Lake Region Healthcare Corporation v. Xavier Becerra, Secretary of Health and Human Services

United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued December 8, 2023 Decided September 3, 2024
No. 22-5318
LAKE R EGION HEALTHCARE C ORPORATION ,
APPELLANT
v.
XAVIER B ECERRA, S ECRETARY OF HEALTH AND H UMAN
S ERVICES ,
APPELLEE
Appeal from the United States District Court
for the District of Columbia
(No. 1:20-cv-03452)
Sven C. Collins argued the cause and filed the briefs for
appellant.
Daniel J. Hettich, Rachel M. Wertheimer, and Barbara S.
Williams were on the brief for amici curiae Hospitals in support
of appellant.
Leif E. Overvold, Attorney, U.S. Department of Justice,
argued the cause for appellee. With him on the brief were
Brian M. Boynton, Principal Deputy Assistant Attorney
General, Michael S. Raab, Attorney, Samuel R. Bagenstos,
General Counsel, U.S. Department of Health & Human

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Services, Janice L. Hoffman, Associate General Counsel,
Susan Maxson Lyons, Deputy Associate General Counsel for
Litigation, and Jonathan C. Brumer, Attorney.
Before: HENDERSON and KATSAS , Circuit Judges, and
R ANDOLPH , Senior Circuit Judge.
Opinion for the Court filed by Circuit Judge KATSAS .
KATSAS , Circuit Judge: Under certain circumstances,
qualifying hospitals that treat Medicare patients are entitled to
an extra payment known as a volume-decrease adjustment
(VDA), which must “fully compensate” the hospital for its
“fixed costs.” 42 U.S.C. § 1395ww(d)(5)(D)(ii). To fully
compensate for fixed costs, the Secretary of Health and Human
Services must determine a hospital’s actual fixed costs and then
must subtract other, baseline payments that reimburse for those
fixed costs. This appeal turns on how to determine the
reimbursed fixed costs. It is a difficult question because the
baseline payments for treating Medicare patients do not
disaggregate between fixed costs, which remain constant no
matter how many patients are treated, and variable costs, which
increase with every patient.
In calculating VDA payments, the Secretary used to
attribute the baseline reimbursements entirely to fixed costs.
Under that approach, a hospital could not receive a VDA
payment unless its fixed costs exceeded its baseline Medicare
reimbursements. But the baseline reimbursements, although
not disaggregated, compensate for both fixed and variable
costs. 42 U.S.C. § 1395ww(a)(4). We hold that, in calculating
the VDA, the Secretary may not deem them compensation for
fixed costs alone.

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I
A
Medicare pays hospitals for providing inpatient care to the
elderly and disabled. 42 U.S.C. § 1395c et seq. Although the
program previously reimbursed all “reasonable costs” incurred
by hospitals to treat beneficiaries, see Methodist Hosp. of
Sacramento v. Shalala, 38 F.3d 1225, 1227 (D.C. Cir. 1994)
(cleaned up), Congress established the inpatient prospective
payment system to give hospitals greater “incentives … to
control costs.” Cape Cod Hosp. v. Sebelius, 630 F.3d 203, 205
(D.C. Cir. 2011).
Under that system, hospitals receive fixed, prospectively
determined payments keyed to various “diagnosis related
group[s]” (DRGs). See 42 U.S.C. § 1395ww(d)(3)(D). These
payments reflect the average cost of treating particular
conditions. See id. § 1395ww(d)(2)(A), (4)(A)–(B). The
payments must account for “all routine operating costs,
ancillary service operating costs, and special care unit
operating costs,” including “the costs of all services for which
payment may be made.” Id. § 1395ww(a)(4). Although DRG
payments thus plainly cover both fixed and variable costs, they
do not disentangle the two categories. Nor do they disentangle
the “bundle” of “particular items or services” within the DRG
itself. Appalachian Reg’l Healthcare, Inc. v. Shalala, 131 F.3d
1050, 1053 (D.C. Cir. 1997).
Special payment rules govern hospitals that are isolated or
in rural areas. 42 U.S.C. § 1395ww(d)(5)(D), (G). A
qualifying hospital must receive an additional payment, known
as a volume-decrease adjustment, if the number of its annual
inpatient cases decreases by more than five percent for reasons
beyond its control. Id. § 1395ww(d)(5)(D)(ii), (G)(iii). This
adjustment, combined with other Medicare reimbursements

