By Brendan Pierson

Dec 11 (Reuters) - The U.S. Department of Health and Human Services overstepped its authority when it boosted Medicare reimbursements to hospitals in low-wage areas to help them recruit and retain staff, a divided federal appeals court ruled on Wednesday.

A 2-1 panel of the San Francisco-based 9th U.S. Circuit Court of Appeals found that HHS's 2020 policy shift ran afoul of the law governing Medicare, the federal health insurance program for seniors and some people with disabilities.

The decision was a victory for a group of 53 California hospitals that sued HHS in 2020 in Los Angeles federal court, saying their Medicare reimbursements were cut by a total of about $3.8 million to make up for the increased payments to hospitals in low-wage areas.

HHS said earlier this year that it would not continue the policy in 2025, meaning that Wednesday's decision will affect only reimbursements for past years going back to 2020.

Lloyd Bookman, a lawyer for the hospitals, said he and his clients were pleased by the ruling.

"Quite simply, the policy that the 9th Circuit found unlawful today was an improper attempt of $(HHS)$ to 'rob Peter to pay Paul,' which the court properly rejected," he said in an email.

HHS did not immediately respond to a request for comment.

Medicare reimbursement rates to hospitals are adjusted based on the prevailing wage in the regions where the hospitals operate, with hospitals in lower-wage areas receiving lower reimbursements.

The 2020 policy was meant to address concerns that lower reimbursements prevented hospital in lower-wage, often rural areas from offering competitive pay. HHS modified its formula to increase reimbursements for the 25% of hospitals with the lowest regional wages, and reduced reimbursements by about 0.2% overall to make the measure budget-neutral.

The hospitals said in their lawsuit that the policy violated the Medicare law's requirement that reimbursements "reflect" regional wages. U.S. District Judge Consuelo Marshall agreed, but sent the issue back to HHS for further review rather than vacating it.

Circuit Judge Kenneth Lee, who was appointed to the court by Republican President-elect Donald Trump in his first term, on Wednesday said that Marshall should have vacated the policy, since it clearly ran afoul of the law.

"No one would say that a grocery receipt 'reflects' the price of groceries if the store gives, say, a 13.6% discount to shoppers in the lowest quartile by income," he wrote.

HHS's interpretation of the law "cannot be so elastic as to smuggle in a costly policy goal not authorized by the statutory provision — no matter how worthwhile that goal may be," Lee wrote.

Lee was joined by Senior Circuit Judge Danny Boggs, visiting from the 6th U.S Circuit Court of Appeals, who was appointed by Republican former President Ronald Reagan.

Circuit Judge Jacqueline Nguyen, who was appointed by Democratic former President Barack Obama, dissented, saying that "reflect" did not have to mean a specific mathematical relationship and that the court's ruling "improperly constrains the agency's ability to address a serious structural problem, with dire consequences for the rural communities that will lose access to health care."

"Just because in this Loper Bright new world we are free to ignore an agency's statutory interpretation doesn't mean that we should," she wrote, referring to the U.S. Supreme Court's June ruling in Loper Bright Enterprises v. Raimondo holding that courts need not defer to agencies' interpretations of ambiguous statutes.

The case is Kaweah Delta Health Care District v. Becerra, 9th U.S. Circuit Court of Appeals, No. 23-55157.

For the hospitals: Lloyd Bookman of Hooper Lundy & Bookman

For the government: Brian Peters of the U.S. Department of Justice

(Reporting By Brendan Pierson in New York)