Preserving Public Benefits in Physical Injury Settlements: Special Needs Trusts and Beyond

 

By, John J. Campbell, CELA, MSCC

 

Introduction

 

            The primary goal of disability and long term care planning in the context of physical injury (PI) settlements and worker’s compensation (WC) settlements is to preserve eligibility for all available and appropriate governmental benefit programs, including Supplemental Security Income (SSI), Medicaid and Medicare. Typically, Medicaid and Medicare eligibility are the first considerations because the need to ensure adequate medical care is paramount. However, SSI is also an important benefit program that can provide much needed additional income, and sometimes more, to those who qualify.

 

            The eligibility criteria for entitlement programs, such as Medicare are vastly different from those for financial needs based benefit programs, such as SSI or Medicaid.  There may be government claims or liens that must be satisfied from settlement proceeds to ensure continued benefit eligibility.  Finally, there may be tax issues and benefit eligibility issues that arise due to the manner in which the settlement will be paid or funded.

 

In complex cases where plaintiffs may need to achieve or maintain eligibility for multiple public benefit programs, it is essential to employ a holistic approach to public benefit planning to ensure that the receipt of settlement proceeds will not foreclose the plaintiff’s ability to access all public benefit programs for which the plaintiff may need to qualify.

 

Special Needs Trusts

 

            There are many PI and WC settlements in which the plaintiff, as the result of disability, may qualify for Social Security Disability Insurance Benefits (DIB) and, as a result, also qualify for Medicare.  However, the severity of the plaintiff’s disabilities may require significant attendant or custodial care in the future.  Since attendant and custodial care expenses will not be covered by Medicare, the plaintiff will need to preserve the ability to qualify for Medicaid.  In addition, the plaintiff may only receive a limited monthly DIB benefit and may wish to qualify for SSI as well to supplement monthly income.  There are those cases, too, in which the plaintiff might currently rely on Medicaid or SSI, in addition to Medicare and DIB, to meet ongoing needs for both support and medical care.

 

            If the plaintiff is over age 65, there is little, other than traditional Medicaid or SSI planning, which can be done to preserve eligibility for those financial needs based benefits.  However, when a plaintiff is disabled and under age 65, a Special Needs Trust may permit the plaintiff to maintain Medicaid and SSI eligibility, while preserving the proceeds of the settlement to provide for items or services not provided under available public benefit programs.

 

Special Needs Trusts and Pooled Trusts

 

Medicaid Special Needs Trusts and Pooled Trusts under OBRA '93

 

            The Omnibus Budget Reconciliation Act of 1993 (OBRA `93) established new Medicaid rules for treatment of both revocable and irrevocable trusts created after August 10, 1993.  These rules are codified under federal law at 42 U.S.C. §1396p(d).

 

            The general rule, as set forth in 42 U.S.C. §1396p(d)(3), is that, in determining an individual's eligibility for Medicaid benefits, trusts "established by such individual" (sometimes called "self-settled trusts") will be included in income or available resources.  A trust is "established by such individual" if the individual's assets form all or part of the corpus of a non-testamentary trust settled by the individual, his or her spouse, or a third person with legal authority to act for the individual or the spouse, or who is acting at the direction or request of the individual or the spouse.[1]  In short, a trust created with the Medicaid applicant's funds generally cannot be used to keep the applicant under the income or available resource ceilings for Medicaid eligibility.

 

            If a self-settled trust is revocable, its corpus is included in the individual's available resources.[2]  Payments from the trust to or for the individual's benefit are included in his or her income.[3]  If the trust is irrevocable, any portion of the trust corpus from which a payment could be made to the individual under any circumstances is included as an available resource.[4]  And, of course, any payment to the individual from the trust is included in his or her income.[5] Any portion of the trust corpus that could not be made available to the individual and any payment to another person from the trust are considered to be transfers without fair consideration, resulting in a period of ineligibility.[6]

 

            The rather uncharitable provisions of §1396p(d)(3) are ameliorated somewhat by the exceptions contained in §1396p(d)(4) (the "(d)(4) exceptions").  Under the (d)(4) exceptions, the treatment otherwise accorded to self-settled trusts does not apply to Special Needs Trusts:

 

“(A) A trust containing the assets of an individual under age 65 who is disabled (as defined in §1382c(a)(3) of the Social Security Act) and which is established for the benefit of such individual by a parent, grandparent, legal guardian of the individual, or a court if the State will receive all amounts remaining in the trust upon the death of such individual up to an amount equal to the total medical assistance paid on behalf of the individual by the state;” [7]

 

nor to “Pooled Trusts:

 

“(C) A trust containing the assets of an individual who is disabled (as defined in §1382c(a)(3) of the Social Security Act) that meets the following conditions: (i) The trust is established and managed by a non-profit association; (ii) A separate account is maintained for each beneficiary of the trust, but, for purposes of investment and management of funds, the trust pools these accounts; (iii) Accounts in the trust are established solely for the benefit of individuals by the individual, by the individual’s parent, grandparent, or legal guardian, or by a court; and (iv) To the extent that amounts remaining in the beneficiary's account upon the death of the beneficiary are not retained by the trust, the trust pays to the State from such remaining amounts in the account an amount equal to the total amount of medical assistance paid on behalf of the beneficiary by the state.”[8]

 

SSI Special Needs Trusts and Pooled Trusts Under the FCIA

 

            In December of 1999, Congress passed the Foster Care Independence Act (FCIA),

containing new anti-fraud provisions applicable to the SSI program.  The FCIA enacted all new provisions regarding treatment of trusts for SSI eligibility purposes.  These provisions are contained in 42 U.S.C. §1382b(e).

 

            The FCIA generally disfavors trusts established by individuals with their own funds and treats the corpus of these trusts as “available resources” to the individual.  The FCIA provides that an individual is determined to have established a trust if any assets of the individual are transferred to the trust.  Trusts created in a will are exempt from the provisions of the FCIA.[9]

 

            Under the FCIA, the corpus of a revocable trust established by the individual is considered an available resource.[10]  In the case of an irrevocable trust established by the individual, that portion of the corpus that could be distributed to or for the benefit of the individual or the individual’s spouse in any circumstance is also considered an available resource.[11]  Further, distributions from the corpus of any of these trusts, other than to or for the benefit of the individual, will incur a transfer penalty,[12] (as will foreclosure of the ability to make distributions from the corpus of these trusts to or for the benefit of the individual altogether).[13] 

 

            The FCIA specifically exempts OBRA ‘93 supplemental needs trusts and pooled trusts from being considered available resources and provides that transfers to fund such trusts by individuals under age 65 will not incur a penalty period.[14]  Thus, the FCIA provides that a trust will be exempt from the general rules regarding self-settled trusts if it complies with all of the criteria in 42 U.S.C. §1396p(d)(4)(A) or (C) applicable to OBRA ‘93 trusts for Medicaid.  Income trusts under 42 U.S.C. §1396p(d)(4)(B) are not exempt for SSI purposes.

 

Sole Benefit Trusts

 

            Third Party Special Needs Trusts are excepted from the provisions of both OBRA '93 and the FCIA applicable to self-settled trusts, since these trusts are created and funded solely with property not belonging to the beneficiary or the beneficiary’s spouse.  Third Party Special Needs Trusts will not be considered an available resource to the beneficiary for purposes of determining the beneficiary’s eligibility for Medicaid or SSI.[15]

 

            Third Party Special Needs Trusts must meet the following conditions to be considered exempt as a resource:

 

1.      The beneficiary must have no authority to compel distributions from the trust or to exercise any powers of ownership over assets in the trust;

 

2.      The assets in the trust must be used only for the beneficiary’s supplemental needs and not for support – otherwise, payments from the trust for support will be treated as income to the beneficiary;

 

3.      The trust may only have one lifetime beneficiary; and

 

4.      The trust must be irrevocable.[16]

 

            Generally, a “Sole Benefit Trust” is a special type of Third Party Trust that can provide great flexibility in settlement planning.  It is not a countable resource of the beneficiary.  Transferring assets to fund a trust for the sole benefit of a minor, blind or disabled child, or for the sole benefit of any disabled individual under age 65, will not incur a transfer penalty for purposes of the grantor’s eligibility for Medicaid and SSI.  Finally, Sole Benefit Trusts do not need to be created by a court or a parent, grandparent or legal guardian of the beneficiary; and are not required to contain a “state pay back” provision.   

