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The Centers for Medicare & Medicaid Services (“CMS”) released the final rule on risk adjustment data validation (“RADV”) audits of Medicare Advantage (“MA”) organizations (the “Final Rule”) on January 30, 2023. Among other changes, this Final Rule will allow CMS to audit a sample of an MA organization’s (“MAO”) diagnoses reported for risk adjustment purposes (from 2018 and later) and then use the audit findings to calculate an extrapolated improper payment amount for the MAO’s contract. This extrapolation technique is controversial for a number of reasons, including whether CMS has the authority to use it in the manner proposed in the Final Rule, and whether it is an actuarially sound method of auditing. As we predicted in February, this Final Rule is now being challenged in court.

Refresher on the RADV Final Rule

The Final Rule will implement the following changes:

  • CMS will extrapolate RADV audit findings beginning with payment year (“PY”) 2018, and will not extrapolate RADV audit findings for PYs 2011 through 2017, though it will continue to collect the non-extrapolated overpayments that are identified. This approach applies to both CMS RADV audits as well as Department of Health and Human Services Office of Inspector General (“OIG”) RADV audits. Prior to the Final Rule, CMS recouped payments for the specific hierarchical condition categories (“HCCs”) that were determined upon audit to be unsupported, but did not extrapolate those findings.
  • CMS will not apply a Fee-For-Service (“FFS”) Adjuster in RADV audits to account for any effect of erroneous diagnosis codes in the data from Medicare Parts A and B that are used to calibrate the MA risk adjustment model.
  • MAOs will be required to remit improper payments identified during RADV audits in a manner specified by CMS.

Challenge in Court

On September 1, 2023, Humana Inc. and its subsidiary Humana Benefit Plan of Texas, Inc. (the “Plaintiffs”), filed a lawsuit against the United States Department of Health and Human Services (“HHS”) and Xavier Becerra in his capacity as Secretary of HHS (collectively, the “Defendants”) to vacate the Final Rule, and enjoin CMS from applying the Final Rule in any audits of the Plaintiffs. As explained below, the Plaintiffs’ complaint challenges the Final Rule on legal, actuarial and administrative grounds.

1. The Final Rule Allegedly Fails to Reconcile MA Payment Audits with CMS’ Statutory Mandate to Ensure Actuarial Equivalence

The Plaintiffs allege that the MA program is based on a foundational bargain that is being threatened by the Final Rule. This bargain is that MAOs agree to provide their enrolled Medicare beneficiaries at least the same level of benefits that the beneficiaries would receive under traditional FFS Medicare and, in turn, CMS agrees to pay the MAOs the same amount that CMS would expect to pay to cover those beneficiaries if they remained in FFS Medicare. This bargain is codified in the statutory mandate of 42 U.S.C. § 1395w-23(a)(1)(C)(i) “to ensure actuarial equivalence.” According to the complaint, the Final Rule breaks this bargain and undermines the financial stability of the MA program.

At the heart of the Plaintiffs’ complaint is an allegation that the Final Rule is actuarially unsound. The Plaintiffs allege that the Final Rule would use one set of data when setting risk adjustment payment amounts for MAOs and a different set of data in RADV audits. This disconnect will result in systemic underpayments to MAOs. More specifically, CMS will use reported diagnosis codes when estimating FFS Medicare costs, and will use documented diagnosis codes in RADV audits. The complaint includes the following simplified illustration of why these different documentation standards could result in a payment problem:

If CMS were to divide $1,000 of total spending associated with epilepsy among 100 beneficiaries whose doctors report an epilepsy diagnosis code in fee-for-service Medicare claims data, it would calculate an average incremental cost of $10 per beneficiary with a reported epilepsy code. But if the agency instead audited those claims forms against the underlying medical records for those beneficiaries and found that 50 of the diagnosis codes were not documented in the medical records, it would divide the $1,000 in spending associated with epilepsy across only the remaining 50 diagnosis codes, for an average expected incremental cost of $20 per beneficiary with a documented diagnosis code. (Emphasis added)

In other words, according to the Plaintiffs, there is a greater number of Medicare beneficiaries who are reported to have a given condition than are documented to have that condition, and using one standard for risk adjustment payments and another for RADV audits is not an actuarially sound methodology, unless an adjustment is made to account for this problem.

