222 F.3d 1019 (D.C. Cir. 2000)
Transitional Hospitals Corporation of Louisiana, Incorporated, and Transitional Hospitals Corporation of Texas, Incorporated, Appelleesv.Donna E. Shalala, Secretary, Department of Health and Human Services, Appellant
No. 99-5166
United States Court of Appeals FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued February 24, 2000Decided August 22, 2000

Appeal from the United States District Court for the District of Columbia(No. 97cv01351)
Anne M. Murphy, Attorney, U.S. Department of Justice,  argued the cause for appellant. With her on the brief were  David W. Ogden, Acting Assistant Attorney General, Anthony J. Steinmeyer, Assistant Director, and Wilma A. Lewis,  U.S. Attorney.
Eugene Tillman argued the cause for appellees.  With him  on the brief was Tamara V. Scoville.
Before:  Williams, Rogers, and Garland, Circuit Judges.
Opinion for the Court filed by Circuit Judge Garland.
Garland, Circuit Judge:


1
The Medicare program reimburses certain categories of hospitals on a "reasonable cost"  basis, rather than under the generally applicable, and less  remunerative, "Prospective Payment System."  Long-term  care hospitals are one such category.  Plaintiffs own two new  facilities for which they sought classification as long-term care  hospitals before they began admitting patients.  The Department of Health and Human Services (HHS) rejected plaintiffs' request, citing regulations that require new hospitals to  have six months of experience before they can qualify as  "long-term."  In enacting those regulations, the Secretary of  HHS took the position that an initial data-collection period is  statutorily required.  Plaintiffs, challenging the regulations in  the district court, took the opposite position:  that the Medicare statute does not mandate an initial data-collection period  and in fact manifestly requires HHS to reimburse them as  long-term hospitals from the first day of operation.  The  district court agreed with plaintiffs and declared HHS' regulations invalid.


2
We do not find the statute as clear as either side suggests,  but rather conclude that Congress intended the Secretary to  exercise discretion in determining the manner in which a  hospital qualifies as a long-term care facility.  We therefore  reverse the decision of the district court.  However, because  the Secretary mistakenly believed that she lacked such discretion, we remand the case to permit her to determine  whether she wishes to retain the existing regulations knowing  that other options are permissible.


3
* Medicare is a federal health insurance program for the  aged and disabled that is administered by the Health Care Financing Administration (HCFA) of HHS.  See 42 U.S.C.  §§ 1395 et seq.  Under Medicare Part A, institutional health  care providers are reimbursed for their services to eligible  patients.  See id. §§ 1395c to 1395i-5.  From its inception  until 1983, Medicare reimbursed hospitals for the "reasonable  cost" of providing inpatient care, subject to certain limitations.  Id. § 1395f(b) (1982);  see also id. § 1395x(v).


4
By 1983, Congress had become concerned that hospitals  reimbursed on a reasonable cost basis lacked incentives to  operate efficiently.  This concern led to the revision of the  Medicare payment system in that year.  See Social Security  Amendments of 1983, Pub. L. No. 98-21, § 601, 97 Stat. 65,  149.  See generally County of Los Angeles v. Shalala, 192  F.3d 1005, 1008-09 (D.C. Cir. 1999).  In place of the reasonable cost method, Congress enacted the Prospective Payment  System (PPS) as the principal method of compensating hospitals for inpatient care provided to eligible patients.  Under  PPS, hospitals are reimbursed according to flat rates established in advance for the various categories of patient diagnoses (known as "diagnosis-related groups" or "DRGs").  42  U.S.C. § 1395ww(d).  The rates reflect the average cost  associated with treating a patient for a specific condition, and  encourage hospitals to keep costs within the anticipated reimbursement levels.  For the care of patients whose hospitalizations are extraordinarily costly or lengthy, the statute authorizes the Secretary to make "outlier payments" to supplement  the standard PPS disbursement.  Id. § 1395ww(d)(5)(A)(i)(vi);  see County of Los Angeles, 192 F.3d at 1009.