 

            A Sole Benefit Trust must meet all of the conditions applicable to Third Party Special Needs Trusts to be exempt as a resource to the beneficiary.  A Sole Benefit Trust must also meet additional requirements. 

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            For the trust to be considered for the “sole benefit of” the beneficiary, the trust must provide that the beneficiary is the only person who will benefit from funds in the trust, both at the present and at any time in the future.  Thus, the trust must provide that the assets in the trust will be spent or distributed in a manner that is “actuarially sound.”[17]  In other words, the trust must provide that the assets will be distributed each year in an amount that is calculated to deplete the trust within the beneficiary’s remaining life expectancy.

 

            The trust can be funded with a lump sum or annuity.  However the trust must be fully funded before the beneficiary reaches age 21 (in the case of a minor child who is not blind or permanently and totally disabled); or before the beneficiary reaches age 65 (in the case of any disabled beneficiary who is not a child of the grantor).  If the beneficiary is a blind or permanently and totally disabled child of the grantor, trust funding can continue over the life expectancy of the beneficiary. 

 

            Once created and funded to preserve the beneficiary’s eligibility for public benefits, the trust must be administered as would any Third Party Special Needs Trust. 

           

            In the context of a settlement where the disabled plaintiff is concerned with providing for a blind or disabled child, a child under age 21 or another disabled person under age 65, a Sole Benefit Trust provides an almost ideal solution to maintaining Medicaid or SSI eligibility for both the beneficiary and the grantor.  According to both Medicaid and SSI law, the beneficiary need only be blind or permanently and totally disabled (or under age 21, for Medicaid only), (in the case of a child of the grantor), or disabled, (in the case of any other individual under age 65).  As a result, Sole Benefit Trusts can also be useful where the grantor wishes to preserve his or her own Medicaid or SSI eligibility, regardless of whether the beneficiary qualifies for Medicaid or SSI.

 

            In situations where the beneficiary’s ability to qualify for Medicaid or SSI is not a concern, the Sole Benefit Trust can be administered to provide for the beneficiary’s general health, education, welfare, support, maintenance and comfort.  So long as the trust is created for the grantor’s blind, disabled or minor child, or for any other disabled individual under age 65, and the trust meets the “sole benefit” requirements, the grantor’s transfer of assets to fund the trust will not subject the grantor to a transfer penalty under Medicaid or SSI law.

 

Special Requirements for SSI Trusts

 

            Even a trust that complies with all of the requirements of 42 U.S.C. §1396p(d)(4)(A) or (C) might not be recognized as a valid exempt trust if it does not also comply with Social Security Administration policies, as set forth in the Program Operations Manual System (POMS) at POMS SI 01120.203.  In particular, the trust must comply with all of the following key requirements, as summarized in POMS SI 01120.203.D.1:

 

1.                     The trust will be established with the assets of the beneficiary, who is under age 65;

 

2.                     The beneficiary is disabled as that term is defined in the Social Security Act;

 

3.                     The beneficiary is the sole beneficiary of the trust.  (Further, the trust does not allow any Prohibited Expenses or Payments under POMS SI 01120.203.B.3);

 

4.                     The trust was established by the beneficiary’s parent, grandparent, legal guardian or a court, if the beneficiary is a minor.  If the beneficiary is not a minor, the trust was established by someone who has legal authority to act with regard to the beneficiary’s assets, as required by POMS SI 01120.203.B.1.e, which would mean that the trust must have been established by the beneficiary’s legal guardian or a Court, or by the individual in the case of a pooled trust account;

 

5.                     The Trust provides specific language providing that, upon the death of the

beneficiary, the trust must first reimburse the State for medical assistance paid for the beneficiary;

 

6.                     The Trust will be fully funded before beneficiary reaches age 65;

 

7.                     The Trust is irrevocable.  (The Trust must contain a specific provision making the Trust irrevocable; and the Trust must name specific individuals as contingent beneficiaries upon the beneficiary’s death, after repayment to the State for medical assistance benefits paid).

