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Legal Network News:
Life Insurance and Medi-Cal Eligibility

by Tim Millar, MBA, CFP

Certain assets provide specific planning difficulties in establishing eligibility for Medi-Cal. One of these problem assets is Life Insurance. The purpose of this article is to review the treatment and analysis of Life Insurance policies for Medi-Cal eligibility purposes and to discuss options for planning with this asset.

Policy Terms:

It is first important to understand some key terms and concepts in a Life Insurance policy.

  • Insured. The insured is the person whose death triggers the death benefits of a policy. The insured doses not necessarily own the policy or derive any rights or benefits of ownership.
  • Owner. The owner owns current rights in a life insurance policy. These usually include the right to the current cash value (see below) and the right to reassign ownership or change beneficiary.
  • Beneficiary(ies). The beneficiary of a life insurance policy becomes owner of the death benefit upon the death of the insured. The owner is also a beneficiary (of current benefits). The term beneficiary usually refers to beneficiaries at death.
  • Face Value or Death Benefit. This is the amount of money payable to beneficiaries on death of the insured. Only in limited circumstances, and in specific policies, may the death benefit be partially available prior to the death of the insured. (So called “living benefits”)
  • Cash Surrender Value. This is the value received by the owner if the policy is surrendered (cashed in) prior to death of the insured. Often the term Net Cash Surrender Value is used to reflect the value after reducing the Cash Surrender Value by any “Surrender Charges” or outstanding loans. Cash values cease to exist when the insured dies.
  • Surrender Charges. Most life insurance policies that provide a cash surrender value contain surrender charges. These are charges an owner must pay to surrender the policy. The size of these charges may vary greatly depending on the policy. Surrender charges usually disappear after the policy has been owned for a certain length of time specified in the policy.
  • Policy Loans. Policies with cash surrender values usually allow the owner to borrow cash value from the policy without forfeiting the underlying policy. Cash surrender values and death benefits are reduced by outstanding policy loans.
  • Non Forfeiture Rights. These are options available to the owner of a policy in lieu of allowing a policy to lapse for non-payment of premiums. They usually include the following rights:
  • Cash Surrender. The right to forfeit the policy for net cash surrender value, as discussed above.
  • Extended Term. The right to convert a policy into a term policy, with no cash value, a death benefit equal to the benefit provided in the underlying policy, and a limited life after which the policy will benefits will lapse.
  • Paid Up Insurance. The right to exchange one policy for another policy requiring no additional premiums, with a reduced or sometimes eliminated cash value, and a reduced death benefit.

Treatment under Medi-Cal:

The cash value of life insurance is usually a countable asset under Medi-Cal. There are two exceptions. The first is for small amounts of insurance. An applicant can exempt the cash value of insurance if the cumulative value of the death benefit of all policies is equal to or less than $1,500. Of course, it is unusual for an individual who owns insurance to own such a small amount of coverage. Apparently the exclusion is to allow the funding of burial costs with insurance.

If the cumulative value exceeds $1,500, then the insurance is counted and there is no exemption, not even for the first $1,500 of coverage.

It is important to note that the face value is used to determine if the insurance is exempt. However, the value of the insurance as a countable asset is the net cash surrender value.

The second exemption is for term insurance policies. Term insurance is insurance that accumulates no cash value. Instead, the premiums pay the actual cost of insurance and do not fund an accumulation account to defer the future cost of coverage.

All other policies owned by the applicant or spouse are countable for eligibility purposes.

Planning Strategies

There are several options for individuals who own life insurance policies that do not fall under one of the two exemptions.

1. Do Nothing.

The first option is to do nothing. The rules do not prohibit the ownership of life insurance, they just require that the net cash surrender value be counted as an available asset.

In some cases, particularly where the net value is low, including the policy as part of the property reserve or Community Spouse Resource Allowance (CSRA) is the best course of action.

2. Surrender the Policy.

This is the course of action that is likely to be recommended by Social Services. The policy can be turned back in to the insurance company in exchange for the net cash surrender value.

This value received would still be a countable asset of course. But by surrendering the policy you turn an illiquid asset into cash, which can then be used for immediate expenses, be spent down, or be sheltered in some other way.

The problem with this option is that it forces the applicant to forfeit the possibly much larger death benefit, which is why the policy was purchased in the first place, to receive only net accumulated cash. In addition, assuming the applicant is ill and is the insured on the policy, this forfeiture occurs just when the policy might be close to having to pay the death benefit. (Insurance companies must love this option.)

However, there are some situations where this is the best option. For some small policies or policies with relatively high premium, this may be the best option. Sometimes policy surrender is recommended where the proceeds are part of a transfer strategy.

In another common situation, the difference between the cash value and the death benefit is very small, and it would make more sense to free assets for other purposes, or better investments, than to hold on to the insurance. Remember, the cash value is forfeit when a death benefit is paid.

3. Take a Policy Loan.

Most cash value policies allow the owner to borrow part of the cash surrender value. These loans are usually at no net interest or very low interest. This allows the owner to reduce the countable value of the policy without having to terminate coverage and thus forfeit the death benefit. Medi-Cal counts the value net of surrender charges and outstanding policy loans.

This approach may also be preferable to surrendering the policy because it avoids any recognition of taxable gain, which could occur when a policy is surrendered.

The proceeds of the loan would be countable, but like a surrender, could be used for other purposes or sheltered in a different manner.

4. Exercise a Non-Forfeiture Option.

This approach relies on the fact that the net cash surrender value is the value used by Medi-Cal to value these assets.

There is no need to get rid of insurance and lose the death benefit. All that needs to be eliminated is the cash value. The ideal solution would be if you could make an election with the insurance company to retain the death benefit but forfeit the cash value. Unfortunately, this is not possible. But the non-forfeiture options may provide a close substitute.

The non-forfeiture options allow a policyholder to cancel their insurance without forfeiting all insurance value. The concept is this: Assume there is an insured who has paid premiums for a life insurance contract for many years. The insured ages, becomes ill, and for any number of reasons is unable to continue paying his premiums.

Without non-forfeiture provisions in the policy, the insured may be forced to surrender the policy, freeing the insurance company of their obligation to pay a death benefit. At this point in time the insured is uninsurable, and the fact that he regularly paid premiums while he was healthy does not protect him from this loss.

Non-forfeiture options allow him to retain some insurance value, even though premiums cannot be paid.

There are two options that work well for Medi-Cal planning purposes. The first is to exchange the policy for ?extended term insurance?, which as described above, has no cash value, but retains the full death benefit. The second is to exchange the policy for “paid-up” insurance.

Extended term is usually the best option since it retains the full death benefit without future premium payments. However, the viability of this option depends on how long the extended term is.

For example, if there was an 80 year old with a reasonable life expectancy of 3 years, and the company offered a 10 year extended term policy, then this might be seen by the client as an option with relatively low risk.

On the other hand, if the extended term offered is only 3 years, the risk of this approach may be too high. Remember, once the extended term has expired, there is no value left in the policy, and the owner and beneficiary will receive no payment form the insurance company.

Paid up insurance does not have this flaw. However, some paid up insurance still has some cash value which could complicate planning.

In either case, the first step is to evaluate the options in the policy.

A final warning when planning with life insurance: Many cash value policies lose their death benefit at the insured age of 100. At that point in time they revert to cash values which may be significantly lower than the benefit expected by the client. Few clients and even some agents are unaware of these provisions. In cases where the insured is nearing age 100, it is extremely important to evaluate non-forfeiture and other options available that might preserve the full policy benefit.

Tim Millar is a Financial Planner with Millar and Associates, in Fremont.

From the September 2000 Legal Network News

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