5
Because PPS was "developed for short-term acute care  general hospitals," Congress acknowledged that it did not  "adequately take into account special circumstances of diagnoses requiring long stays."  S. Rep. No. 98-23, at 54 (1983).Thus, Congress altogether excluded from PPS certain types  of hospitals that treat atypical patient populations.  These  hospitals instead receive reimbursement for inpatient care  under the reasonable cost system.  See 42 U.S.C.  § 1395ww(d)(1)(B).  One type of hospital subject to the statutory exclusion is a long-term care hospital, which the statute describes as "a hospital which has an average inpatient length  of stay (as determined by the Secretary) of greater than 25  days."  Id. § 1395ww(d)(1)(B)(iv)(I).1 The availability of this  exclusion is the central issue in the case before us.


6
* HHS implemented the new PPS reimbursement scheme by  enacting regulations in 1984.  In issuing its final rule, although not in the rule itself, HHS announced that it intended  to apply the statutory exclusions prospectively only:  any  change in a hospital's status (i.e., whether it was subject to or  excluded from PPS) that occurred during one cost reporting  period would generally take effect only at the start of the  next period, with each period typically lasting one year.  See  Medicare Program;  Prospective Payment for Medicare Inpatient Hospital Services, 49 Fed. Reg. 234, 243 (1984).Thus, a new hospital would not qualify for the exclusion at  least until the initial reporting period was over.  To accommodate new hospitals, HHS permitted an abbreviated initial  cost reporting period of six months, rather than the usual one  year.  See 42 C.F.R. § 405.471(c)(5)(i), (c)(5)(ii)(B) (1983),


7
now codified at 42 C.F.R. § 412.23(e)(1), (e)(3)(ii).2


8
In 1992, HHS formalized its prospective approach to exclusions by proposing and then adopting the following rule:


9
For purposes of exclusion from the prospective payment systems ..., the status of each currently participating hospital ... is determined at the beginning of each cost reporting period and is effective for the entire cost reporting period.  Any changes in the status of the hospital are made only at the start of a cost reporting period.


10
42 C.F.R. § 412.22(d).  Thus, a hospital that qualifies for the  exclusion in the middle of a reporting period will not benefit  until the next reporting period.  By the same token, a  hospital that ceases to qualify in the midst of a cost reporting  period will nevertheless be compensated as though it were  exempt for the entire period.  See Medicare Program; Changes to the Hospital Inpatient Prospective Payment Systems and Fiscal Year 1993 Rates, 57 Fed. Reg. 23,618, 23,657  (1992).  For a new hospital, HHS' rule confirmed that the  exclusion does not begin until the first six months of data  collection have passed.


11
In response to the notice of proposed rule making, the  National Association of Long Term Hospitals (NALTH) suggested that HHS permit new long-term care hospitals to self certify their average length of stay from the start.  See  Letter from NALTH to HCFA at2 (July 31, 1992) (J.A. at 53) [hereinafter NALTH Ltr.].3  HHS, however, concluded  that it did not have the discretion to permit self-certification  by long-term care hospitals.  "We do not believe that the  statute permits us," the Department said, "to extend the  exclusion for long-term care hospitals to a hospital which has  not demonstrated actual compliance with the statutory requirement."  Medicare Program;  Changes to the Hospital  Inpatient Prospective Payment Systems and Fiscal Year  1993 Rates, 57 Fed. Reg. 39,746, 39,800-01 (1992) [hereinafter Final Rule]. The "criterion for exclusion as a long-term care  hospital (average inpatient length of stay greater than 25  days) can be assessed only over a period of time.  Thus, a  hospital cannot qualify as a long-term care hospital until it  has been in operation for some period of time."  Id. at 38,801.

B

12
Plaintiffs Transitional Hospitals Corporation of Louisiana  and Transitional Hospitals Corporation of Texas (hereinafter  "the THC plaintiffs") opened two new hospitals at the end of  1992.  Both were intended to treat patients with medically  complex conditions requiring extended inpatient stays, thereby qualifying for the long-term care hospital exclusion from  PPS.  Before commencing operations, the THC plaintiffs  wrote HCFA stating that they "only expect to admit patients  whose medical conditions will result in lengths of stay in  excess of 25 days."  Letter from Counsel for THC to HCFA  at 2 (Nov. 12, 1992) (J.A. at 57) [hereinafter THC Ltr.].  They  asked HCFA to exclude them from PPS from the starting  date of their Medicare provider agreements, rather than  reimburse them under PPS during their first six months of  operation.  See id. at 4 (J.A. at 59).


