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Federal Third Circuit Upholds Use of Annuity to Protect Community Spouse

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

November 13, 2008

In a notable decision, the Federal Third Circuit Court of Appeals has upheld the purchase of an annuity by a community spouse that converts excess resources into protected income. The Court's opinion in the case of James v. Richman, issued on November 12th, is available online at http://www.paelderlaw.com/pdf/JamesThirdCircuitOpinion.pdf

The community spouse was represented by PCM President, Matthew J. Parker who is a principal of Marshall, Parker & Associates, a Northcentral and Northeastern Pennsylvania elder law firm with offices in Williamsport, Wilkes-Barre, Scranton and Jersey Shore (www.paelderlaw.com).

When her husband entered a nursing home in August 2005, Josephine James purchased a $250,000 single premium immediate irrevocable annuity. The actuarially sound annuity included an endorsement that "[t]his Contract may not be surrendered, transferred, collaterally assigned, or returned for a return of the premium paid. This Contract is irrevocable and has no cash surrender value. An Owner may not amend this Contract or change any designation under this Contract."

The purchase of the annuity, combined with the purchase of an automobile, reduced the couples' resources to within Medicaid resource eligibility limits. But, when Mr. James subsequently applied for Medicaid his application was denied. The Pennsylvania Department of Public Welfare (DPW) took the position that Mrs. James $250,000 annuity was an available resource which put the couple over the resource limits. In the Department's view, the annuity had a value of $185,000. In support of its position, DPW eventually produced a declaration from a finance company which expressed interest in purchasing the payments from Mrs. James' annuity for $185,000.

The Third Circuit's opinion was written by Senior Judge Jane Roth and joined by Chief Judge Anthony Scirica.[2] The central issue of the case is whether a state Medicaid agency can treat a non-revocable, non-transferrable annuity as an available resource for purposes of calculating Medicaid eligibility. Or, in the alternative, can the state agency treat the steam of payments which the community spouse will ultimately receive from the annuity as an available resource.

Could DPW treat the annuity as a resource?

The Court relied on Medicaid law and SSI (Supplemental Security Income) Program regulations to find that DPW could not treat Mrs. James annuity as an available resource. It held that in determining whether an annuity may be treated as a resource a state cannot use a methodology that is more restrictive than that used by SSI. Under 42 U.S.C. § 1396a(a)(10)(C)(i)(III) "the Department can not treat as available resources any assets that the SSI regulations would not treat as available resources." [Opinion, page 10].

Judge Roth noted that the SSI regulations provide that "if an individual has the right, authority or power to liquidate the property, or his or her share of the property, it is considered a[n] (available) resource." 20 C.F.R. § 416.1201(a)(1). The SSI Program Operations Manual System (POMS) makes it clear that the "power to liquidate" referred to by the regulation is not simply the de facto ability to accomplish a change in ownership of an asset, but must also include the power to do so without incurring legal liability. See, POMS SI 01110.115. Since, Mrs. James lacks the legal power to change ownership in her annuity without breaching the annuity contract the annuity cannot be treated as an available resource.

Could DPW treat the payments to be received from the annuity as a resource of the community spouse?

DPW's somewhat novel argument in James was that Mrs. James right to receive income from the annuity could be sold by her and thus could be treated as an available resource. In rejecting this theory Judge Roth noted that "[t]here is no statutory basis for such a theory and, indeed, adopting it would tend to undermine the MCCA rule that 'no income of the community spouse shall be deemed available to the institutionalized spouse.' 42 U.S.C. §1396r-5(b)(1). Under such a theory, there is no clear limit on the hypothetical transaction proceeds that could be treated as assets, whether based on the sale of a future stream of payments tied to a fixed income retirement account, social security, or even a regular paycheck." [Opinion, pages 11-12].

Judge Roth also rejected DPW's argument that the court should look to the underlying purpose of Medicaid rather than relying merely on the words of the federal statute. The courts "do not create rules based on our own sense of the ultimate purpose of the law being interpreted, but rather seek to implement the purpose of Congress as expressed in the text of the statutes it passed. [A]n irrevocable, non-alienable annuity does not fit the statutory definition of an available resource." [Opinion, page 12]

It should be noted that the James annuity was purchased prior to the Deficit Reduction Act (DRA).[3] In a post DRA case, Weatherbee v. Richman, USDC Western District of Pennsylvania, No1:07-cv-00134, DPW has taken the position that a provision in the DRA has given states the authority to effectively void the spousal income protections of 42 U.S.C. §1396r-5(b)(1) as applied to annuities.[4] This reading of the section seems strained and appears to be at odds with CMS's interpretation of this section.[5] Given the Court's opinion in James, it seems increasingly unlikely that DPW will prevail in Weatherbee. In any event, post DRA spousal annuities do have to comply with the DRA transfer and remainder beneficiary rules set out in 42 U.S.C. § 1396p(c)(1)(G) and 42 U.S.C. § 1396p(c)(1)(F).


[1] Certified as an Elder Law Attorney by the National Elder Law Foundation. Mr. Marshall is Managing Attorney of the Marshall, Parker & Associates. He can be contacted through the firm's website at www.paelderlaw.com.

[2] The third member of the panel, Judge Michael Fisher, would have remanded the case to the District Court for further fact finding relevant to the annuity’s marketability.

[3] Deficit Reduction Act of 2005 (DRA) (Pub.L.109-171).

[4] Section 6012(a) of the DRA added a new section 1917(e) to the Social Security Act. Section 1917(e)(1), codified at 42 U.S.C. § 1396p(e)(4), 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)." Paragraph 1 is the DRA section that requires disclosure on an application for Medical Assistance of a description of any interest the individual or community spouse has in an annuity.

[5] Contrary to DPW's interpretation, CMS appears to interpret § 1396p(e)(4) to mean that the transfer of asset provisions of the DRA do not change the resource and income aspects of an annuity. "The State may take into consideration the income or resources derived from an annuity when determining eligibility for medical assistance or the extent of the State's obligations for such assistance. This means that even though an annuity is not penalized as a transfer for less than fair market value (see II. Evaluation and Treatment of Purchases of Annuities and Certain Transactions On or After February 8, 2006 below for further information about treating the purchase of an annuity as a transfer of assets), it must still be considered in determining eligibility, including spousal income and resources, and in the post-eligibility calculation, as appropriate. 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." CMS State Medicaid Director Letter, SMDL # 06-018, July 27, 2006, available online at http://www.paannuity.com/pdf/cms_transfer_of_assets.pdf


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