Discouraging life settlements

Bill Boersma, at his niche blog On Life Insurance, comments on life settlements in life insurance contracts. This thoughtful piece brings up an issue for those who advise clients on personal planning issues. 

• Many people who have bought whole life or universal life policies years ago now find that it is difficult, as their financial condition has changed, to keep up with premium payments.
• They may find the need to make the hard decision to discontinue paying the premiums, and taking the current cash value of the policy. If they do so, however, they forfeit the death benefit under the policy, which will often be much higher than the cash value.
• They will often consult with the agent who sold them the policy about what their options may be.
• The agent may not tell them, and often is directly forbidden under his agency contract from informing them, that a life settlement is an option.

A life settlement (sometimes called a "viatical" settlement) is an agreement between an insurer and an insured to take an early buyout of the death benefit under the policy, in exchange for which the insurer receives a discount. This is often a very useful alternative for someone who has a terminal illness and pressing financial and medical needs as a result.

An example scenario: Jane Carter has a policy that she has held for the last 12 years, and for which she has paid nearly $250,000 in premiums over that time. The policy obligates the life insurer to pay a death benefit of $1 million to her three children. Unless the policy is paid up, where no further premium needs be paid, she still has to pay the annual premium of $16,500. This was feasible when she was working and earning $140,000 per year, but now she is retired and living on her social security and pension benefits.

Jane has been diagnosed with cancer and the prognosis is grave. She has perhaps 2-3 years to live. The medical expenses have been high, and she is strapped for cash. She does not think that she will be able to afford to pay the premium this year.

If approached, the life insurer may well be willing to negotiate an early life settlement, paying her perhaps $800,000 in satisfaction of her policy. This saves the company $200,000 off the death benefit and puts a significant sum of cash in Jane's hands. Both sides would see a significant gain as a result of such an agreement.

But if the agent she speaks with is not allowed to tell her about this option, she probably will not learn about it. The insurer would prefer that she default on the policy, take the cash value that has built up - maybe $100,000 or so - and go her own way. Her children, on her death, will receive only whatever is left of the cash value, if anything.

Boersma's piece notes a harsh reality: The agent represents the company, not the client, and his loyalties lie with the company. Someone who has a fiduciary responsibility to the client, such as an independent fee-based advisor or an attorney, has an obligation to advise her of the reasonable alternatives. The agent has no such responsibility.

Inherited IRAs not protected

The U.S. Supreme Court has ruled, in the case of Clark v. Rameker, that inherited IRAs cannot be protected in a bankruptcy filing. As a result, IRAs that have been inherited from a deceased worker (the "participant") are available as assets to pay creditors.

The opinion for a unanimous court, written by Justice Sotomayor, focuses on key differences between IRAs owned by the participant and inherited IRAs:

"Inherited IRAs do not operate like ordinary IRAs. Un­like with a traditional or Roth IRA, an individual may withdraw funds from an inherited IRA at any time, with­out paying a tax penalty. §72(t)(2)(A)(ii). Indeed, the owner of an inherited IRA not only may but must with­draw its funds: The owner must either withdraw the entire balance in the account within five years of the original owner’s death or take minimum distributions on an annual basis. . . And unlike with a traditional or Roth IRA, the owner of an inherited IRA may never make con­tributions to the account. 26 U. S. C. §219(d)(4)."

The code, she noted, does not define the term "retirement funds." Considering the ordinary meaning of the term (a Scalia-like endeavor, it would seem), it would mean funds set aside for the owner's retirement. Disregarding a particular owner's subjective intention, and focusing on the objective characteristics, she noted three factors:

"Three legal characteristics of inherited IRAs lead us to conclude that funds held in such accounts are not objec­tively set aside for the purpose of retirement. First, the holder of an inherited IRA may never invest additional money in the account. . .  

"Second, holders of inherited IRAs are required to with­ draw money from such accounts, no matter how many years they may be from retirement. . .  