13
Kathleen Buto, the Director of HCFA's Bureau of Policy  Development, wrote back denying plaintiffs' request.  Buto  said that the statute mandates exclusion only for "a hospital which has [emphasis added] an average length of stay (as  determined by the Secretary) of greater than 25 days."Letter from HCFA to Counsel for THC at 2 (Dec. 24, 1992)  (J.A. at 63) (alteration and emphasis in original) [hereinafter  Buto Ltr.].  Noting that HHS regulations implement that  mandate by "examining [a hospital's] actual operating experience in a past period, rather than by relying on its admission  criteria or other formalized statements of how the hospital is  intended or expected to operate," Buto concluded that the  THC plaintiffs could not qualify for the exclusion in advance.Id. at 2-3 (J.A. at 63-64).


14
Having had their request turned down, the THC plaintiffs  proceeded with the six-month cost reporting period.  During  that time, they were reimbursed under PPS, supplemented by  outlier payments.  At the end of the six-month period, both  hospitals demonstrated average inpatient lengths of stay exceeding 25 days, thereby qualifying for exclusion from PPS-and entitling them to payment for "reasonable costs"--during  the next cost reporting period.  See Linville Aff. pp 7, 8, 13  (J.A. at 35, 37).  Plaintiffs estimate that their PPS reimbursement during the initial six-month period was approximately  $1.2 million per hospital less than it would have been under  the reasonable cost standard.  See id. pp 11, 12 (J.A. at 36).


15
The THC plaintiffs requested a hearing before the Provider  Reimbursement Review Board, which is authorized by statute  to hear the complaints of providers dissatisfied with the  compensation they have received.  See 42 U.S.C. § 1395oo(a),  (d).  Plaintiffs challenged the validity of the regulations that  denied them compensation for reasonable costs during their  first months of operation.  The Board, however, concluded  that it lacked authority to determine the validity of HHS  regulations.


16
Plaintiffs then brought suit in the United States District  Court for the District of Columbia.  Ruling on the parties'  cross motions for summary judgment, the court concluded  that the Medicare statute was neither silent nor ambiguous  on the question.  Rather, the court concluded that the statute  unambiguously requires HHS to provide a PPS exclusion  from the beginning of a new long-term care hospital's participation in the Medicare program.  The court further held that  even if the statute were ambiguous, the Secretary's regulations did not constitute a permissible interpretation of the  legislative language.  The court therefore declared the regulations invalid insofar as they preclude new long-term care  hospitals from securing immediate exclusion from PPS.  See  Transitional Hosps. Corp. v. Shalala, 40 F. Supp. 2d 6, 15  (D.D.C. 1999).  This appeal by the Secretary followed.

II

17
We review de novo the district court's ruling on the motions for summary judgment.  See United Seniors Ass'n v.  Shalala, 182 F.3d 965, 969 (D.C. Cir. 1999).  In judging the  validity of the Secretary's regulations, we apply the familiar  two-step framework of Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 842-43 (1984).We first ask "whether Congress has directly spoken to the  precise question at issue," in which case we "must give effect  to the unambiguously expressed intent of Congress."  Id.  If  the "statute is silent or ambiguous with respect to the specific  issue," we move to the second step and defer to the agency's  interpretation as long as it is "based on a permissible construction of the statute."  Id. at 843.  However, deference is  "only appropriate when the agency has exercised its own  judgment."  Phillips Petroleum Co. v. FERC, 792 F.2d 1165,  1169 (D.C. Cir. 1986).  "When, instead, the agency's decision  is based on an erroneous view of the law, its decision cannot  stand."  Id.


18
* We begin with Chevron step one, and with the Secretary's  contention that Congress unambiguously expressed its intent  to bar the relief plaintiffs request.


19
The statutory provision at issue is quite brief.  It excludes  from PPS any "hospital which has an average inpatient length  of stay (as determined by the Secretary) of greater than 25  days."  42 U.S.C. § 1395ww(d)(1)(B)(iv).4  When the Secretary adopted her implementing regulations, she took the  position that the statute does not permit her to certify a  hospital as long-term in advance because the criterion for  exclusion, an average inpatient length of stay greater than 25  days, "can be assessed only over a period of time."  Final  Rule, 57 Fed. Reg. at 39,801.  "Thus," she said, "a hospital  cannot qualify as a long-term care hospital until it has been in  operation for some period of time."  Id.  Similarly, when  HCFA turned down plaintiffs' request for self-certification, it  stressed that, because under the statute only a hospital that  "has" the requisite length of stay is eligible, a hospital cannot  qualify until it makes the requisite showing that it "has" that  average length of stay.  See Buto Ltr. at 2 (J.A. at 63).


