St. Anthony Regional Hospital v. Burwell

Filing 27

ORDER Accepting 22 Report and Recommendation that the district court affirms the Secretary's decision and enters judgment in favor of the Secretary re 1 Complaint filed by St Anthony Regional Hospital. Signed by Chief Judge Leonard T Strand on 2/6/2018. (src)

IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF IOWA
CENTRAL DIVISION
ST. ANTHONY REGIONAL
HOSPITAL,
Plaintiff,

No. C16-3117-LTS

vs.

ORDER

ALEX M. AZAR II, Secretary of
Department of Health and Human
Services1,
Defendant.
____________________
I.

INTRODUCTION

This case is before me on a Report and Recommendation (R&R) by the Honorable
Kelly K.E. Mahoney, United States Magistrate Judge. Doc. No. 22. Judge Mahoney
recommends that I affirm the decision of the Secretary of the Department of Health and
Human Services (the Secretary) denying an administrative appeal by plaintiff St. Anthony
Regional Hospital (the Hospital) related to the calculation of its reimbursement for the
treatment of patients insured through Medicare. The Hospital has filed timely objections
(Doc. No. 23) to the R&R and the Secretary has filed a response (Doc. No. 26) to the
objections. The procedural history and relevant facts are set forth in the R&R and are
repeated herein only to the extent necessary.
II.
A.

APPLICABLE STANDARDS

Judicial Review of the Secretary’s Decision

1
 Secretary Azar is substituted for his predecessor in accordance with Federal Rule of Civil

Procedure 25(d). 

Because the Secretary’s decision is the result of formal adjudication, judicial
review is governed by the standard set forth in the Administrative Procedure Act (APA).
See 42 U.S.C. § 1395oo(f)(l) (Medicare Act incorporates APA); see also St. Mary’s
Hosp. of Rochester v. Leavitt, 416 F.3d 906, 909-10, 914 (8th Cir. 2005) (decisions of
the Board and CMS Administrator involve formal adjudication entitled to Chevron2
deference). Under the APA, a reviewing court may set aside an agency decision if it is
“arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law”
or “unsupported by substantial evidence.” 5 U.S.C. § 706(2)(A), (E).
The Secretary’s construction of its regulations and the statutes it administers is
entitled to substantial deference. See Shalala v. Guernsey Mem’l Hosp., 514 U.S. 87,
94-95, 97-100 (1995) (discussing deference owed to CMS Administrator’s decision made
through formal adjudication when decision was in accord with a provision in the Manual);
see also Auer v. Robbins, 519 U.S. 452, 461 (1997) (deference to agency’s construction
of a regulation); Chevron, 467 U.S. at 842-45 (deference to agency’s construction of a
statute). “A reviewing court should not reject reasonable administrative interpretation
even if another interpretation may also be reasonable.” Shalala v. St. Paul-Ramsey Med.
Ctr., 50 F.3d 522, 528 (8th Cir. 1995) (quoting Creighton Omaha Reg’l Health Care
Corp. v. Bowen, 822 F.2d 785, 789 (8th Cir. 1987)). “This broad deference is all the
more warranted when, as here, the regulation concerns ‘a complex and highly technical
regulatory program,’ in which the identification and classification of relevant ‘criteria
necessarily require significant expertise and entail the exercise of judgment grounded in
policy concerns.’” Thomas Jefferson Univ. v. Shalala, 512 U.S. 504, 510-12 (1994)
(quoting Pauley v. BethEnergy Mines, Inc., 501 U.S. 680, 687 (1991)) (discussing review
of a decision by the CMS Administrator).

The court should reject an agency

interpretation, however, that is plainly erroneous or that contradicts the plain meaning of

2

Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984).

2

the statute, the plain meaning of the regulation, or “other indications of the [drafter’s]
intent at the time of . . . promulgation.” St. Paul-Ramsey, 50 F.3d at 527-28 (quoting
Thomas Jefferson Univ., 512 U.S. at 512); see also Chevron, 467 U.S. at 843 n.9.
B.