CMS previously addressed this problem and provided for a solution in its February 2012 announcement of the FFS Adjuster. The FFS Adjuster would account for the difference between the “perfect documentation” standard in RADV audits versus the reported documentation standard that is used for MA risk adjustment payments. However, since then, CMS has declined to apply a FFS Adjuster and the Final Rule does not include one. The complaint alleges, inter alia, that CMS did not adequately justify its decision to leave out the FFS Adjuster and the resulting RADV audit methodology is actuarially unsound. 

2. The Retroactive Application of the Final Rule is Allegedly an Abuse of Discretion

Plaintiffs allege that 42 U.S.C. § 1395hh(e)(1)(A) prohibits CMS from retroactively applying rules unless the “retroactive application is necessary to comply with statutory requirements” or the “failure to apply the change retroactively would be contrary to the public interest.” The Plaintiffs allege that neither exception is applicable here.

Plaintiffs allege that they expressly premised their previous MA bids and MA business on the understanding that CMS would use a FFS Adjuster in extrapolated RADV audits, which premise was based on the February 2012 CMS notice that adopted the FFS Adjuster. Accordingly, the Plaintiffs’ prior bids had not accounted for the potential reduction in compensation that results from the extrapolated RADV audits that do not include a FFS Adjuster. If these prior bids had contemplated this new audit methodology, they would have been much higher. Further, the Plaintiffs’ annual bid certifications explicitly relied on CMS’ public commitment to apply a FFS Adjuster to account for this differentiation, and CMS did not respond in the contrary to these bid certifications.

Altogether the decision to not include a FFS Adjuster exposes the Plaintiffs, and other similarly situated MAOs, to unanticipated and unaccounted for liabilities. Thus, the Final Rule does not fit into either statutory exception to the prohibition on retroactive rulemaking because: (i) prospective application would not be contrary to the public interest since Plaintiffs, and other similarly situated MAOs, relied on CMS’ past promises to utilize a FFS Adjuster in future RADV audits in formulating their MA bids and operating their MAOs, and (ii) as detailed above, the Final Rule contravenes the mandate for actuarial soundness rather than complying with a statutory mandate.

Causes of Action

The Plaintiffs also allege that the Defendants’ implementation of the Final Rule violates three components of the Administrative Procedure Act (“APA”):

  1. Rationale For Final Rule (5 U.S.C. §§ 706(2)(A), (C)) – Plaintiffs claim that the Final Rule is arbitrary and capricious and in excess of the Defendants’ statutory authority on account of the lack of empirical or factual justifications for their decision to not include a FFS Adjuster in the RADV audits, and because of the failure of the Defendants’ legal rationales to adequately explain this change in policy. The Final Rule therefore violates the APA’s requirement for the Defendants to put forth reasoned agency decision-making.
  2. Retroactivity (5 U.S.C. § 706(2)(A), (C)) – Plaintiffs claim that since at least 2012, they have predicated their MA bids on the understanding that CMS would apply a FFS Adjuster before making any recoupments from RADV audits. The Plaintiffs’ actuaries certified that these prior bids were actuarially sound based on this understanding. CMS’ application of the Final Rule to RADV audits for years that were prior to the implementation of the Final Rule is therefore a retroactive abuse of the Defendants’ discretion. As discussed above, applying the RADV audit methodology only prospectively would not be contrary to the public interest, and applying it retroactively does not comply with a statutory mandate.
  3. Inadequate Notice (5 U.S.C. § 706(2)(D)) – Plaintiffs claim that the Final Rule did not comply with the APA’s notice-and-comment requirements because the decision to not include a FFS Adjuster did not observe the necessary notice-and-comment procedure required by the APA. More specifically, the decision to exclude a FFS Adjuster rests largely on the D.C. Circuit’s reasoning in UnitedHealthcare v. Becerra, 16 F.4th 867 (D.C. Cir. 2021), which was not decided until years after the initial version of the Final Rule was proposed on November 1, 2018, and at no point did CMS request comment on how this ruling implicated their decision to exclude the FFS Adjuster. Therefore the Defendants’ promulgation of the Final Rule did not observe the notice-and-comment period and the Plaintiffs et al were deprived of their right to object to, and potentially alter, CMS’ implementation of the Final Rule.

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This litigation will be closely watched by the industry. We will keep you informed as the litigation progresses. In the meantime, please contact a member of the Sheppard Mullin Healthcare Team if you have any questions.