20
The statute seems neither so clear, nor so dictatorial, to us.Although it does establish a criterion based on average length  of stay, the statute is silent as to how and when that length  should be calculated.  Nothing in the language precludes the  Secretary from determining length of stay based on a prediction drawn, as plaintiffs suggest here, from a hospital's policy  of admitting only "patients whose medical conditions will  result in lengths of stay in excess of 25 days."  THC Ltr. at 2  (J.A. at 57);  cf. County of Los Angeles, 192 F.2d at 1013-15  (affirming HHS' use of predictions to determine statutorily mandated range of outlier payments).


21
Nor does the statute's use of the present tense verb "has"  definitively resolve the question.  Although to qualify it must  be true that a hospital "has" the requisite length of stay, that  word does not tell us how to determine whether that state of  being exists.  The agency has implicitly recognized as much  by adopting a policy of determining a hospital's status at the  beginning of a cost reporting period, and then permitting it to  retain that status for the entire period--even if conditions  change in the interim.  See 42 C.F.R. § 412.22(d).  Under this policy, HHS excludes a hospital for the next period based  on data derived from the prior period, regardless of whether  the hospital actually "has" the requisite average on each day  of the next period.  See id.


22
Moreover, nothing in the statutory language precludes an  alternative form of relief requested by plaintiffs:  retroactive  reimbursement for reasonable costs incurred during the first  six months if, at the end of that period, the hospital shows  that it had a 25-day average during that period.  Again, the  word "has" does not unambiguously decide this question. Each of plaintiffs' hospitals could have accurately said on its  six-month anniversary that today it "has" a greater than 25day average--referring to the entire period from day one  through and including day 180.  It would therefore have been  consistent with the literal language to reimburse the hospital  on that day for all of its reasonable costs incurred to date.


23
Finally, and perhaps most important, this is not a statute  as to which we can only infer, from Congress' silence, an  implicit intent to delegate to the Secretary the authority to  reasonably interpret the statutory terms.  See Chevron, 467  U.S. at 844.  Rather, in this case the statute excludes a  hospital that has an average length of stay of greater than 25  days, "as determined by the Secretary."  42 U.S.C.  § 1395ww(d)(1)(B)(iv).  Thus, Congress has provided "an express delegation of authority to the agency to elucidate a  specific provision of the statute by regulation."  Chevron, 467  U.S. at 843-44;  see also 42 U.S.C. §§ 1302(a), 1395hh(a)  (granting HHS authority to issue regulations to administer  Medicare program).  This means that the Secretary has  discretion to determine how to calculate the qualifying length  of stay, and that we are bound to uphold her determination as  long as she exercises that discretion in a reasonable way.  See  Chevron, 467 U.S. at 843-44.

B

24
The THC plaintiffs also see the statute as clear and unambiguous--although in precisely the opposite way as that perceived by HHS.  In their view, and in the view of the district  court, the use of the present tense "has" requires that if during any given period the hospital "has" a 25-day average,  it must be considered exempt for the entire period.  See THC  Br. at 22-23.  The use of the present tense, plaintiffs contend,  requires that the exclusion "be applied on a current basis,"  and "allows no alternative temporal reading."  Id.  Or, as the  district court put it, "the plain language of the statute indicates that a long-term care hospital may obtain an exemption  from the Prospective Payment System whenever it 'has' an  average inpatient length of stay greater than 25 days."Transitional Hosps., 40 F. Supp. 2d at 10.5


25
Again we disagree, this time for the mirror image of our  reasoning with respect to HHS' interpretation.  Because the  statute does not tell us how to determine whether a hospital  "has" the required average length of stay, it cannot be read  as requiring the agency to make that determination constantly and instantaneously--any more than it can be read (as  HHS would have it) as requiring the agency to make that  determination prospectively only.  In Methodist Hospital v.  Shalala, 38 F.3d 1225 (D.C. Cir. 1994), we considered a  similar argument regarding the wage index used to determine  reimbursement rates under PPS.  In that case, the plaintiff  hospitals contended that the Medicare statute required retroactive application of corrections made to the index to ensure  that the Secretary was not employing an incorrect index in  the period prior to the next correction.  We rejected that  claim, noting that it "would require the Secretary to make  virtually continuous adjustments in the wage index."  Id. at  1230.  "The statute," we said, "does not specify how the  Secretary should construct the index, nor how often she must  revise it....  Congress through its silence delegatedthese  decisions to the Secretary."  Id.  The same is true here.