Review of Report and Recommendation
A district judge must review a magistrate judge’s R&R under the following

standards:
Within fourteen days after being served with a copy, any party may serve
and file written objections to such proposed findings and recommendations
as provided by rules of court. A judge of the court shall make a de novo
determination of those portions of the report or specified proposed findings
or recommendations to which objection is made. A judge of the court may
accept, reject, or modify, in whole or in part, the findings or
recommendations made by the magistrate judge. The judge may also
receive further evidence or recommit the matter to the magistrate judge with
instructions.
28 U.S.C. § 636(b)(1); see also Fed. R. Civ. P. 72(b). Thus, when a party objects to
any portion of an R&R, the district judge must undertake a de novo review of that portion.
Any portions of an R&R to which no objections have been made must be reviewed
under at least a “clearly erroneous” standard. See, e.g., Grinder v. Gammon, 73 F.3d
793, 795 (8th Cir. 1996) (noting that when no objections are filed “[the district judge]
would only have to review the findings of the magistrate judge for clear error”). As the
Supreme Court has explained, “[a] finding is ‘clearly erroneous’ when although there is
evidence to support it, the reviewing court on the entire evidence is left with the definite
and firm conviction that a mistake has been committed.” Anderson v. City of Bessemer
City, 470 U.S. 564, 573 (1985) (quoting United States v. U.S. Gypsum Co., 333 U.S.
364, 395 (1948)). However, a district judge may elect to review an R&R under a moreexacting standard even if no objections are filed:

3

Any party that desires plenary consideration by the Article III judge of any
issue need only ask. Moreover, while the statute does not require the judge
to review an issue de novo if no objections are filed, it does not preclude
further review by the district judge, sua sponte or at the request of a party,
under a de novo or any other standard.
Thomas v. Arn, 474 U.S. 140, 150 (1985). Thus a district court may review de novo
any issue in a magistrate judge’s report and recommendation at any time. Id.
III.

THE R&R

Judge Mahoney thoroughly and accurately explained the background regulations
used to calculate the reimbursement paid to hospitals that treat patients insured through
the Medicare program. Doc. No. 22 at 1-6. As such, I will provide only a brief overview
here. Hospitals are paid a fixed rate per patient based on each discharged patient’s
diagnosis, regardless of how much the hospital actually spends on a particular patient (the
Diagnosis Related Group (DRG) payment). See Good Samaritan Hosp. v. Shalala, 508
U.S. 402, 406 n.3 (1993). This system has the potential to disadvantage a hospital if its
patient volume shrinks, as hospitals have fixed costs (such as rent, interest, depreciation
and costs associated with regulatory compliance) that do not automatically shrink along
with patient volume. To protect a hospital that experiences a 5% or greater reduction in
patient volume through no fault of its own, Congress created the Volume Decrease
Adjustment (VDA) payment, which is to be used “as may be necessary to fully
compensate the hospital for the fixed costs it incurs in . . . providing inpatient hospital
services, including the reasonable cost of maintaining necessary core staff and services.”
42 U.S.C. § 1395ww(d)(5)(D)(ii). The VDA payment is at issue in this case.
Judge Mahoney summarized the method used to calculate the Hospital’s VDA
payment as follows:
The regulations promulgated by the Secretary in effect during the
relevant time period did not provide a specific formula for calculating the
4

VDA payment. See 42 C.F.R. § 412.92(e)(3) (2009). Instead, the
regulation directed that the following factors be considered in determining
the VDA payment amount: “(A) [t]he individual hospital’s needs and
circumstances, including the reasonable cost of maintaining necessary core
staff and services in view of minimum staffing requirements imposed by
State agencies; (B) [t]he hospital’s fixed (and semi-fixed) costs . . . ; and
(C) [t]he length of time the hospital has experienced a decrease in
utilization.” Id. § 412.92(e)(3)(1). In addition, the regulation provided
that the VDA payment could not exceed the difference between the
hospital’s total Medicare costs and the hospital’s DRG payment. Id. §
412.92(e)(3).
A section of the Medicare Provider Reimbursement Manual (Manual
or PRM), issued around the same time as the regulation, also addressed
calculation of the VDA payment:
[A VDA] payment is made to an eligible [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, not to exceed the difference
between the hospital’s Medicare inpatient operating cost and
the hospital’s total DRG revenue.
Fixed costs are those costs over which management has no
control. Most truly fixed costs, such as rent, interest, and
depreciation, are capital-related costs and are paid on a
reasonable cost basis, regardless of volume. Variable costs,
on the other hand, are those costs for items and services that
vary directly with utilization such as food and laundry costs.
In a hospital setting, however, many costs are neither
perfectly fixed nor perfectly variable, but are semifixed.
Semifixed costs are those costs for items and services that are
essential for the hospital to maintain operation but also vary
somewhat with volume. For purposes of [the VDA payment],
many semifixed costs, such as personnel-related costs, may
be considered as fixed on a case-by-case basis.
In evaluating semifixed costs, [the Secretary] consider[s] the
length of time the hospital has experienced a decrease in
utilization. For a short period of time, most semifixed costs
are considered fixed. As the period of decreased utilization
5

