Federal Court Overturns CMS Audit Rule
A U.S. District Court judge has delivered a significant victory to Medicare Advantage insurers by vacating a controversial Centers for Medicare & Medicaid Services (CMS) regulation that threatened to recoup billions of dollars in alleged overpayments. The September 25 ruling from the Northern District of Texas sided with Humana, one of the nation’s largest health insurers, in a legal dispute with far-reaching consequences for the Medicare Advantage industry.
The court determined that CMS violated essential procedural requirements outlined in the Administrative Procedure Act (APA) when implementing its 2023 final rule. This decision represents a critical setback for federal regulators who sought to enhance oversight of Medicare Advantage plans through more aggressive audit methodologies.
Background of the Regulatory Change
The controversy originated in early 2023 when CMS issued its final rule introducing substantial changes to how the agency conducts Risk Adjustment Data Validation (RADV) audits. The regulation granted CMS authority to extrapolate overpayment findings from a sample of Medicare Advantage enrollees to an entire plan population, potentially magnifying the financial consequences of audit findings.
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Understanding the Fee-for-Service Adjuster
At the heart of this legal dispute lies a technical but consequential tool: the fee-for-service (FFS) adjuster. Since 2012, CMS had employed this mechanism to account for inherent differences between Medicare Advantage medical records and traditional fee-for-service claims data during audits.
Purpose of the Adjuster
The FFS adjuster was designed to ensure “actuarial equivalence” between Medicare Advantage and traditional Medicare programs. This adjustment recognized that coding practices differ substantially between MA plans, which use detailed medical records for risk adjustment, and fee-for-service Medicare, which relies on claims data for payment purposes.
Why CMS Eliminated It
In its 2023 rule, CMS controversially removed this long-standing adjuster, arguing that statutory equivalence requirements did not apply to RADV audits. The agency contended that other coding adjustments rendered the FFS adjuster unnecessary, marking a dramatic shift from over a decade of established policy.
The Legal Battle Between Humana and CMS
Humana responded swiftly to the rule change, filing suit against the Department of Health and Human Services later in 2023. The insurer challenged the regulation on multiple grounds, asserting it was unlawful, arbitrary and capricious, and improperly applied retroactively.
Humana’s Core Arguments
The insurance giant argued that eliminating the FFS adjuster exposed it to hundreds of millions of dollars in unexpected financial liabilities. Critically, Humana emphasized its reasonable reliance on CMS’s prior policy framework, which had remained consistent for more than a decade. This reliance argument proved particularly compelling to the court.
Retroactive Application Concerns
Adding to the controversy, CMS sought to apply the new audit methodology retroactively to payment year 2018. This retroactive enforcement raised serious concerns about fairness and due process, as health plans had made business decisions based on the previous regulatory framework.
Financial Impact on Medicare Advantage Plans
The financial stakes in this case were extraordinarily high, affecting not just Humana but the entire Medicare Advantage industry.
Industry-Wide Implications
CMS estimated it could recover approximately $4.7 billion in overpayments from Medicare Advantage plans using the revised audit methodology. This massive potential recoupment represented one of the most significant regulatory enforcement actions in Medicare Advantage history.
Humana’s Exposure
Among major insurers, Humana faced the largest potential risk from these clawbacks. Financial analysts estimated that roughly 17% of Humana’s 2023 earnings—approximately $900 million—could come under scrutiny through the enhanced audit process. Such exposure threatened substantial financial instability for the healthcare giant.
Court’s Reasoning and Decision
The district court’s decision hinged on procedural violations rather than the substantive merits of CMS’s policy change.
Lack of Fair Notice
The court found that CMS failed to provide adequate notice of the rule change during the regulatory comment period. Specifically, the agency’s justification that actuarial equivalence doesn’t apply to audits was not a “logical outgrowth” of the proposed rule, which had focused primarily on equity concerns between audited and unaudited plans.
Surprise Switch Doctrine
Applying what legal scholars call the “surprise switch” doctrine, the judge ruled that this abrupt shift in rationale deprived stakeholders of meaningful opportunity to comment on the actual basis for the final rule. This procedural deficiency rendered the entire regulation invalid.
Rejection of Harmless Error Defense
The government attempted to argue that any procedural error was harmless and shouldn’t invalidate the rule. However, the court rejected this defense, citing the significant retroactive financial impact on Medicare Advantage plans as evidence of real harm.
Future Implications for MA Oversight
This ruling creates uncertainty about CMS’s future oversight capabilities for Medicare Advantage programs.
CMS’s Aggressive Audit Plans
In May, CMS announced intentions to audit every Medicare Advantage plan annually for potential overpayments, describing it as an “aggressive” oversight enhancement. However, these plans have apparently stalled following the court’s decision.
Path Forward
CMS now faces a choice: appeal the district court’s decision, initiate new rulemaking with proper procedural safeguards, or develop alternative approaches to Medicare Advantage oversight. The agency must balance legitimate program integrity concerns with insurers’ need for regulatory predictability and procedural fairness.
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