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received by the hospital, must “fully compensate the hospital
for the fixed costs it incurs in the period in providing inpatient
hospital services, including the reasonable cost of maintaining
necessary core staff and services.” Id. § 1395ww(d)(5)(D)(ii),
(G)(iii).
B
Over time, HHS has used three different methods to
calculate the VDA. We refer to them as the “total-total,”
“fixed-total,” and “fixed-fixed” approaches.
Under the total-total approach, the VDA is the difference
between the hospital’s total costs for treating Medicare
beneficiaries and the total DRG payments it has received. HHS
seemed to endorse this approach in guidance issued in 1990,
see Provider Reimbursement Manual 15-1, § 2810.1(D), and in
preambles to later rules fixing annual DRG payments, see
Medicare Program; Changes to the Hospital Inpatient
Prospective Payment Systems and Fiscal Year 2007 Rates, 71
Fed. Reg. 47,870, 48,056 (Aug. 18, 2006); Medicare Program;
Changes to the Hospital Inpatient Prospective Payment
Systems and Fiscal Year 2009 Rates, 73 Fed. Reg. 48,434,
48,631 (Aug. 19, 2008). This approach compensates
qualifying hospitals for their fixed and variable costs.
Under the fixed-total approach, the VDA is the difference
between the hospital’s fixed costs for treating Medicare
beneficiaries and the total DRG payments it has received. The
Centers for Medicare & Medicaid Services, which administers
Medicare for the Secretary, adopted this approach in 2014.
Unity Healthcare Muscatine, Iowa v. Blue Cross Blue Shield
Ass’n/Wisc. Physicians Serv., 2014 WL 5450066, *5 (CMS
Adm’r Sept. 4, 2014). CMS reasoned that because the total-
total approach results in compensation for variable costs, it is
inconsistent with the VDA’s statutory limit to fixed costs. Id.

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In contrast, the fixed-total method effectively treats all DRG
payments as compensation for fixed costs, at least up to the
amount of the hospital’s total fixed costs. Id. This approach
ensures that the VDA never compensates for even a penny of
variable costs. See id. at *5–6.
Under the fixed-fixed approach, the VDA is the difference
between the hospital’s fixed costs for treating Medicare
beneficiaries and an estimate of what portion of its DRG
payments afford compensation for those fixed costs. An
estimate is necessary because HHS does not make available the
actuarial data that would enable hospitals or administrative
adjudicators to disaggregate DRG payments into portions
attributable to fixed and variable costs. By using such an
estimate, the fixed-fixed method acknowledges that DRG
payments represent compensation for both kinds of costs.1
The Provider Reimbursement Review Board (PRRB),
which hears administrative appeals regarding Medicare
reimbursement decisions, developed the fixed-fixed method in
a series of adjudications beginning in 2015. It has concluded
that the fixed-total method used by CMS “takes the portion of
the DRG payment intended for variable costs and
impermissibly characterizes it as payment for the hospital’s
fixed costs.” Lake Region Healthcare Corp. v. Nat’l Gov’t
Servs., Inc., 2020 WL 13747016, *10 (PRRB Aug. 14, 2020)
1 The fixed-fixed approach caps the VDA at the amount
calculated under the total-total approach. The cap rests on a
regulation making hospitals ineligible for the adjustment in years
when they make a profit treating Medicare patients. See Medicare
Program; Changes to the Inpatient Hospital Prospective Payment
System and Fiscal Year 1988 Rates, 52 Fed. Reg. 22,080, 22,091
(June 10, 1987). In other words, the VDA may not “exceed the
difference between the hospital’s Medicare inpatient operating costs
and total [DRG] payments.” Id. The cap is not at issue here.

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(Lake Region I). To implement the fixed-fixed method, the
PRRB uses a hospital’s own ratio of fixed costs to total costs
for Medicare patients to estimate the percentage of DRG
payments that compensate for fixed costs. Id. The PRRB has
consistently applied the fixed-fixed method in reviewing
hospital reimbursement decisions. See id. at *6 & n.45. And
CMS, which may review decisions of the PRRB, has
consistently reversed those decisions in favor of its fixed-total
approach. See id.
In 2017, HHS changed course and adopted the fixed-fixed
approach by rule. 82 Fed. Reg. 37,990, 38,180 (Aug. 14, 2017)
(2017 Rule).2 HHS continued to defend the lawfulness of its
fixed-total approach but acknowledged that hospitals wanted it
to “make an effort, in some way,” to disaggregate the fixed-
cost and variable-cost components of DRG payments. Id. To
estimate the percentage of DRG payments that compensate for
fixed costs, the 2017 Rule uses the hospital’s own ratio of
“fixed inpatient operating costs” to “total inpatient operating
costs” for treating all of its patients, Medicare and non-
Medicare alike. 42 C.F.R. § 412.92(e)(3). HHS imposed this
new approach only prospectively, for cost-reporting periods
after October 1, 2017. See id.
2 The actual name of the rule is a mouthful: Medicare Program;
Hospital Inpatient Prospective Payment Systems for Acute Care
Hospitals and the Long-Term Care Hospital Prospective Payment
System and Policy Changes and Fiscal Year 2018 Rates; Quality
Reporting Requirements for Specific Providers; Medicare and
Medicaid Electronic Health Record (EHR) Incentive Program
Requirements for Eligible Hospitals, Critical Access Hospitals, and
Eligible Professionals; Provider-Based Status of Indian Health
Service and Tribal Facilities and Organizations; Costs Reporting and
Provider Requirements; Agreement Termination Notices.

