How to Use Community

Spouse Annuities

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Using Annuities Under the Deficit Reduction Act

Written By: Attorney Jeffrey A. Marshall, CELA[1]

This article was originally published in the Winter 2007 edition of the Elder Law Section Newsletter of the Pennsylvania Bar Association

Medicaid Implications of Immediate Annuities[2]

Immediate annuities have long been utilized to protect the financial security of retirees. A commercial immediate annuity is purchased from an insurance company. The investor pays a sum of money to the insurance company. In return, the insurance company agrees to provide payments to the investor over a stated period of time.

There are many variations of annuity investments. With an immediate annuity the insurance company begins to make the contracted payments immediately.[3] An immediate annuity can provide a retiree with the security of a guaranteed income for a term of years or for life. Lifetime guaranteed income is an attractive option not available with most non-annuity investments.

Immediate annuities can have an extra benefit for the community spouse of an individual who needs long-term care. For purposes of Medicaid eligibility, a married couple's countable resources are pooled and excess resources are at risk. However, the income of the community spouse is protected.[4] A community spouse can retain his or her income without affecting the Medicaid eligibility of the institutionalized spouse.

An immediate annuity converts a cash sum into a guaranteed stream of payments. Such payments have traditionally been treated as income under Medicaid law. As a result, the purchase of an immediate annuity can convert an otherwise countable resource (cash) into a non-countable stream of payments for a community spouse.

But what if there were a potential buyer for the stream of payments being received by the community spouse? Can a state Medicaid agency force a community spouse to turn the promise of future income payments into a countable resource?

James v. Richman

The issue of whether the future payment stream of an immediate annuity can be a countable resource was decided recently in a Pennsylvania case. In the first federal court decision on the issue, the Federal District Court for the Middle District of Pennsylvania has permanently enjoined Pennsylvania from treating an actuarially sound, irrevocable, non-assignable immediate annuity as a resource of the community spouse. Robert A. James v. Estelle B. Richman, United States District Court for the Middle District of Pennsylvania, Civil Action No. 3 :05-CV-2647 (November 21, 2006).[5]

When Robert James entered a nursing home, his wife, Josephine, had investments that were in excess of her allowed community spouse resource allowance. To spend down to the eligibility level, Mrs. James purchased an actuarially sound immediate annuity. The annuity was irrevocable, non-assignable and had no cash value. Mrs. James annuity was similar to the annuity which was involved in an earlier Pennsylvania case, Mertz v. Houstoun, 155 F.Supp.2d 415 (E.D. Pa. 2001).

When Mr. James thereafter applied for Medicaid benefits, his application was denied by the Luzerne County Assistance office. The denial notice specified that the immediate annuity owned by the community spouse was a countable asset – which meant the couple still had excess resources. Mr. James, represented by PBA Elder Law Section members Matthew Parker and Kevin Grebas, of Marshall, Parker & Associates, filed an action in Federal Court which challenged the denial as being in violation of pre-emptive federal Medicaid law.

In support of its denial of benefits, the Department of Public Welfare (DPW) took the position that the annuity was a countable resource because Mrs. James could sell the future payment stream of the annuity. It offered an affidavit from an officer of J.G. Wentworth Company stating that Wentworth would buy the community spouse's rights to the annuity's income payments. Thus, argued DPW, the annuity payments constituted a countable resource.

[P]laintiff's wife has the power to liquidate her interest in the income stream produced by the annuity. As the declaration of Michael B. Goodman shows, there is a market for such annuity payments, and J.G. Wentworth is willing to purchase Josephine's interest for approximately $185,000. The proceeds of the purchase could then be used to pay for Robert's nursing care without impoverishing Josephine. Because the annuity has a market value, it is a countable resource for determining Medicaid eligibility.[6]

On November 20th, the Court rejected DPW's arguments and permanently enjoined it from denying Medicaid benefits to Mr. James. Judge Caputo explained the Court's ruling as follows:

Defendant [DPW] essentially argues that, even if the income stream itself cannot be considered for purposes of determining Medicaid eligibility, the market value of that income stream should be a countable resource to preclude eligibility. Such a rule would completely undermine federal law, which excludes income of the community spouse from factoring into the institutionalized spouse's Medicaid eligibility. Indeed, a holding that the market value of an income stream derived from an irrevocable actuarially sound annuity is a countable resource would effectively contravene the MCCA [Medicare Catastrophic Coverage Act of 1988[7]], which provides that "no income of the community spouse shall be deemed available to the institutionalized spouse." 42 U.S.C. § 1396r-5(b)(1). To be sure, Defendant's argument blurs the distinction drawn by the MCCA between assets and income.