           

            Failure of the trust to comply both with OBRA ‘93 and the requirements in the POMS will result in trust assets being considered an available resource or in transfers to fund the trust being considered transfers without fair consideration, resulting in a penalty period.

 

Will Medicaid or SSI Criteria Apply?

 

            In 1999, the federal court was presented with, 1) whether, in an SSI state[18], a trust approved under the federal SSI eligibility criteria could nonetheless be considered invalid under state Medicaid law; and 2) whether a Medicaid beneficiary in an SSI state can be denied Medicaid benefits under state Medicaid regulations if the individual continues to qualify for SSI.[19] 

 

            The Court held that, in SSI states, Medicaid agencies cannot employ methodology or criteria more restrictive than that of SSI when evaluating trusts because a SSI recipient automatically qualifies for Medicaid.   

 

            The Court’s holding in Ramey governs any situation in which state Medicaid regulations in an SSI state might impose more restrictive criteria for eligibility than those imposed by federal regulations governing SSI.  In an SSI state, an individual who is eligible for SSI under the federal Social Security regulations cannot be denied Medicaid benefits by the application of a more restrictive state law or regulation.

 

            In SSI states, a trust, which is approved by the Social Security Administration for an SSI beneficiary, cannot also be required to comply with any additional requirements under state Medicaid law; and an individual who qualifies for SSI cannot be denied Medicaid under any state Medicaid law that might impose eligibility requirements, (e.g., regarding treatment of in-kind income), stricter than those imposed by SSI. 

 

            Thus, for a person whose Medicaid eligibility is due to eligibility for SSI, that person’s Medicare Set-Aside Trust and Special Needs Trust must comply with SSI criteria, regardless of what criteria may exist under state Medicaid law.  Further, if such an individual qualifies for SSI, even after consideration of all cash and in-kind income, that individual cannot be denied Medicaid benefits, even if a calculation of the individual’s cash and in-kind income under state Medicaid regulations might otherwise result in ineligibility.

 

Special Needs Trusts for Medicare:  The Medicare Set-Aside Special Needs Trust

 

Workers’ Compensation Settlements

 

            Federal law provides Medicare with expansive rights in the context of WC settlements

involving claimants who are, or soon will become eligible for Medicare benefits.  The Medicare Secondary Payer (MSP) statute and regulations establish Medicare’s status as secondary payer in relation to the WC carrier or self-insured employer.  Any overpayments or conditional payments that Medicare may make prior to settlement must be reimbursed before any other claims or liens.

 

            The MSP statute and regulations also specifically provide that Medicare will not pay for any future medical expenses after a settlement is received until the total future medical expenses related to the employee’s injury equals the portion of the settlement which was allocated to future medical expenses.[20]

 

            If the WC settlement does not close out future medical expense liability, Medicare will continue to be secondary payer with relation to the WC carrier.  However, federal law also allows Medicare to retain its secondary payer status after a WC settlement that does foreclose future liability for the claimant's work injury-related medical and prescription drug expenses, [21] at least until the amount of the settlement which was allocated to future medical and prescription drug expenses is exhausted on those expenses. 

 

            Where proper allocations to future medical expenses and future prescription drug expenses are not made as part of settlement that closes out future medical expenses, CMS will consider the entire settlement as being allocated to future medical and prescription drug expenses by application of a formula found in the federal regulations.  If CMS believes that a WC settlement does not reasonably consider Medicare's interests and that the settlement is an attempt to shift responsibility for the WC claimant's future medical and prescription drug expenses from the WC carrier to Medicare, CMS even has the power to disregard the settlement altogether.[22]  In such instances, CMS may then continue to treat the WC carrier as a primary payer, even after the settlement has been approved and finalized by the state WC judge or commissioner.  Any conditional payments or overpayments Medicare may make for the claimant’s work injury- related medical and prescription drug expenses after settlement can result in a post-settlement MSP claim, leaving the claimant, his or her attorney and the WC carrier or self-insured employer vulnerable to potential future liability.