continues, [the Secretary] expect[s] that a cost-effective
hospital would take action to reduce unnecessary expenses.
Therefore, if a hospital did not take such action, some of the
semifixed costs may not be included in determining the
amount of the [VDA] payment . . . .
PRM 15-1 § 2810.1(B) . . . .
***
Here, the Hospital’s total Medicare costs were $8,348,116, and its
DRG payment was $6,273,905. AR 14, 32, 34. The MAC, the Board,
and the CMS Administrator all classified the following expenses as
variable: (1) purchased laundry services, (2) dietary cost of food, (3) central
distribution supplies, (4) drugs and intravenous (IV) solutions, (5) operating
supplies, and (6) implantable devices. Nar 12, 30-31. Based on this
classification, the Hospital’s variable Medicare costs were $1,543,034 and
its fixed Medicare costs were $6,805,082. AR 14.
The [Secretary] determined that the Hospital’s VDA payment should
be its total Medicare costs, less its variable Medicare costs and its DRG
payment (or stated another way, the Hospital’s fixed Medicare costs less its
DRG payment). AR 7, 14. Thus, the CMS Administrator found that the
Hospital’s VDA payment should be $531,177 . . . . AR 14.
Doc. No. 22 at 2-5 (footnotes omitted).
The Hospital argues that the Secretary’s methodology for calculating the VDA
payment is arbitrary and capricious because it violates the plain language of the statute
and is inconsistent with the example set forth in the Manual. Additionally, the Hospital
argues that the Secretary erred in calculating its VDA payment by failing to take into
account certain “semi-fixed” variables. Judge Mahoney considered each of these bases
for overturning the Secretary’s decision.
1.

The Methodology

Judge Mahoney first found that the Secretary’s methodology does not violate the
plain language of the statute:
6

The statute requires that a hospital be “fully compensate[d]” for its fixed
Medicare costs through a combination of the VDA payment and the DRG
payment (indeed, the Hospital recognizes that the VDA payment need not
equal its fixed Medicare costs and that whether its fixed costs have been
fully compensated is based on both the VDA and DRG payments). Here,
the Hospital received payment (through both the DRG and VDA payments)
totaling its fixed Medicare costs. That is all that the plain language of the
statute requires. The statute is ambiguous whether a hospital must also
receive its usual share of reimbursement (through the DRG payment) for
its variable costs. Although the Secretary could have reasonably interpreted
the statute to require the usual partial payment for variable Medicare costs
in addition to payment for the totality of a hospital’s fixed Medicare costs,
as advocated by the Hospital, the Secretary’s interpretation is also
reasonable. It is therefore entitled to [Chevron] deference.
Doc. No. 22 at 9. Further, Judge Mahoney found that the Secretary’s methodology does
not contradict the policy of the statute: “the Secretary considered the entire DRG payment
as compensating a hospital’s fixed costs (because the statute does not require that a
hospital be compensated for any of its variable costs, even if the DRG payment ordinarily
compensates a hospital for some of those costs).” Id. at 11.
As to whether the Secretary’s methodology violates the Manual, Judge Mahoney
first considered whether the Secretary’s consistency with the Manual is a relevant issue:
As an initial matter, the Manual contains interpretative rules adopted
without notice and comment, and it is intended to provide guidance without
binding the Secretary. See St. Paul-Ramsey, 50 F.3d at 527 n.4. As such,
“‘[a]n action based on a violation of [the Manual] does not state a legal
claim’ because interpretative rules are not mandatory and ‘never can be
violated.’” Id. (first alteration in original) (quoting Drake v. Honeywell,
Inc., 797 F.2d 603, 607 (8th Cir. 1986)); see also Saint Marys Hosp. of
Rochester v. Leavitt, 535 F.3d 802, 808 (8th Cir. 2008) (“[T]he [Manual],
while a useful guide to interpreting the Medicare statute and regulations, is
not strictly binding on the Secretary.” (quoting [Baptist Health v.
Thompson, 458 F.3d 768, 778 n.9 (8th Cir. 2006)])).
Doc. No. 22 at 12. Judge Mahoney concluded that regardless of the weight to be given
the Manual, the Secretary’s methodology was not inconsistent with the Manual:
7