26
But, plaintiffs argue, if Congress had intended the exclusion to apply prospectively, it could have drafted the statute  to provide a PPS exclusion for a hospital that "had" an  average inpatient length of stay greater than 25 days "during  its most recent cost reporting period."  Transitional Hosps.,  40 F. Supp. 2d at 11 (quoting Pls.' Mot. for Summ. J. at 15)  (emphasis omitted).  Frankly, we do not see such a revised  statute as particularly less ambiguous.  Indeed, we do not see  why HHS could not have proffered the same editorial suggestion and then made the opposite argument:  If Congress had  intended hospitals to receive retroactive reimbursement as  plaintiffs contend, wouldn't it have defined the exclusion as  covering hospitals that "had" the requisite average during  their "most recent cost reporting period"?  In any event,  while positing a "clearer" way to write a statute may suggest  that an existing statute is ambiguous, it surely does not  establish that it is unambiguous.  And if the statute is not  unambiguous, Chevron requires us to defer to a reasonable  reading by the Secretary.


27
We also must take care to read the word "has" in the  context of the entire phrase of which it is a part.  Two  elements of that context are important here.  First, the  statutory exclusion is for a hospital that has "an average"  inpatient length of stay of greater than 25 days.  The criterion of "an average" strongly militates against plaintiffs' view  that a hospital's status must be measured at every moment in  time.  As HHS correctly points out, an average is a criterion  that can only be assessed over a period of time.  Moreover,  the statute refers not to an average "over" a period of 25  days, but to an average "of" 25 days--necessarily indicating  that the period of measurement must be more than 25 days in  order reasonably to determine whether the "average" during  that period was at least 25 days.  Hence, the use of the word  "has" in conjunction with the word "average" would not  preclude waiting until six months have passed to determine  whether, at that point, the hospital "has" an average of 25  days over a 180-day period.


28
Indeed, were we to read the statute as literally as plaintiffs  and the district court suggest, plaintiffs' own contention--that they "met the 25-day requirement at all times during their  operation" and so were entitled to payment from the first  day--would be plainly incorrect.  THC Br. at 4.  On day one,  the hospitals could not have had a 25-day average because 25  days had not yet passed.  If a hospital must be, and may only  be, paid for days on which it "has" a 25-day average, plaintiffs could not have qualified earlier than the 25th day.  Even  then, they could have done so only if every patient present on  day one were still at the hospital 25 days later.


29
The second element of context that is important here is the  statute's parenthetical phrase, "as determined by the Secretary."  As we have discussed above, by employing this phrase  Congress has made "an express delegation of authority to the  agency to elucidate [the] specific provision of the statute by  regulation."  Chevron, 467 U.S. at 843-44.  This further takes  the case out of the realm of Chevron step one's de novo  review, and into the realm of Chevron step two--which asks  only whether the agency's interpretation is reasonable.  See  id.  And that gives the agency considerable leeway to determine how "has" is to be defined, and whether to require  prospective, contemporaneous, or retrospective evaluation  and payment.  See San Bernardino Mountains Community  Hosp. Dist. v. Secretary of Health & Human Servs., 63 F.3d  882, 886-87 (9th Cir. 1995) (holding that inclusion of phrase  "as determined by the Secretary" in Medicare Act's definition  of "sole community hospital" "make[s] clear that Congress  intended to delegate to the Secretary the task of outlining  and defining the criteria for attaining sole community hospital  status").