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II
Lake Region Healthcare Corporation operates a hospital in
Fergus Falls, Minnesota. In 2013, it experienced a decrease in
Medicare inpatient discharges that qualified it for a VDA.
Lake Region sought an adjustment of $1,947,967, which it
calculated using the PRRB’s variant of the fixed-fixed
approach. J.A. 41. A Medicare contractor denied Lake Region
any adjustment. Applying the fixed-total approach, the
contractor concluded that no adjustment was permissible
because Lake Region’s fixed costs for the year for treating
Medicare patients were less than its total DRG payments for
the year. Id. at 59.
On administrative review, the PRRB and CMS continued
their duel. The PRRB adhered to its fixed-fixed approach,
reversed the contractor’s decision, and awarded Lake Region
the full amount of its requested adjustment. Lake Region I,
2020 WL 13747016, at *10–11. In turn, CMS adhered to its
fixed-total approach, reversed the PRRB’s decision, and
reinstated the decision of the contractor. Lake Region
Healthcare Corp. v. Nat’l Gov’t Servs., Inc., 2020 CMS Adm’r
Decision LEXIS 11, at *37 (Sept. 29, 2020) (Lake Region II).
Somewhat curiously, CMS asserted that the PRRB’s fixed-
fixed approach—a close variant of the approach that HHS now
requires—“is in direct contradiction” with the Medicare
statute, regulations, and agency guidance. See id. at *34–35.
Lake Region then sought judicial review. In the district
court, it urged application of the total-total method or, in the
alternative, the fixed-fixed method. The government defended
CMS’s application of the fixed-total method.
On cross-motions for summary judgment, the district court
ruled for the government. Lake Region Healthcare Corp. v.
Becerra, No. 1:20-cv-03452, 2022 WL 9936856 (D.D.C. Oct.

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17, 2022) (Lake Region III). First, the court ruled out use of
the total-total method as “contradict[ing] the clear statutory
directive that the VDA compensate only fixed costs.” Id. at *8.
Then, the court concluded that both the fixed-total and fixed-
fixed methods “fall within the range of permissible
interpretations” of the governing statute. Id. Citing Chevron
U.S.A. Inc. v. NRDC, 467 U.S. 837 (1984), the court reasoned
that because the statute did not “specify” how HHS should
calculate the VDA, Congress had “delegated” that question to
HHS “[t]hrough its silence.” Lake Region III, 2022 WL
9936856, at *8. Moreover, it reasoned, payments for each
DRG consist of a “single, undifferentiated number” that is not
easily separated into its “fixed and variable components.” Id.
at *9. The court thus endorsed CMS’s reading of the statue as
“reasonable, even if it might not be the best.” Id.3
III
When the district court reviews a PRRB or CMS order, we
review its decision de novo. Forsyth Mem’l Hosp., Inc. v.
Sebelius, 639 F.3d 534, 537 (D.C. Cir. 2011). Like the district
court, we apply the judicial-review provisions of the
Administrative Procedure Act. See 42 U.S.C. § 1395oo(f)(1).
So we must independently “decide all relevant questions of
law.” Loper Bright Enters. v. Raimondo, 144 S. Ct. 2244, 2272
(2024) (cleaned up); see 5 U.S.C. § 706(2).
This case turns on a question of statutory construction—
whether CMS’s total-fixed method for calculating volume-
3 The district court further concluded that CMS’s approach was
consistent with HHS regulations and did not represent a break from
prior agency precedent. Lake Region III, 2022 WL 9936856 at *5–
7, *10–11. Because we resolve this case on statutory grounds, we
need not consider these rulings.