[T]he Manual makes clear that a VDA payment should compensate a
hospital for its fixed and semifixed costs, but not its variable costs. PRM
15-1 § 2810.1(B). And the Manual recognizes that MAC should “evaluat[e]
semifixed costs” to determine whether a hospital could have “take[n] action
to reduce unnecessary expenses”; if so, the Manual instructs that “some of
the semifixed costs may not be included in determining the amount of the
[VDA] payment.” Id. This provision seems at odds with the example’s
use of total Medicare costs (as opposed to fixed and semifixed costs) in
determining the VDA amount. The Board explained in a 2006 decision:
[T]he text [of the Manual] explicitly dictates that fixed (and
semi-fixed) costs may comprise the [VDA payment], [but] the
use of the term “operating costs” in the subsequent examples
may suggest that variable costs could be included. However,
the Board finds that the examples are intended to demonstrate
how to calculate the [VDA payment cap] as opposed to
determining which costs should be included in the [VDA
payment].
Greenwood Cnty. Hosp., 2006 WL 3050893, *6 n.19 (citations omitted).
That “program Inpatient Operating Cost” in the example does not include
a hospital’s variable costs is further supported by another example in the
Manual, which involves calculating whether a hospital had excess staff that
could have been reduced:
Hospital B’s nursing staff[] . . . exceeds the core staff
[allowed] . . . . Hospital B is eligible for a [VDA] payment .
. . , but its cost . . . must first be reduced to eliminate the
salary costs of the . . . excess of core staff. Once the excess
salary costs are eliminated, the cost report is re-run,
generating a new Program Inpatient Operating Cost that is the
basis for the [VDA] payment . . . .
PRM 15-1 § 2810.1(C)(6)(a), Example B. Thus, “program Inpatient
Operating Cost” does not necessarily mean a hospital’s total Medicare
costs, but rather, the costs a hospital is eligible to have reimbursed (which
does not include variable costs). The Secretary could reasonably read the
Manual as supporting its methodology of the difference between a hospital’s
fixed and semifixed costs (a hospital’s eligible costs) and a hospital’s DRG
payment.
8

Doc. No. 22 at 13-14. Judge Mahoney concluded that the Secretary’s methodology is
not inconsistent with the Manual and, even if there is an inconsistency, it is not relevant
because the Manual is not binding on the Secretary. Therefore, “the Secretary’s resulting
decision was not arbitrary and capricious nor inconsistent with the law.” Id. at 14.
2.

