United States: CMS Disproportionate Share Hospital Policy To Get Second Look By First Circuit

Last Updated: August 18 2017
Article by Kristyn Bunce DeFilipp

An appeal recently filed in the United States Court of Appeals for the First Circuit could give further clarity regarding the CMS's ability to discount Medicaid DSH payments for hospitals that received funds from Medicare and private insurers.

DSH Uncompensated Care Costs and the FAQ Policies

The Medicaid Act requires state Medicaid programs to increase payments to hospitals that treat a disproportionate share of Medicaid and uninsured patients. 42 U.S.C. §§ 1396a(a)(13)(A)(iv); 1396r-4(a)(1)(B). Although states are generally free to determine which hospitals will be designated as "disproportionate share hospitals," once designated, these providers are entitled to increased reimbursements on a hospital-specific basis ("DSH payments"). But DSH payments may not exceed the costs the hospital incurs in providing services to Medicaid-eligible patients "as determined by the Secretary and net of payments" under the Medicaid Act. 42 U.S.C. § 1396r-4(g)(1)(A).

Each state is required to audit its DSH program, and report to the Secretary on that audit. 42 U.S.C. § 1396r-4(j). The audit must confirm that each DSH did not receive payments for more than the hospital's "uncompensated care costs." § 1395r-4(j)(2)(C). This audit requirement was implemented via final rule in 2008. The 2008 rule defined "total annual uncompensated care costs" to include the cost of care for services to Medicaid-eligible individuals, plus the cost of care to uninsured individuals, minus "the sum of regular Medicaid rate payments, Medicaid managed care organization payments, supplemental/enhanced Medicaid payments, uninsured revenues, and Section 1011 payments."1 42 C.F.R. § 447.299(c)(16).

In 2010, CMS posted answers on its website to "frequently asked questions" about the DSH audit reporting requirement. According to CMS's answers, hospitals would have to deduct payments received from private health insurance (per FAQ 33) and Medicare for dually-eligible individuals (per FAQ 34) from the costs it incurred in providing services to those patients (taken together "FAQ DSH Policies"). The FAQ DSH Policies are likely to result in lower DSH payments, because they would increase the revenue reported without changing the hospital's expenses.

Challenges to the FAQ Policies

Numerous parties have challenged the FAQ DSH Policies. Two of these cases have resulted in preliminary injunctions barring enforcement of FAQ 33. Those injunctions remain in place during the pendency of the cases:

  • Texas Children's Hospital v. Burwell (D. D.C.): In 2014, two disproportionate share hospitals (one in Texas, one in Seattle) sued the Secretary in the United States District Court for the District of Columbia, asserting that FAQ 33 was contrary to the provisions of the Medicaid Act and violated the procedural requirements of the APA. The district court granted a preliminary injunction enjoining CMS from enforcing that policy. The parties cross-moved for summary judgment in June 2016, and the summary judgment motions remain pending.
  • Children's Hosp. of the King's Daughters, Inc. v. Price (E.D.Va.): In 2017, a not-for-profit pediatric hospital in Norfolk, Virginia sued CMS and the Secretary in the United States District Court for the Eastern District of Virginia. This case makes the same claims as in Texas Children's Hospital. On June 20, 2017 the district court found that plaintiff was likely to succeed on the merits of its statutory and procedural APA challenges, and issued a preliminary injunction prohibiting CMS from enforcing FAQ 33.

Two courts have entered final judgment in favor of plaintiff hospitals challenging the FAQ Policies.