Rather, so long as the principal or corpus of an irrevocable annuity or trust cannot be reached by the applicant or spouse, the income derived from such an asset cannot be counted as a resource for Medicaid purposes, notwithstanding that income stream's market value in the eyes of a third party.[8]

Thus, DPW has lost this latest skirmish in its long war on spousal annuities.[9] Pennsylvania and some other State Medicaid agencies see the ability of a community spouse to protect his or her financial security through the purchase of an actuarially sound immediate annuity as a loophole in federal Medicaid law.[10] If so, it is a loophole that Congress has continually refused to close.[11]

A cynic might suggest that the Congressional attitude towards Medicaid annuities is rooted more in the power of the insurance lobby in Washington than in concern for the financial plight of middle class community spouses. Whatever its motivation, Congress has continued the special treatment of annuities in the Deficit Reduction Act of 2005 (DRA).[12]

The Impact of James v. Richman on Post-DRA Annuities

Mrs. James purchased her annuity prior to the enactment of the DRA. Did the DRA change the prior law's mandate that annuity payments of this type be treated as income rather than resource? Or is Judge Caputo's reasoning in James v. Richman equally applicable to annuities purchased post-DRA?

The DRA made only limited changes to the annuity rules:

(1) It changes the rules regarding when an annuity purchase or modification is to be treated as a transfer for less than fair value and codifies these transfer rules.[13]

(2) It requires that the state be named as remainder beneficiary (subject to the preferred interest of the community spouse and minor and disabled children) to the extent of benefits paid. [14]

(3) It requires that applicants for Medicaid funded long-term care disclose their interest in annuities.[15]

However, Congress made no change in the treatment of annuities for purposes of the MCCA income and resource rules. It is this distinction that is at the heart of the ruling in James.

Even though a Medicaid applicant and spouse comply with the three new DRA annuity requirements, the annuity is still to be considered under MCCA income and resource rules in making eligibility determinations. In the section which establishes the disclosure requirements, the DRA provides that "[n]othing in this subsection [the disclosure subsection] shall be construed as preventing a State from denying eligibility for medical assistance for an individual based on the income or resources derived from an annuity described in paragraph (1)."[16]

This provision is explained by CMS in a DRA guidance letter to State Medicaid Directors: "In other words, even if an annuity is not subject to penalty under the provisions of the DRA, this does not mean that it is excluded as income or resource." [17]

Thus, the DRA does nothing to change the pre-existing spousal income and resource rules. Whether or not an annuity is compliant with the new DRA requirements should have no effect on the annuity's treatment for purposes of the spousal income/resource rules. The ruling in James should be equally applicable to post-DRA annuities.

Indeed, in James, both parties agreed that the DRA did not change prior law regarding the income/resource treatment of annuities. As noted by DPW in its brief in opposition to the motion for summary judgment:

Section 6012(a) of the DRA, codified at 42 U.S.C. §1396p (e) (4), expressly states that '[n]othing in this subsection shall be construed as preventing a State from denying eligibility for medical assistance for an individual based on the income or resources derived from an annuity described in paragraph (1) [requiring disclosure on an application for Medical Assistance of a description of any interest the individual or community spouse has in an annuity].' Clearly, as shown by this language, Congress in passing the DRA did not intend to change the way annuities should be treated to determine whether they are available resources.[18] [emphasis added]

Since "Congress in passing the DRA did not intend to change the way annuities should be treated to determine whether they are available resources" the reasoning and decision of Judge Caputo in James should be fully applicable to post-DRA annuities.

The DPW Draft Operations Memorandum on Annuities

DPW has not yet acquiesced in the District Court’s decision in James. The Commonwealth has filed a notice of its intent to appeal Judge Caputo's order to the 3rd Circuit Court of Appeals.

In addition, in December, DPW issued a draft Operations Memo (the "Memo") which sets out its proposed treatment of annuities under the DRA.[19] The Memo takes the position that, depending on the overall income of the community spouse, a DRA compliant non-qualified annuity may be treated as either an available resource or as income:

The CAO will review the non-qualified annuity owned by the CS that meets all the [DRA Compliant] requirements above to determine whether to treat the annuity as a resource or as income.

A non-qualified annuity that meets the requirements above and provides the CS with monthly income that, when combined with all other available income to the CS, exceeds the Community Spouse Monthly Maintenance Needs Allowance (CSMMNA), shall be treated as an available resource. . . .

A non-qualified annuity that meets the requirements above and provides the CS with monthly income that, when combined with all other available income to the CS, is equal to or less than CSMMNA, shall be treated as income.[20]

In effect, the Department appears to be establishing a new Hurly-type methodology. A community spouse can protect excess resources by purchasing a DRA compliant annuity that takes her income up to her Community Spouse Monthly Maintenance Needs allowance. Any excess over that amount is a resource that must be spent down.