The Calculation

Turning to the issue of whether the Secretary erred in calculating the VDA
payment by failing to take into account certain “semifixed” costs, Judge Mahoney stated:
The Secretary determined that the Hospital’s costs related to purchased
laundry services, food, central distribution supplies, drugs, IV solutions,
operating room supplies, and implantable devices were variable and thus,
not compensable. The Hospital argued below that none of its costs should
be classified as variable because it reduced its costs as much as possible,
and “[t]he only costs incurred by [the Hospital] for . . . supplies and
services were directly related to the care provided to its actual patients,” so
all its costs were necessary for the hospital to maintain operation. AR 77,
256. The Hospital essentially makes that same argument on appeal,
although the Hospital clarifies that not all its costs were used in connection
with treating patients (as suggested below), arguing instead that certain
minimum levels of food and supplies must be maintained in case of
emergency and thus, cannot be reduced.
Neither the statute nor the regulation defines fixed costs. The
Hospital relies on the definitions of fixed and semifixed costs that appear in
the Manual: fixed costs are defined as costs “over which management has
no control,” and semifixed costs are defined as costs “for items and services
that are essential for the hospital to maintain operation but also vary
somewhat with volume.” PRM 15-1 § 2810.1(B). The Hospital argues
that the costs classified as variable are actually semifixed costs because they
were essential for the hospital to maintain operation.
The Hospital’s argument misses the mark. The Hospital ignores the
definition of variable costs that appears in the Manual: “those costs for
items and services that vary directly with utilization[,] such as food and
laundry costs.” Id. Thus, the Manual explicitly recognizes that food and
laundry costs—two categories of expenses at issue here—are variable costs.
9

The Hospital argues that whether an expense is classified [as]
variable must be determined on a case-by-case basis. Although the decision
to compensate semifixed costs is determined on a case-by-case basis, id.,
the same cannot be said for variable costs. The regulation provides that
when determining the VDA payment amount, the MAC should consider an
“individual hospital’s needs and circumstances, including the reasonable
cost of maintaining necessary core staff and services in view of minimum
staffing requirements imposed by state agencies”; a hospital’s “fixed (and
semi-fixed) costs”; and “[t]he length of time the hospital has experienced a
decrease in utilization.” 42 C.F.R. § 412.92(e)(3)(i). At the time of the
regulation’s adoption, further explanation appeared in the Federal Register:
Fixed costs are defined as those over which management has
no control. Many truly fixed costs, for example, rent, interest
and depreciation, are capital-related costs and are paid on a
reasonable cost basis, regardless of patient volume. Variable
costs, on the other hand, are those costs for items and services
that vary directly with utilization. However, in a hospital
setting, many costs are neither perfectly fixed nor perfectly
variable, but are semifixed. Semifixed costs are those costs
for items and services that are essential for the hospital to
maintain operation but which will also vary with volume. For
purposes of this adjustment, many semifixed costs, such as
personnel-related costs, may be considered as fixed costs on
a case-by-case basis. An adjustment will not be made for truly
variable costs, such as food and laundry services.
Medicare Program, Fiscal Year 1990; Mid-Year Changes to the Inpatient
Hospital Prospective Payment System, 55 Fed. Reg. 15150, 15156 (Apr.
20, 1990) (emphasis added). Neither the statute nor the regulation prevents
the Secretary from categorically excluding certain costs as variable, and
guidance issued at the time of the regulations adoption (as well as the
Manual) supports the Secretary’s decision to categorically exclude certain
costs as variable. That the Hospital could not reduce its expenses any
further is insufficient to transform its variable costs into semifixed costs.
Cf. Trinity Reg’l, 2017 WL 2403399, at *7 (“[E]ven assuming arguendo
such [variable] costs could be considered semi-fixed or fixed, the [hospital]
failed to provide convincing evidence (e.g., contracts) demonstrating that
any portion of these costs was fixed or semi-fixed.”). The Secretary’s
decision was supported by substantial evidence.
10

The Secretary has routinely classified the types of costs at issue here
as variable. See id. at *7 (affirming MAC’s exclusion of costs related to
“billable medical supplies, billable drugs, . . . [and] dietary and laundry as
variable” because “the types of cost associated with all of [these] categories
would generally be expected to be inherently correlated to some degree with
patient volume”); Fairbanks Mem’l Hospital, 2015 WL 5852432, at *3
(affirming MAC’s exclusion of costs related to medical supplies,
pharmaceuticals, food, dietary formula, and linen and bedding as variable
as “they either vary directly with utilization or are within the [hospital’s]
control”); Lakes Regional Healthcare, 2014 WL 5450078, at *2 (affirming
MAC’s exclusion of “billable medical supplies, billable drugs, [and] IV
drugs[] . . . as variable costs”); Unity Healthcare, 2014 WL 5450066, at
*5 (affirming MAC’s exclusion of “billable medical supplies, billable drugs
and IV solutions, . . . and dietary and linen expenses as variable”). The
Secretary’s decision to categorically exclude certain costs as variable was
not arbitrary and capricious.
Doc. No. 22 at 14-16. Accordingly, Judge Mahoney recommends that I affirm the
Secretary’s decision in all respects. Id. at 17.
IV.

