Tuesday, October 15, 2013

No. 3: Medicaid and Life Settlements

Recently Texas enacted a law--and other states are considering laws--allowing the owner of a life insurance policy to sell it in the secondary market and use the funds toward long-term care expenses. Also, the arrangement supposedly would increase the assets the individual could retain and still qualify for Medicaid, and supposedly would lessen the state's Medicaid costs. Here I discuss such laws.

The Nature of Life Settlements
A life settlement involves the sale of an existing life insurance policy to an investor who speculates on human life. A typical life settlement involves a policy with a death benefit of at least $1 million on the life of a person at least aged 70. 

Life settlements almost never involve traditional cash-value policies, because such policies contain substantial cash values and secondary market participants are not willing to risk the large amounts necessary to acquire such policies. That is why virtually all life settlements involve universal life policies with small cash values or term life policies with no cash values. 

The net purchase price paid to the policyholder must exceed the policy's cash value because otherwise the policyholder would surrender the policy to the insurance company. However, the net purchase price must be well below the policy's fair market value because of the compensation of intermediaries and other expenses associated with life settlements. 

Illusory Savings
The Texas law and other proposed laws are an example of efforts by life settlement promoters to win public acceptance. For several reasons, however, the purported advantages for consumers and states are illusory. First, the Texas law refers to policies of more than $10,000, but the typical candidate for Medicaid owns little or no life insurance. Second, even for those who own policies of more than $10,000, life settlements are not usually feasible because, as mentioned, life settlements typically involve policies of at least $1 million. Third, most small policies are traditional cash-value policies and, as mentioned, are almost never used in life settlements. 

Other Efforts
Another example of efforts by life settlement promoters to win public acceptance is their attempt to have states enact laws requiring life insurance companies to disclose to policyholders the option to enter into a life settlement. That effort is made despite the fact that very few policyholders are candidates for life settlements, as previously discussed. 

The effort by life settlement promoters to enact Medicaid life settlement laws is analogous to the effort by long-term care insurance companies to persuade states to promote private long-term care insurance. A few states have developed "partnership programs" under which states encourage citizens to buy private long-term care insurance. The programs provide that, when the policyholder receives policy benefits, the benefits received increase by that amount the assets the person can own and still qualify for Medicaid. However, the assets are increased only to the extent policy benefits are paid. If a claim is denied, there would be no increase in the assets the person can own and still qualify for Medicaid. In the programs in California and Indiana, for example, letters were written on the governors' stationery urging citizens to return a reply card. The programs are schemes by list developers who sell the respondents' names to insurance agents. 

The Texas law and similar proposals will not reduce state Medicaid costs. Nor will they help consumers. In the July 2008 and January 2012 issues of The Insurance Forum, I described the California and Indiana partnership programs. Also, in the July 2008 issue, I explained why the characteristics of the long-term care exposure make it impossible for private insurance to solve the serious problem of financing long-term care.