The Department's approach is understandable, and to some extent perhaps even laudable, in that it may allow a low income community spouse to preserve extra resources. Unfortunately, the approach appears to be in conflict with both state and federal law.

The Memo Conflicts with Federal Law.

The Memo conflicts with Federal law in at least two areas:

(1) In its attempt to provide support for its argument that a DRA compliant annuity can have a marketable value, the Memo states that an annuity owned by a Medicaid applicant or spouse cannot be non-assignable. Any non-assignability provision in an annuity contract is void.

"As a condition of eligibility for medical assistance, any provision in an annuity or similar contract for the payment of money owned by an applicant, recipient or spouse of an applicant or recipient, limiting the right to sell, transfer or assign the right to receive payments or restricting the right to change the beneficiary is void. It will be presumed that any annuity or similar contract to receive money is marketable without undue hardship."[21]

Yet, the Memo then states, in accordance with the DRA, that an annuity will be considered to be a transfer of assets unless it is non-assignable.[22] In other words, if the DPW Memo is correct, it is impossible to comply with the federal requirements of 42 U.S.C. '1396p(c)(1)(G).

If there is a conflict between Federal and State Medicaid law, such that it is impossible to comply with both, the state law is pre-empted.[23] This would appear to be the case with the Annuity Operations Memo and with those portions of Act 42 that void non-assignability provisions in annuities.[24]

(2) By treating a DRA compliant annuity as a resource depending on the total income of the community spouse, the Memo also conflicts with the MCCA distinction between resources and income as noted by the court in James

The Memo Conflicts with State Law.

There is also no support in state law for the Memo's resource/income distinction. It appears to violate the mandatory requirements of Section 441.7 of Act 42. [25]

Section 441.7. Income for the Community Spouse.--(a) When a community spouse has income below the monthly maintenance needs allowance as determined under the department's regulations and Title XIX of the Social Security Act (49 Stat. 620, 42 U.S.C. §1396 et seq.), the institutionalized spouse may transfer additional resources to the community spouse only in accordance with this section.
Section 441.7 then sets up an intricate system for determining the total excess resources the community spouse may retain. The Department’s income/resource differentiation based on the CSMMNA differs from the methodology required by Section 441.7.

Planning Opportunities

The Department's Draft Operations Memo on Annuities appears to be inconsistent with both federal and state law. It is being promulgated by DPW without compliance with Commonwealth Documents Law.[26] As a result of these deficiencies, court challenge is likely.

This means that Elder Law Attorneys and their clients currently have at least two potential responses to the DPW Memo: (1) disregard it, or (2) comply with it.

Even if the attorney and client decide that compliance is the appropriate course, the Memo provides planning opportunities through the purchase of annuities.

(1) A community spouse (CS) may purchase a DRA compliant annuity with the CS as annuitant. Because it is DRA compliant, the purchase does not create a transfer penalty. To the extent that the CS income, including the annuity payments, does not exceed the CSMMNA, the annuity will not be treated as a resource. In effect, this provision is similar to the original Hurly agreement, except that the CS actually has to purchase an annuity that is DRA compliant. This is a substantial improvement over the modified Hurly rules of Act 42.

(2) If there are still excess resources, the institutionalized spouse (IS) may also purchase a DRA compliant annuity with the IS as annuitant and the CS as beneficiary. Because it is DRA compliant, the purchase will not be treated as a transfer, and the annuity payments should be treated as income and paid for the IS care.

It appears that, even under the Memo, all of a married couple's excess resource can be spent down using DRA compliant annuities, resulting in immediate Medicaid eligibility for the IS.

Obviously, the amount of ultimate savings will depend on many variables. But, it appears that almost any community spouse with excess resources should be able to improve her financial security of through the use of DRA compliant annuities.

It is likely that the Departments overly restrictive annuity provisions will be subject to court challenge. In the meantime, the DPW Annuity Operations Memorandum provides attractive opportunities for cautious elder law attorneys to use annuities to accelerate an institutionalized spouse's qualification for Medicaid and preserve the financial security of the community spouse.


[1] *Copyright, 2007 by Jeffrey A. Marshall. Mr. Marshall is certified as an Elder Law Attorney by the National Elder Law Foundation. He is managing attorney of Marshall, Parker & Associates, LLC and a member of the PBA Elder Law Section Council. Attorney Marshall received his law degree from Stanford University in 1972. His free newsletter "The Elder Care Law Alert" is available through his website, www.paelderlaw.com. He can be contacted at webmail@paelderlaw.com.