ANALYSIS

The Hospital objects to Judge Mahoney’s conclusions (1) that the Secretary’s
methodology was a reasonable interpretation of the governing statutes requiring Chevron
deference and (2) that the Secretary correctly classified certain expenses as “variable”
rather than “fixed” or “semifixed” when calculating the VDA amount. Having reviewed
the record de novo, I will address each objection individually.
A.

The Methodology
The Hospital contends that Judge Mahoney’s recommendation in favor of the

Secretary’s methodology results in the Hospital “los[ing] its entitlement to normal
reimbursement for its variable costs in accordance with other Medicare statutes.” Doc.
No. 23 at 1. Given its proper context, the Hospital argues that, “[t]he VDA statute . . .
11

addresses reimbursement outside of and in addition to the normal [DRG] system in order
to compensate hospitals for their fixed costs in certain extraordinary circumstances.” Id.
at 2. Judge Mahoney reached this allegedly erroneous conclusion, according to the
Hospital, because she wrongly interpreted various silences in the VDA statute to create
ambiguity. See id. at 3-6. The Hospital does not address whether the Secretary’s
interpretation of the statute is entitled to Chevron deference, or whether an exception to
such deference applies.
The Hospital’s argument that it must be reimbursed for variable cost beyond those
covered in the normal DRG system is without support.3 The DRG system compensates
a hospital for a set amount of both variable and fixed costs associated with treating a
particular patient. See, e.g. 42 U.S.C. § 1395ww(a)(4) (“[T]he term ‘operating costs of
inpatient hospital services’ includes all routine operating costs, ancillary service operating
costs, and special care unit operating costs with respect to inpatient hospital services as
such costs are determined on an average per admission or per discharge basis,”
(emphasis added)); § 1395ww(a)(1)(A)(i) (“The Secretary . . . shall not recognize as
reasonable . . . costs for the provision of such services by a hospital for a cost reporting
period to the extent such costs exceed the applicable percentage . . . .of the average of
such costs for all hospitals in the same grouping as such hospital for the comparable time
periods”). However, the fact that a DRG payment will typically cover some variable
costs is a factual reality, not a legal requirement. As Judge Mahoney noted, the DRG
payment is set at a standard rate to encourage hospitals to provide services at lower costs.
Thus, a hospital is rewarded for treating a patient efficiently and punished for treating a

3

Notably, the Hospital does not cite any case in which a court or administrative agency adopted
its interpretation of the statute, instead relying on generic canons of statutory construction
regarding plain language and reading statutory provisions in context. See Doc. No. 23 at 2-3
(citing King v. Burwell, 135 S. Ct. 2480, 2489, 2492 (2015) (reciting plain language and in pari
material (upon the same matter or subject) canons)).

12

patient inefficiently. Cnty. of L.A. v. Shalala, 192 F.3d 1005, 1008 (D.C. Cir. 1999)
(hospitals reimbursed for their actual costs had “little incentive . . . to keep costs down,”
as “[t]he more they spent, the more they were reimbursed.” (alteration in original)
(quoting Tucson Med. Ctr. v. Sullivan, 947 F.2d 971, 974 (D.C. Cir. 1991))). A hospital
that incurs either variable or fixed costs at a greater rate per patient than the DRG payment
will face the negative incentive of being forced to absorb those costs.
The VDA system, in its proper context, is a limitation on the negative incentives
created by the DRG system. However, as Judge Mahoney correctly noted, the limitation
is limited. See 42 U.S.C. § 1395ww(d)(5)(D)(ii) (“In the case of a sole community
hospital that experiences . . . a decrease of more than 5 percent in its total number of
inpatient cases . . . the Secretary shall provide for such adjustment to the payment
amounts under this subsection as may be necessary to fully compensate the hospital for
the fixed costs it incurs in the period in providing inpatient hospital services.” (emphasis
added)). Thus, while the DRG system allows for variable costs, the VDA system
specifically excludes them.
The Hospital incorrectly frames the issue by claiming to have lost reimbursement
for variable expenses otherwise authorized by statute. The Hospital has been reimbursed
for some variable expenses covered by the DRG payment but there is no authority
authorizing reimbursement for variable expenses beyond those incidentally included in
the DRG payment.4 The Hospital seems to assert that hospitals are generally entitled to
dollar-for-dollar reimbursement of all Medicare costs, but this is not true under either
payment. The record suggests that the Hospital was unable to reduce its volume-related
costs in accordance with shrinkage—an eventuality anticipated by the VDA payment and