30
Plaintiffs resist the conclusion that Congress has delegated  definitional authority to HHS.  They argue that the fact that the parenthetical "as determined by the Secretary" follows  the phrase "an average inpatient length of stay," means that  Congress has only given the agency "discretion to determine  how the average length of stay will be calculated"--and not  whether the hospital "has" that average.  THC Br. at 26.This is far too sophistic a reading.  First, the concession that  the agency has discretion to determine how to calculate the average necessarily means it has discretion to determine  whether a hospital "has" that average--since a hospital cannot have a qualifying average unless it satisfies the agency's  calculation methodology.  Second, even if word placement  were decisive, it is as true that the delegating parenthetical  follows the phrase "has an average inpatient length of stay"  as that it follows the phrase "an average inpatient length of  stay."  At most this renders the scope of Congress' delegation ambiguous, which again moves us to Chevron's second  step.  See Chevron, 467 U.S. at 844.6

C

31
In reaching the conclusion that the statute unambiguously  requires retroactive reimbursement for the hospitals' initial cost reporting period, the district court relied on another  district court opinion, County of Los Angeles v. Shalala, 992  F. Supp. 26 (D.D.C. 1998), which held that a provision of the  Medicare statute required HHS to make retroactive adjustments to outlier payments.7  County of Los Angeles held that  the provision, which set a range for the "total amount of the  additional payments made," 42 U.S.C. § 1395ww(d)(5)(A)(iv)  (emphasis added), unambiguously required the Secretary to  adjust the additional payments retroactively to ensure that  the total fell within the range.  See County of Los Angeles,  992 F. Supp. at 36.  It thus rejected the Secretary's interpretation of the provision as merely instructing her as to where  to set outlier thresholds for the coming year.  The district  court in the instant case followed that line of reasoning, and  held that HHS could not use prior-period experience merely  to determine how to reimburse the plaintiff hospitals in the  future, but rather had to reimburse the hospitals for their  reasonable costs from the first date of their operation.  See  Transitional Hosps., 40 F. Supp. 2d at 12.


32
Although the district court's reliance on the opinion in  County of Los Angeles cannot be faulted, this court reversed  that decision seven months later.  See County of Los Angeles  v. Shalala, 192 F.3d 1005 (D.C. Cir. 1999).  Rejecting an  argument based on verb tense, we held that "instead of  embodying a retrospective inquiry into the amount of outlier  payments that have been made," "the phrase 'payments made  under this subparagraph' might just as plausibly reflect a  prospective command to the Secretary about how to structure  outlier thresholds for payments to be made in advance of each  fiscal year."  Id. at 1013.  In so holding, we cited the Supreme Court's decision in Regions Hospital v. Shalala, 118  S. Ct. 909 (1998).  There, the Court held that the statutory  phrase, "recognized as reasonable," "by itself[ ] does not tell  us whether Congress means to refer the Secretary to action  already taken or to give directions on actions about to be taken."  Id. at 916 (quoting Administrators of the Tulane  Educ. Fund v. Shalala, 987 F.2d 790, 796 (D.C. Cir. 1993))."In other words," the Court said, "the phrase 'recognized as  reasonable' might mean costs the Secretary (1) has recognized as reasonable for [prior reimbursement] purposes, or  (2) will recognize as reasonable as a base for future ...  calculations."  Id.  By the same token, we conclude that the  phrase at issue here--"has an average inpatient length of  stay (as determined by the Secretary) of greater than 25  days"--is ambiguous and may refer to the hospital's status at  the beginning of, during, or at the close of a cost reporting  period.  Cf. United States Dep't of the Treasury v. FLRA, 960  F.2d 1068, 1072 (D.C. Cir. 1992) (holding that statutory  phrase "adversely affected" is ambiguous and permits "alternative temporal readings").

III

33
Having concluded that the analysis of Chevron step one  does not resolve the case, we would ordinarily move to step  two and ask whether the Secretary's interpretation of the  meaning of the statute is reasonable.  Plaintiffs argue that  the Secretary's interpretation is not reasonable, contending  that HHS has no justification for not permitting selfcertification, for not utilizing the alternative of retroactive  reimbursement, and for denying both options to long-term  care hospitals while making them available to another category of PPS-excluded institutions:  rehabilitation hospitals.  See  42 C.F.R. § 412.23(b)(8), (b)(9).


