — rational basis present

Key Cases Cited

Cooper Univ. Hosp. v. Sebelius, 636 F.3d 44 (3d Cir. 2010) (upholding Secretary’s exclusion of state charity days from Medicare DSH)
Adena Reg’l Med. Ctr. v. Leavitt, 527 F.3d 176 (D.C. Cir. 2008) (charity-care days not includable in Medicare DSH calculation)
Univ. of Wash. Med. Ctr. v. Sebelius, 634 F.3d 1029 (9th Cir. 2011) (distinguishing Medicaid DSH payments from Medicare DSH and excluding state-only populations)
Phoenix Mem’l Hosp. v. Sebelius, 622 F.3d 1219 (9th Cir. 2010) (upholding exclusion of non-waiver populations from Medicare DSH)
Cookeville Reg’l Med. Ctr. v. Leavitt, 531 F.3d 844 (D.C. Cir. 2008) (discussing DRA’s effect in ratifying agency rule)
FCC v. Fox Television Stations, 556 U.S. 502 (2009) (agency must examine relevant data and articulate satisfactory explanation)
Motor Vehicle Mfrs. Ass’n v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29 (1983) (standard for arbitrary and capricious review)
FCC v. Beach Commc’ns, Inc., 508 U.S. 307 (1993) (rational basis standard for equal protection review of agency classifications)