4

Indeed, if the VDA payment did account for variable costs, as suggested by the Hospital, it
would counteract the policy behind adopting the DRG payment in the first place and remove a
hospital’s incentive to reduce costs.

13

explicitly exempted from reimbursement. See generally PRM 15-1 § 2810.1(B). The
Secretary’s interpretation of the statute, as demonstrated through the methodology used
to calculate the VDA payment, is neither plainly wrong nor remotely unreasonable.
Even if the Hospital’s interpretation of the statute had support, its argument fails
for a more pragmatic reason. The Hospital objects that Judge Mahoney “interpreted the
VDA’s statute’s silence regarding the usual reimbursement of a hospital’s variable costs
as ambiguous” and relatedly “admitted that the statute was ambiguous and that the
Hospital’s interpretation best served the purpose of the VDA, but then failed to
recommend that this Court overturn the Secretary’s decision.” Doc. No. 23 at 3, 5. The
Hospital’s argument misconstrues5 the court’s authority to supplant its judgment with that
of an administrative agency:
When a court reviews an agency’s construction of the statute which
it administers, it is confronted with two questions. First, always, is the
question whether Congress has directly spoken to the precise question at
issue. If the intent of Congress is clear, that is the end of the matter; for
the court, as well as the agency, must give effect to the unambiguously
expressed intent of Congress.
Chevron, 467 U.S. at 842-43. Here, the parties have largely acknowledged various gaps
in the statute that require the Secretary to take action to implement the reimbursements.
Moving to the second question:
If . . . the court determines Congress has not directly addressed the precise
question at issue, the court does not simply impose its own construction on
the statute, as would be necessary in the absence of an administrative
interpretation. Rather, if the statute is silent or ambiguous with respect to
the specific issue, the question for the court is whether the agency’s answer
is based on a permissible construction of the statute.

5

The Hospital does not cite Chevron and seems to imply that Judge Mahoney erred by affording
any deference at all to the Secretary. See, e.g. Doc. No. 23 at 6 (“If the statute is indeed
ambiguous, as the Magistrate has stated in the Recommendation, then the intent and purpose of
the statute should control, not the Secretary’s interpretation.”).

14

“The power of an administrative agency to administer a
congressionally created . . . program necessarily requires the formulation
of policy and the making of rules to fill any gap left, implicitly or explicitly,
by Congress.” Morton v. Ruiz, 415 U.S. 199, 231 (1974). If Congress
has explicitly left a gap for the agency to fill, there is an express delegation
of authority to the agency to elucidate a specific provision of the statute by
regulation. Such legislative regulations are given controlling weight unless
they are arbitrary, capricious, or manifestly contrary to the statute.
Sometimes the legislative delegation to an agency on a particular question
is implicit rather than explicit. In such a case, a court may not substitute
its own construction of a statutory provision for a reasonable interpretation
made by the administrator of an agency.
Id. at 843-44 (emphasis added). This is clearly a case in which there is an explicit gap
in the legislation.

See, e.g. 42 U.S.C. § 1395ww(d)(5)(D)(ii) (directing that “the

Secretary shall provide for such . . . payment . . . as may be necessary” (emphasis
added)). The Secretary has filled that gap in a manner that I find to be reasonable in light
of the statutory framework and purpose. Even if I were to find that the Hospital’s
interpretation is also reasonable, Chevron dictates that the Secretary’s reasonable
interpretation be given controlling weight. The Hospital’s objection is overruled.6
B.