34
HHS replies that it is perfectly reasonable to rely on actual  data regarding length of stay rather than on a hospital's self interested prediction.  The Department explains that it permits self-certification by rehabilitation hospitals because the  criteria for qualification of such hospitals are based on the  "characteristics of the patients and the types of services that  the facility furnishes," Final Rule, 57 Fed. Reg. at 39,801,8 criteria which--unlike length of stay--a hospital can "virtually guarantee[ ]" from the first day of operations, HHS Reply  Br. at 12.  With respect to the alternative of retroactive  adjustment, HHS points out that no one suggested such an  option until after the district court litigation began in this  case.9  Moreover, HHS argues that retroactive adjustments  are as likely to hurt hospitals that slip below the average  during a period for which they have been prospectively  qualified, as it is to help them by providing reimbursement  for a prior period in which they became qualified along the  way.  By setting reimbursement rates "that are not later  subject to retroactive correction," HHS contends, "the Secretary promotes certainty and predictability of payment for not  only hospitals but the federal government." HHS Br. at 41  (quoting County of Los Angeles, 192 F.3d at 1019).


35
Although we ordinarily would now proceed to evaluate  these various arguments under the standards of Chevron's  second step, we cannot do so in this case.  While the Secretary has discretion to establish a reasonable mechanism for  determining whether a hospital has the requisite average  length of inpatient stay, that discretion must be exercised  through the eyes of one who realizes she possesses it.  At  several points, the Department's briefs suggest that the  Secretary did realize that she had such discretion.10  At other  points, the briefs suggest quite the opposite.11  Most relevant, however, is that the notice issued at the time the final rule  was promulgated makes it quite clear the Secretary did not  believe that she had the discretion to do what the plaintiffs  request.  See, e.g., Final Rule, 57 Fed. Reg. at 39,800-01  ("We do not believe that the statute permits us to extend the  exclusion for long-term care hospitals to a hospital which has  not demonstrated actual compliance with the statutory requirement.") (emphasis added);  id. at 39,800 (declaring the  Secretary's doubt that "the law would support such a policy");id. at 39,801 ("[T]he [statutory] criterion for exclusion ... can  be assessed only over a period of time.  Thus, a hospital  cannot qualify as a long-term care hospital until it has been  in operation for some period of time.") (emphasis added).12


36
As the Supreme Court has instructed, an agency "order  may not stand if the agency has misconceived the law."  SEC  v. Chenery Corp., 318 U.S. 80, 94 (1943);  see Phillips Petroleum, 792 F.2d at 1169-70.  Applying that principle, this court  has held that "an agency regulation must be declared invalid,  even though the agency might be able to adopt the regulation  in the exercise of its discretion, if it was not based on the  [agency's] own judgment but rather on the unjustified assumption that it was Congress' judgment that such [a regulation is] desirable" or required.  Prill v. NLRB, 755 F.2d 941,  948 (D.C. Cir. 1985) (internal quotations omitted) (alterations  in original).  Because the Secretary evaluated the various  reimbursement alternatives on the assumption that "a hospital cannot qualify as a long-term care hospital until it has  been in operation for some period of time," Final Rule, 57  Fed. Reg. at 39,801, and because that assumption is incorrect, the Secretary must make a fresh determination as to whether  she wishes to adopt the self-certification or retroactive adjustment options.

IV

37
For the foregoing reasons, the judgment of the district  court is reversed.  The case is remanded to that court with  instructions to remand it to HHS for further consideration  consistent with this opinion.



Notes:


1
 The statute lists the following types of excluded hospitals:
(i) a psychiatric hospital (as defined in section 1395x(f) of this title),(ii) a rehabilitation hospital (as defined by the Secretary),(iii) a hospital whose inpatients are predominantly individuals under 18 years of age,(iv)(I) a hospital which has an average inpatient length of stay (as determined by the Secretary) of greater than 25days ......(v)(I) a hospital that the Secretary has classified ... for purposes of applying exceptions and adjustments to payment amounts under this subsection, as a hospital involved extensive-ly in treatment for or research on cancer....42 U.S.C. § 1395ww(d)(1)(B).


2
  The regulations permit hospitals that experience a change in  their average length of stay to establish exclusion eligibility by  having an average length of stay greater than 25 days for the  immediately preceding six month period.  See 42 C.F.R.  § 405.471(c)(5)(i), (c)(5)(ii)(B) (1983), now codified at 42 C.F.R.  § 412.23(e)(1), (e)(3)(ii).  According to HHS, a new hospital that  treats patients with an average length of stay greater than 25 days  "will always experience [a] change in length of stay because its  initial length of stay is zero inpatient days."  HHS Br. at 9 n.5.