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decrease adjustments is consistent with the statutory command
to “fully compensate” qualifying hospitals for their “fixed
costs.” 42 U.S.C. § 1395ww(d)(5)(D)(ii). The district court
deferred to HHS’s reading of the statute under Chevron. See
Lake Region III, 2022 WL 9936856, at *9–10. Other courts
have done the same. See, e.g., Unity HealthCare v. Azar, 918
F.3d 571, 577–78 (8th Cir. 2019); Stephens Cnty. Hosp. v.
Becerra, No. 19-cv-3020, 2021 WL 4502068, *9–10 (D.D.C.
Sept. 30, 2021). But Chevron has now been overruled, so we
must “exercise independent judgment” in construing the
Medicare statute. Loper Bright, 144 S. Ct. at 2262.
We hold that HHS’s fixed-total approach does not afford
the requisite full compensation for fixed costs. We recognize,
as other courts have emphasized, that the statute does not
specify exactly how HHS should calculate the VDA. But it
does require attention to unreimbursed fixed costs—those a
hospital has actually incurred minus those for which it has
already been reimbursed. DRG payments cannot fairly be
understood as compensation only for fixed costs. As noted
above, they are keyed to the average cost of treating particular
conditions within the DRG. 42 U.S.C. § 1395ww(d)(3)(A); see
also 42 C.F.R. §§ 412.2(c), 412.64(a). And they cover “all
routine operating costs, ancillary service operating costs, and
special care unit operating costs,” including “the costs of all
services for which payment may be made.” 42 U.S.C.
§ 1395ww(a)(4) (emphases added). DRG payments thus
unambiguously compensate for variable as well as fixed costs.
By attributing the payments solely to fixed costs, the fixed-total
method overstates the amount of a hospital’s reimbursed fixed
costs and thus understates the amount of its unreimbursed fixed
costs, shortchanging the hospitals.
CMS offers several responses: The statute does not
prescribe any particular method for calculating the VDA. DRG

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payments are lump-sum amounts covering both fixed and
variable costs. And disentangling them into fixed-cost and
variable-cost components would be difficult if not impossible.
The courts deferring to CMS under Chevron have embraced
these arguments. See, e.g., Lake Region III, 2022 WL
9936856, at *8–9; Unity HealthCare, 918 F.3d at 577; Stephens
Cnty. Hosp., 2021 WL 4502068, at *8–9.
We are unpersuaded. Accountants and auditors routinely
break down business costs into fixed and variable components.
HHS itself must consider fixed and variable costs in setting the
annual DRG payments. In some contexts, it must determine
the portion of DRG payments attributable to particular kinds of
costs. For example, to account for wage differences in different
areas, the Medicare statute requires adjustments for the portion
of DRG payments “attributable to wages and wage-related
costs.” 42 U.S.C. § 1395ww(d)(3)(E)(i). And in making those
adjustments, CMS “determines the proportion of the [DRG
payment] that is attributable to wages and labor-related costs.”
42 C.F.R. § 412.64(h), (h)(2). For these reasons, HHS’s
arguments about the prohibitive difficulty of disentangling
DRG payments fall flat.
HHS does not release the data that it uses to calculate the
DRG payments, which would enable a more precise calculation
of the fixed- and variable-cost components of the DRGs using
industry averages. But the agency cannot use the unavailability
of that data to justify a demonstrably false working assumption
that DRG payments compensate only for fixed costs. When
HHS does not release the best available data, hospitals,
contractors, and the PRRB must resort to proxies. See Pomona
Valley Hosp. Med. Ctr. v. Becerra, 82 F.4th 1252, 1261 (D.C.
Cir. 2023). And here, there are reasonable proxies for
disentangling DRG payments into their fixed and variable
components. As noted above, the PRRB has long used a

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hospital’s own ratio of fixed costs to total costs for treating
Medicare patients to determine the ratio of its DRG payments
reflecting compensation for its fixed costs. Lake Region I,
2020 WL 13747016, at *6 & n.45. And HHS itself, for
payment years after 2017, mandates using the hospital’s own
ratio of fixed costs to total costs for treating all patients to
determine the ratio of its DRG payments reflecting
compensation for its fixed costs. 42 C.F.R. § 412.92(e)(3). We
recognize that the regulation, which has only prospective
application, is not directly controlling here. But it confirms our
view that HHS can at least attempt to estimate how much
compensation a hospital has already received for its fixed costs.
The total-fixed approach does not even do that much.
Like the district court in Stephens County Hospital, we
recognize that no method for calculating the VDA is perfect.
2021 WL 4502068, at *9. Nonetheless, a method that ignores
all compensation for variable costs is not one that reasonably
approximates full compensation for fixed costs. Moreover,
while DRG payments are keyed to average costs, the VDA,
which requires the Secretary to “fully compensate the hospital
for the fixed costs it incurs,” 42 U.S.C. § 1395ww(d)(5)(D)(ii)
(emphasis added), is keyed to the actual fixed costs of
individual hospitals. So, in determining how much of a DRG
payment compensates a hospital for its fixed costs, using the
fixed-to-total cost ratio of the individual hospital may in fact
be a more precise method—as opposed to a flawed “proxy,”
Stephens Cnty. Hosp., 2021 WL 4502068, at *10 (cleaned
up)—than using the industry-wide, fixed-to-total cost ratios
that HHS declines to release. Regardless, all we hold today is
that the fixed-total method used by CMS did not “fully
compensate” Lake Region for its “fixed costs” in 2013.

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IV
We reverse the grant of summary judgment to HHS,
reverse the denial of summary judgment to Lake Region, and
remand with instructions to set aside CMS’s decision and then
remand to the agency for further proceedings consistent with
the opinion.
So ordered.

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