"Finally, the holder of an inherited IRA may withdraw the entire balance of the account at any time—and for any purpose—without penalty. . . "

IRAs that are owned by the participant continue to be protected to the extent provided by Federal or state law. (Both must be considered under the Bankruptcy Code.) In Michigan, that law is MCL 600.5451-1-k. Qualified retirement plans, including 401-k plans, are exempted under MCL 600.5451-1-l and under provisions of Federal law.

The legal basis of the "no asset test" rule

We noted in our March 2 post that CMS's web-published materials announce that asset limits will not apply to disqualify persons newly eligible for Medicaid on the basis of their Modified Annual Gross Income - i.e., the "Obamacare" Medicaid expansion applicable in many but not all states. Michigan is included.

The legal basis for this position is the new 42 USC 1396a-e-14, added by the Affordable Care Act and effective January 2014, which includes as its subparagraph C:

(C) No assets test.—A State shall not apply any assets or resources test for purposes of determining eligibility for medical assistance under the State plan or under a waiver of the plan. 

The statute goes on to make exceptions under subparagraph D, however, for those who were previously eligible on other bases. Just to be clear, it also specifically exempts anyone over the age of 65. Thus, we will still have resource limits for those who wish to qualify for Medicaid coverage for nursing home care for the elderly.

(D) Exceptions.—
    (i) Individuals eligible because of other aid or assistance, elderly individuals, medically needy individuals, and individuals eligible for medicare cost-sharing.— 

Subparagraphs (A), (B), and (C) shall not apply to the determination of eligibility under the State plan or under a waiver for medical assistance for the following:
       (I) Individuals who are eligible for medical assistance under the State plan or under a waiver of the plan on a basis that does not require a determination of income by the State agency administering the State plan or waiver, including as a result of eligibility for, or receipt of, other Federal or State aid or assistance, individuals who are eligible on the basis of receiving (or being treated as if receiving) supplemental security income benefits under subchapter XVI, and individuals who are eligible as a result of being or being deemed to be a child in foster care under the responsibility of the State.
       (II) Individuals who have attained age 65.

Why use a lawyer?

"Why should I pay a couple hundred dollars to a lawyer when I can get this online form for $35?"

This is a fair question. A few recent examples will help to illustrate the answer.

• Clients came in with a will prepared by Quicken WillMaker. The first several pages of the will provided detailed instructions for their funeral services, how their bodies are to be handled, etc. I explained to them that this may be useful as their requests to their children, but that none of this is binding on anyone. In Michigan, decisions on the handling of a dead body are made by the next of kin, not by the personal representative of the estate.
• A quit-claim deed done years ago to transfer a cabin, using a form found at an office supply store, was ineffective because the grantor was a married man at the time, and his wife did not join in the deed. The fact that the man had been single and the only grantee when he acquired the land did not change that outcome.
• In a recent reported case coming out of Florida, Ann Aldrich created a will using an "EZ Will Form" in 2004. The form did not include a residuary clause, a provision directing what should happen with the remainder of the individual's property after specific bequests are made. As a result, after her death, her two nieces received a substantial sum of money, even though the rest of the will showed that her brother was her intended beneficiary.

The answer to the question: Yes, you can do it for $35, but you can do it right for a little more. A simple quit-claim deed done in our office may cost $100, for example. When your transaction involves property worth several thousands of dollars, spending what it takes to do it right makes much more sense.

Increase in estate tax exemption

The federal estate tax exemption will increase from $5,250,000 in 2013 to $5,340,000 in 2014. A single person who dies with less than that amount in taxable assets will not have a concern about Federal estate taxes.

The talk of the town

NPR does a story on Lacrosse, Wisconsin, “The Town Where Everyone Talks About Death.” About 96% of the residents of Lacrosse have executed advance directives; by comparison, about 30% of adults nationwide have done so. This is the result, the story says, of one man’s efforts to train nurses to begin the discussion with patients and their families well in advance of a serious illness.