The Calculations
The Hospital next contends that Judge Mahoney erred by “fail[ing] to determine

whether the Secretary made the required individualized determination for the Hospital
regarding the classification of certain ‘semi-fixed costs’ of the Hospital as ‘variable
costs.’” Doc. No. 23 at 7. The Hospital contends that the Secretary summarily dismissed
its argument that certain costs should be considered semifixed for the purpose of

6

The Hospital has not objected to that portion of the R&R that addresses whether the Secretary’s
methodologies is consistent with the Manual and the weight to be given the Manual. I find no
error in that portion of the R&R, clear or otherwise.

15

calculating the VDA and the Secretary’s failure to explain the dismissal through specific
findings violated the regulations at issue.
I agree with Judge Mahoney that substantial evidence supports the Secretary’s
decision to classify purchased laundry services, food, central distribution supplies, drugs,
IV solutions, operating room supplies and implantable devices as “variable” costs for
which the Hospital is not entitled to reimbursement. The Hospital’s argument that the
Secretary failed to make an individualized determination of whether these costs were
semifixed as opposed to variable is without merit.7 The burden of proof for obtaining
reimbursement rests on the Hospital.

42 C.F.R. §§ 412.92(e)(2)(i); PRM 15-1 §

2810.1(C), (D). Despite the Hospital’s argument that it cannot reduce its expenses any
further, Judge Mahoney correctly found that the Secretary has routinely found similar
classes of expenses to be variable, see Doc. No. 22 at 16 (collecting cases), and there is
nothing arbitrary or capricious about the use of categories in this manner to process
claims. See, e.g., St. May’s Hosp. of Troy v. Blue Cross & Blue Shield Ass’n, 788 F.2d
888, 890 (2d Cir. 1986); Wis. Dep’t of Health & Hum. Servs. v. Bowen, 797 F.2d 391,
399 7th Cir. 1986); Univ. of Cincinnati v. Heckler, 733 F.2d 1171, 1174-77 (6th Cir.
1984); Goleta Valley Cmty. Hosp. v. Shweiker, 647 F.2d 894, 897 (9th Cir. 1981).
The six cost categories identified by the Secretary are likely to vary with
utilization. Unlike rent, for example, which does not fluctuate based on the number of
patients, the volume of laundry services logically depends on patient demand. In any
event, the statute, regulation, and Manual give the agency broad discretion to determine
which, if any, semi-fixed costs are to be treated as fixed for purposes of the VDA

7

Oddly, the Hospital seems to be contending that none of its costs are variable. It did not identify
any variable costs during the administrative proceedings, leading the MAC to review the
Hospital’s request for the purpose of removing variable costs. This is counter to basic accounting
principles and contrary to the Manual’s assertion that even semi-fixed costs are not truly fixed
and may no longer be subject to compensation if a hospital fails to take action to reduce them
over a period of time. See PRM 15-1 § 2810.1(B)

16

payment. The statute at issue makes no mention of “semi-fixed” costs and the regulation
merely states that the MAC is to “consider” semi-fixed costs in determining the VDA,
without specifying how. 42 C.F.R. § 412.92(e)(3)(i). Finally, the Manual does not state
that semi-fixed costs must be compensated, rather it states “[f]or the purposes of this
adjustment, many semifixed costs, such as personnel-related costs, may be considered as
fixed on a case-by-case basis.” PRM 15-1 § 2810.1(B) (emphasis added).
The Hospital did not carry its burden in establishing that certain categorically
variable costs should be considered as anything other than variable costs. The Hospital’s
objection is overruled.
V.

CONCLUSION

For the reasons set forth herein:
1.

Plaintiff St. Anthony Regional Hospital’s objections (Doc. No. 23) to the
Report and Recommendation are overruled.

2.

I accept United States Magistrate Judge Kelly K.E. Mahoney’s Report and
Recommendation (Doc. No. 22) without modification. See 28 U.S.C. §
636(b)(1).

3.

Pursuant to Judge Mahoney’s recommendation:
a.

The Secretary’s determinations regarding the Hospital’s Medicare
Reimbursements are affirmed; and

b.

Judgment shall enter against the Hospital and in favor of the
Secretary.

17

IT IS SO ORDERED.
DATED this 6th day of February, 2018.

__________________________
Leonard T. Strand, Chief Judge

18