3
  NALTH noted that HHS permits new rehabilitation hospitals  to self-certify that their inpatient populations meet the exclusion  criteria for that category.  See NALTH Ltr. at 1-2 (J.A. at 52-53);discussion infra Part III.


4
  Neither side makes an argument based on legislative history. The PPS exclusion was passed as part of a large bill enacting wholesale changes in the Medicare program, and specific references  to the long-term care exclusion occur only in general passages  explaining the need for a reasonable costs alternative to PPS for  certain types of hospitals.  See, e.g., H.R. Conf. Rep. No. 98-47, at  192-93 (1983);  S. Rep. No. 98-23, at 53-55 (1983);  H.R. Rep. No.  98-25, at 8-9, 141-42 (1983).


5
  Plaintiffs also proffer an argument they describe as based on  statutory purpose, contending that they are entitled to an exemption from their first day of operation because Congress' exclusion of  long-term care hospitals from PPS demonstrates its recognition  that PPS is an inadequate method for reimbursing such hospitals. But this simply begs the question discussed in the text:  were  plaintiffs' hospitals "long-term," within the meaning of the statute,  from that first day?


6
  Plaintiffs assert that Congress confirmed their reading of the  long-term care exclusion in its 1997 amendments to the Medicare  statute, which place payment limits on newly participating long term care hospitals.  Those amendments provide that:
in the case of a hospital or unit that is within a class of hospital described in subparagraph (B) which first receives payments under this section on or after October 1, 1997--
(i) for each of the first 2 cost reporting periods for which the hospital has a settled cost report, the amount of the payment with respect to operating costs ... [shall be] equal to the lesser of ... [the amount of operating costs or a national limit.]
42 U.S.C. § 1395ww(b)(7)(A).  Plaintiffs contend that this language  indicates that Congress intended newly participating long-term care  hospitals to receive reimbursement for reasonable costs from the  date of their first reporting period.  But as the Secretary points  out, this provision does not materially advance the analysis.  By its  terms, it applies only to a "subparagraph (B)" hospital.  A subparagraph (B) hospital, in turn, is defined as including a hospital that  comes within subsection (d)(1)(B)(iv)--the precise subsection that is  in dispute in this case.  See id. § 1395ww(b)(7)(B);  cf. Methodist  Hosp., 38 F.3d at 1231 (noting, in the context of the Medicare  statute, that "the views of a subsequent Congress form a hazardous  basis for inferring the intent of an earlier one") (internal quotation  omitted).


7
  As discussed in Part I above, outlier payments are a supplement to PPS reimbursement for hospitals with patients that stay  for unusually long periods.  See 42 C.F.R. §§ 412.80 et seq.


8
  The statute excludes from PPS "a rehabilitation hospital (as  defined by the Secretary)."  42 U.S.C. § 1395ww(d)(1)(B)(ii).  The  Secretary's implementing regulation defines such a hospital as one that, inter alia, serves an inpatient population of whom at least 75  percent require intensive rehabilitative services for the treatment of  specified conditions including stroke, spinal cord or brain injury,  major multiple trauma, and amputation.  See 42 C.F.R.  § 412.23(b)(2).


9
  Neither NALTH in its comments on the 1992 proposed rule,  nor the THC plaintiffs themselves in their 1992 request to HCFA,  proposed retroactive reimbursement.  See HHS Reply Br. at 14 n.7.


10
  See, e.g., HHS Br. at 25, 28.


11
  See, e.g., HHS Br. at 12 (stating that in promulgating 1992  regulations, "HHS concluded that a self-certification procedure for  long-term care hospitals would violate its statutory mandate");  id.  at 15 (stating that in rejecting THC plaintiffs' request for self certification, HCFA explained "that nothing in the statute or regulations would allow it to grant the hospitals an immediate exclusion  from the PPS").


12
  The Buto letter, although somewhat more equivocal, reflects  a similar understanding.  See Buto Ltr. at 2 (J.A. at 63) (denying  plaintiffs' request because statute mandates exclusion only for "a  hospital which has [emphasis added] an average length of stay (as  determined by the Secretary) of greater than 25 days") (alteration  and emphasis in original).