In Michigan, a statute [MCL 700.5506] provides for a person to prepare and sign a Designation of Patient Advocate form to permit another person “to exercise powers concerning care, custody, and medical or mental health treatment decisions for the individual” when the need arises. Under section 5508, the patient advocate is authorized to act only if the person is unable to participate in medical decisions for himself.

The patient advocate form is essential for unmarried couples, same-sex couples, and others who do not wish to rely on their nearest relatives to make these decisions for them.

Another available document is the advance directive, sometimes known as a “living will.” This one is not based on a statutory provision, but rather is based on a Michigan Supreme Court decision that held that a family member may only request that extraordinary medical interventions be discontinued if there is “clear and convincing evidence” that this is what the patient wished. A writing signed by the patient, specifying when and how he does not want (and does want) such interventions is the clearest and most convincing evidence.

We normally recommend that both documents be prepared. The advance directive is an excellent reminder to the Patient Advocate of what the individual wants and does not want when the time comes to act. We also make available a special optional form of advance directive, for interested clients, to direct that these decisions be made in conformance with the teachings of the Catholic Church.

It is also important that these issues be discussed in advance, with all interested family members or others, so that the individual’s wishes are known.

CMS addresses issues for newly eligible Medicaid beneficiaries

If you have been following the Affordable Care Act, you know that Michigan is one of the states which elected to expand its Medicaid program, effective April 1, 2014. Previously, Medicaid coverage was available only to those who were poor enough to qualify and who met certain category requirements, the most prominent being pregnant women, children, the elderly and the disabled. A person between 18 and 55, not disabled, but just poor, did not qualify.

The ACA introduced a new concept of eligibility based on what it defines as the person's "Modified Annual Gross Income" or MAGI. If your household MAGI is under a specified level, essentially 138% of the current year's Federal Poverty Level, you can be eligible for Medicaid coverage. Importantly, the "MAGI individuals," as the Centers for Medicare and Medicaid Services (CMS) calls people newly eligible under these rules, are not subject to asset or resource limits. Formerly, a poor person who was in one of the permitted categories would be eligible only if he had less than $2,000 in countable assets. Under the MAGI criterion, a person can have thousands of dollars in the bank and still qualify for Medicaid as long as his MAGI is under the limit.

On February 21, 2014, Cindy Mann, Director of CMS, issued a letter to all of the state Medicaid agencies (PDF) addressing several questions that have arisen under this new program, as it concerns persons receiving Long-Term Supports and Services (LTSS) such as nursing home care. Few people will be eligible for LTSS under the MAGI criteria. The letter observes that "The vast majority of people in need of Medicaid-covered LTSS will qualify under eligibility categories related to age or disability." But for those who will become newly-eligible, some of the MAGI rules will be different from those that apply to persons eligible based on age and disability.

We can paraphrase the letter's conclusions as follows:

Estate recovery - States will not be able to assert claims for estate recovery for medical assistance paid to persons eligible only under MAGI, since they are regarded as exempt under the new law. States may continue to assert claims for estate recovery for those over the age of 55 for nursing home care, home-based community services, and some other benefits, as previously.

CMS has announced that it "intends" to eliminate or limit estate recovery for any benefits other than LTSS; just how it plans to put that intent into practice is not clear.

Asset transfers during a 5-year lookback period - will apply to MAGI individuals.

Annuities, promissory notes, life estate interests - will apply to MAGI individuals.

Special needs trusts - At least as they concern self-settled trusts, CMS considers that the current rules will apply to MAGI individuals. The letter is silent as to third party trusts.

Home equity limitations - As with other beneficiaries, MAGI individuals will only be able to exempt the first $543,000 to $810,000 of the value of the home. (Why CMS has arrived at this conclusion is unknown; it does not seem to be consistent with the "no asset test" stance of the new law.)

Post-eligibility income - CMS has determined that its regulations "as currently written" cannot be applied to MAGI individuals, but it is considering new regulations on this topic. It does believe that it has the authority to do so under the Medicaid statute.

For additional information:

• UC Berkeley's Labor Center's explanation of MAGI under the ACA (PDF)
• The eligibility levels publications at Medicaid.gov