  • New Hampshire Hospital Association et al. v. Burwell (now Price) (D. N.H.): In 2015, a group of non-profit New Hampshire hospitals and the New Hampshire Hospital Association petitioned CMS to repeal the FAQ Policies. CMS rejected their petition, and the hospitals sued CMS and the Secretary in the United States District Court for the District of New Hampshire in January 2016. The hospitals prevailed on their motion for preliminary injunction in March 2016. On March 2, 2017, the district court granted the plaintiffs' motion for summary judgment, and permanently enjoined CMS from enforcing the FAQ Policies. The district court's decision held that (1) that the Medicaid Act does not authorize the Secretary to determine, absent regulation, what constitutes "costs" for purposes of DSH payment calculations; and (2) the FAQ Policies were substantive rules that should have been promulgated through notice-and-comment rulemaking under the APA. The court rejected plaintiff's assertion that CMS violated the APA by substantively amending the New Hampshire State Medicaid Plan without notice and the opportunity to comment, because the notice-and-comment period requirement for state plans is imposed on the state, not CMS.
  • Tennessee Hospital Association v. Price (M.D. Tenn.): A similar case challenging both FAQ Policies was brought in the United States District Court of the District of Tennessee in late 2016. In that case, the Court issued a preliminary injunction prohibiting CMS from imposing or requiring the state of Tennessee to impose DSH recoupment payments based on the FAQ policies during the pendency of the case. On June 21, 2017, the district court followed New Hampshire Hospital Association and granted plaintiffs summary judgment on their analogous APA counts – holding, like the other courts, that the FAQ Policies violated the APA by conflicting with the Medicaid Act and the 2008 rule. The court declined, however, to grant a declaratory judgment to block CMS from implementing a final rule formalizing the FAQ Policies.

In all four cases, the courts ruled primarily on procedural Administrative Procedure Act (APA) grounds – that is, the courts each believed that CMS did not go through a proper rulemaking process in order to adopt the policies that the agency was attempting to enforce through the two FAQs. Two of the cases touched on the underlying merits: whether the CMS policy was justified at all. Both the New Hampshire and Tennessee courts expressed skepticism that CMS got the policy right, but ultimately ruled based on procedural defects. Typically, courts reviewing agency action will review the action under the so-called "Chevron deference" standard. Chevron analysis is generally seen as a two-step process; under the first step, the court is bound to uphold an agency action that faithfully interprets a clear and unambiguous statute. Where the statute is unclear or ambiguous, the reviewing court will give deference to the agency, as long as the agency did not proceed in an arbitrary or capricious fashion.

The 2017 Final Rule on DSH Uncompensated Care

CMS has not been dissuaded by these adverse rulings. First, it issued a proposed rule formalizing the FAQ policies in 2016, and finalized that rule on April 3, 2017. The final rule specifies that uncompensated care costs must include only those costs for Medicaid-eligible individuals that remain after deducting payments made to the hospitals by Medicaid, Medicare and other third party payments. 42 C.F.R. § 447.299. This final rule went into effect on June 2, 2017.

Second, last month, Secretary Price appealed the New Hampshire Hospital Association decision to the United States Court of Appeals for the First Circuit. To date, the government has not appealed the Tennessee decision, but it could still do so before its deadline in late August.

DSH Uncompensated Care Costs Remain Uncertain

Where does all of this action leave disproportionate share hospitals?

The hospitals' procedural challenges to the FAQ Policies are of limited utility now that CMS has formalized the substance of those policies. But, the claims still have value as they apply to DSH payments from 2011 through 2016. Therefore, if the First Circuit and, potentially, the Sixth Circuit uphold the district court decisions, disproportionate share hospitals will not be subject to recoupment for overpayments in those years calculated using the FAQ policies.

The government may be queuing up a circuit split between at least the First Circuit and the Sixth Circuit regarding the substantive propriety of the FAQ Policies covered by the final rule. Both district courts that issued final judgments expressed skepticism that the FAQ Policies represented a reasonable interpretation of the Medicaid Act. Ultimately, however, both decisions rested on the FAQ Policies' procedural defects. It remains to be seen whether, under a Chevron deference standard, the final rule will be found to be a reasonable interpretation of the Medicaid Act.


1 "Section 1011 payments" refers to a provision of the Medicare Prescription Drug, Improvement, and Modernization Act that made payments available to hospitals that provide emergency services to undocumented immigrants. Pub. L. No. 108-173, 117 Stat. 2066, 2432 – 35 (Dec. 8, 2003).

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