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Supreme Court to Decide Critical Case on When CMS Must Use Formal Rulemaking when Instructing Medicare Contractors

On January 15, 2019, the U.S. Supreme Court will hear arguments in a hotly-contested case involving a challenge by hospitals over when Medicare’s instructions to its contractors impact a “substantive legal standard” and thus must be issued through formal rulemaking.  In Azar v. Allina Health Services, the Court will review the U.S. Court of Appeals for the D.C. Circuit’s decision that threw out a new Medicare rate calculation methodology for Disproportionate Share Payments (DSH) to hospitals adopted by the U.S. Department of Health and Human Services (HHS) because the agency promulgated it through “interpretative guidance” but failed to undergo notice-and-comment rulemaking. The Supreme Court is now tasked with answering a broader question: what is the legal standard for when HHS must use formal rulemaking and not “interpretative” instructions to its contractors in the administration of the Medicare program?

The U.S. argues strenuously that the hospitals’ position “would substantially undermine [HHS’s] ability to administer the broad and complex Medicare program,” and that affirming the D.C. Circuit’s decision would impose “drastic constraints on” the Center for Medicare and Medicaid Services (CMS).  Allina Health Systems responds that “it is utter hyperbole” for the U.S. to suggest that the logic of the decision below would require CMS “to promulgate all of its manuals and instructions . . .through notice and comment.”  The outcome of this case may have considerable implications for how CMS administers the Medicare program, which impacts all participating health systems and providers.


Hospitals that serve a disproportionate number of low-income patient are entitled to a Medicare Disproportionate Share Hospital Adjustment (DSH Payments) to cover the cost of providing care to a large proportion of Medicaid and uninsured individuals. DSH Payments are calculated using a formula to determine the proportion of low-income patients treated at a hospital. A key component of that formula is the number of patients “entitled to benefits under [Medicare] Part A [hospital insurance].” CMS calculates and provides this calculation to Medicare Administrative Contractors (MACs), which in turn use it to determine the amount of DSH payment due to a hospital. 

The core issue is whether Medicare beneficiaries in the Medicare Advantage program, Part C, should be included as patients entitled to Part A benefits. CMS’s inclusion of Part C days generally results in a lower calculated proportion of low-income inpatient days, and thus a lower DSH Payment for hospitals.

In 2004, CMS issued a Final Rule that included a new methodology that counted Medicare Part C inpatient days, in addition to Part A days in its calculation. This differed from the 2003 Proposed Rule that sought “to clarify” that Part C days are excluded from the DSH calculations because they are not considered covered and paid under Part A. Allina challenged the 2004 rule which was  vacated by the U.S. District Court because it was not a “logical outgrowth” of the proposed rule, and thus violated the Administrative Procedures Act (APA). The U.S. Court of Appeals for D.C. affirmed that decision. 

Allina Health Services v. Azar

In June 2014, sixteen days after the D.C. Circuit’s mandate vacating the 2004 rule, CMS issued instructions that included Part C days (consistent with the vacated 2004 rule) for hospitals nationwide, and did so without notice, comment opportunity, or explanation for the departure from the prevailing pre-2004 standard reinstated by the 2004 rule’s vacatur.

This action by CMS gave rise to the case now before the Supreme Court.  A core legal issue is whether the APA requirements are incorporated sub silencio into the Medicare Act. Under the APA, agency rules are classified as either “legislative,” which require formal rulemaking, or “interpretive,” which do not. In contrast, the Medicare Act requires any “rule, requirement, or other statement of policy (other than a national coverage determination) that establishes or changes a substantive legal standard governing the scope of benefits, the payment for services, or the eligibility of individuals, entities, or organizations to furnish or receive services or benefits” to go through formal rulemaking. (emphasis added).

Administratively, Allina sought and achieved expedited judicial review, and filed suit.  Allina challenged the CMS instruction by arguing that it involved a “substantive legal standard” but did not go through formal rulemaking. The U.S. District Court granted summary judgment to CMS, on the basis that treating Part C patients as Part A entitled was an “interpretative rule” exempt from the APA’s notice-and-comment requirement, and that Medicare Act Section 1395hh(a)(2) incorporated the APA’s exemption. On appeal, the D.C. Circuit reversed and remanded, effectively vacating the 2012 Medicare formula announced through an instruction. The panel held the 2012 Medicare formula that included Part C days established a “substantive legal standard” and therefore were not interpretative. The Circuit Court also held that the Medicare Act does not exempt interpretive rules, but instead broadly requires notice and comment for every rule, requirement, or other statement of policy that establishes or changes a substantive legal standard.

The government sought certiori and the Supreme Court granted it.  In its arguments, the Solicitor General takes the stringent position that “the agency may adopt interpretations of the Medicare Act without promulgating them through notice-and-comment rulemaking, and may later change its interpretation without undertaking notice-and-comment rulemaking.”  In fact, it says, “an agency always remains free to choose whether to fill a statutory or interpretive gap by rulemaking or by adjudication.” Thus, the U.S. argues, even if the D.C. Circuit vacates a rule, as it did here, CMS can achieve the same outcome through an “interpretive” instruction that could only be challenged through administrative appeals and then judicial appeals. 

Allina argues that, as the D.C. Circuit concluded, the agency cannot “evade the specific notice-and-comment requirements Congress enshrined in the Medicare Act when altering a substantive legal standard that reduces payments to hospitals—to the tune of billions of dollars.”  It disputes the DOJ view that there is a circuit split, and says that no federal appellate court has adopted the reasoning that “substantive legal standard” should be read to exclude agency guidance, such as instructions to contractors, on the basis that it is not legally binding and thus, by definition, lacks the force of law.

Potential Impacts

The Supreme Court’s affirming vacatur of the 2012 Medicare instruction would provide up to $4 billion to health systems in withheld DSH payments. But, there is more than money at stake. According to HHS, the agency’s ability to efficiently administer the Medicare program would be hampered if the Supreme Court holds that the Medicare statute contains no exception to notice and comment rulemaking for interpretative rules. In its petition for cert., HHS noted that because of the scope and complexity of the Medicare program, the agency relies extensively on interpretative guidance published in policy manuals to administer Medicare. HHS argued that converting these informal guidance documents “into regulations requiring notice and comment would jeopardize the flexibility needed in light of Medicare’s complex and frequently changing statutory context and administrative developments.” (Petition for Writ of Certiorari at 20).  Allina counters that its position permits reasonable distinctions between agency actions that create “substantive legal standards” and those that don’t, and that the D.C. Circuit already has articulated a commonsense approach to applying this rule.

CMS could attempt to limit the impact of an affirmative decision by the Supreme Court by applying the Court’s holding to a narrow set of agency actions, thus preserving much of CMS’s ability to administer the Medicare program through informal guidance. As with any agency action, the initial decision to proceed through notice and comment or through informal guidance lies with CMS. Therefore, reasonably within the confines of an affirmative decision, CMS will have the opportunity to implement the Supreme Court’s holding as the agency interprets it.


It is too early to say for certain what long term implications Azar v. Allina Health Services will have on providers, or on CMS’s stewardship of the Medicare program.  Oral arguments are scheduled for January 15, 2019. We will provide an update following that hearing, and periodically as a clearer picture of the impact of this litigation develops.

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As a former official in the Civil Fraud Section of the U.S. Department of Justice, Larry has deep experience handling FCA investigations and qui tam litigation for industry leading health care clients across the country.

Daryl Berke