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.
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
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.
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
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
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
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,
From the September 2000 Legal Network
to LNN archives