[2] Disclosure of interests: The author is a shareholder in a company, Pennsylvania Care Management, Inc. that assists Pennsylvania attorneys in the purchase of Medicaid annuities for their clients. See www.paannuity.com. The author's law firm represents the plaintiff in James v. Richman. The views expressed in this article are solely the personal views of the author.

[3] Another common form of annuity is the "deferred annuity." With a deferred annuity earnings are accumulated for a time before payments begin.

[4] 42 U.S.C. § 1396r-5(c)(1)(A) and 42 U.S.C. § 1396r-5(d)(1)(B).

[5] A copy of the Court's memorandum and order in James is available online at www.paannuity.com.

[6] Defendant [DPW's] Brief in Opposition (filed 08/10/2006 ), pp 3-4.

[7] 102 Stat. 754 (the Omnibus Reconciliation Act of 1988), 42 U.S.C. ß 1396r-5, amending Title XIX of the Social Security Act. MCCA established the spousal impoverishment provisions including the treatment of resources and income.

[8] Memorandum and Order (filed 11/21/2006 ), p 17.

[9] Compare Bird v. DPW, 731 A.2d 660 (Pa.Cmwlth. 1999), and Dempsey v. DPW, 756 A.2d 90 (Pa.Cmwlth. 2000), with Mertz v. Houstoun, 155 F.supp.2d 415 (E.D.Pa. 2001). The Department has filed a notice of appeal of the District Court decision.

[10] See, "The Role of Annuities in Medicaid Financial Planning: A Survey of State Medicaid Agencies", National Association of State Medicaid Directors, October 2003.

[11] As early as 1991, Christine Nye, director of the Health Care Financing Administration, identified the treatment of annuities as a loophole that only Congress could close. Ms. Nye stated, "If the annuity is actuarially equal in value to the transferred resource, the transfer would be one in which fair market value is received and no penalty would be imposed. If not equal, the penalty under section 1917 for failure to receive fair market value would be applied, that is, to deny payment for institutional services for a prescribed period of time. . . . While this is a big policy loophole, we see no way to close it absent legislation." Letter to Regional Administrator, Region 4, Atlanta , January 24, 1991 .

[12] The Deficit Reduction Act of 2005; P.L. 109-171. The annuity provisions, as modified by the Amended by the Deficit Reduction Act of 2005 and the Tax Relief and Health Care Act of 2006, are located at 42 U.S.C. '1396p(c)&(e).

[13] 42 U.S.C. '1396p(c)(1)(G)

[14] 42 U.S.C. '1396p(c)(1)(F)

[15] 42 U.S.C. '1396p(e)(1)

[16] DRA § 6012(a); amended 42 U.S.C. §1396p(e)(4).

[17] CMS, State Medicaid Director letter, dated July 27, 2006 , Enclosure to Section 6012, Section I.D. available at http://www.paelderlaw.com/pdf/cms_transfer_of_assets.pdf. The Centers for Medicare and Medicaid Services (CMS) is the federal agency charged with implementing the DRA’s Medicaid provisions.

[18] Defendant [DPW’s] Brief in Opposition (filed 08/10/2006 ), p 6.

[19] DPW's Draft Operations Memos are available to Elder Law Section members in member's area of the Pennsylvania Bar Association's website. To get the memos, go to the PBA website (http://www.pa-bar.org), and logon to get to the Member's Area, then go to Committees/Sections, then select Sections, then select Elder Law Section , then click the link to the OPS Memos.

[20] DPW undated Operations Memo "Annuities," page 5.

[21] DPW undated Operations Memo "Annuities," page 2. This statement is supported by existing Pennsylvania law under Act 42. See 62 PA. STAT. ANN. § 441.6 (b). In this regard, Act 42 is also in conflict with mandatory federal Medicaid requirements.

[22] DPW undated Operations Memo "Annuities," page 2.

[23] Under the Medicaid Act, 42 U.S.C. § 1396 et seq., and under the Supremacy Clause of the United States Constitution, U.S. CONST. art. VI, cl. 2.

[24] See 62 PA. STAT. ANN. § 441.6 (b) "Any provisions in an annuity owned by an applicant or spouse of an applicant that has the effect of limiting the right of such owner to sell, transfer or assign the right to receive payments thereunder, or restricts the right to change the designated beneficiary thereunder, is void."

[25] 62 PA. STAT. ANN. § 441.7 (a)

[26] See, Eastwood Nursing and Rehabilitation Center v. DPW 910 A.2d 134 (Pa.Cmwlth 2006) and Newport Homes, Inc et al v. PennDot, 332 A.2d 568 (Pa. Cmwlth 1975).



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