 

            For example, a seriously disabled claimant settled his WC claim for $1,000,000 without notifying Medicare.  The settlement,  which provided a complete release of liability to the employer and the WC insurance carrier for the claimant’s future, work injury-related medical expenses, did not contain a reasonable allocation of a portion of the settlement toward those medical expenses.  After the settlement, the claimant developed serious complications from his work-related injuries, requiring a two-month hospital stay; multiple surgeries; ninety days in a skilled nursing facility after his hospital discharge; and intensive physical therapy.  The claimant’s health care providers did not bill the claimant for the costs of treatment, but rather, submitted billing for their charges to Medicare.  Medicare, not knowing of the claimant’s WC settlement, paid a total of $250,000.  Even though the settlement agreement foreclosed the employer’s and the WC carrier’s liability for the claimant’s future medical expenses, Medicare can still seek and obtain recovery of its post-settlement overpayment from those entities under the MSP statute and regulations.   

 

            Even if the settlement contains a reasonable allocation to future medical and prescription drug expenses, the claimant will have the responsibility to ensure that these allocated funds are spend only on future, work injury-related medical and prescription drug expenses of the type normally covered by Medicare.  Otherwise, CMS will deny future coverage for work related medical care.[23] 

 

            When a WC claim is settled without the parties properly complying with the requirements of the federal MSP statute and regulations,[24] the WC carrier, the claimant, and their attorneys remain exposed to significant potential liability after the settlement, and the claimant risks the denial of future Medicare benefits.  A Worker’s Compensation Medicare Set-Aside Arrangement (WCMSA) provides a safe vehicle for settling a WC claim for future medical expenses; and for the proper post-settlement administration of WC future medical and prescription drug expense allocations.[25]

 

            Beginning in July, 2001, CMS has released a total of eight memoranda through which CMS has refined its policies and procedures for the review and processing of proposals for WCMSAs.  All of CMS' memoranda are available online at:  http://www.cms.hhs.gov/WorkersCompAgencyServices/

 

            Currently, CMS review and approval is only mandatory for WC settlements of future medical expenses in which the claimant is already eligible for Medicare and the total value of the settlement, including past and future medicals expenses, attorney’s fees and costs, indemnity and any Medicare overpayments, is $25,000 or more; or where the claimant is reasonably expected to become eligible for Medicare within 30 months of the settlement and the total value of the settlement, including past and future medicals expenses, attorney’s fees and costs, indemnity and any Medicare overpayments, is greater than $250,000.  However, these are workload review criteria only.  CMS still requires that Medicare’s interests be reasonably considered, even in settlements that do not meet these criteria. 

 

            The funds in a WCMSA may only be used to pay for the claimant’s future, work injury-related medical and prescription drug expenses arising from the WC claim that are of the type normally covered by Medicare.  Funds in a WCMSA may not be used to pay premiums for Medicare Supplemental (“Medigap”) Insurance.

 

            CMS does not allow the payment of administrative fees or attorney’s fees from funds in any WCMSA created after May 7, 2004.  Therefore, it is extremely important to provide a means to pay these expenses out of settlement proceeds other than those that will be used to fund the Medicare Set-Aside Arrangement.  In many cases, a separate annuity can be funded to pay anticipated expenses directly to the trustee or professional custodian, who would be required upon termination of administration to refund any unused payments to the beneficiary or to some other payee designated by the beneficiary.

 

Physical Injury Settlements

 

            Until recently, CMS only actively asserted its post-settlement status as secondary payer following settlement of WC claims.  But CMS now claims that Medicare retains its secondary payer status after settlement of PI claims as well.[26]

 

            According to CMS, its position regarding PI settlements is not new, but is based upon language in the MSP statute that has been in effect since at least 1989.  The MSP statute, at 42 U.S.C. §1395y(b)(2)(A) states:

 

Payment under this subchapter may not be made . . . with respect to any item or service to the extent that. . .

(ii) payment has been made or can reasonably be expected to be made promptly (as determined in accordance with regulations) under a workmen's compensation law or plan of the United States or a State or under an automobile or liability insurance policy or plan (including a self-insured plan) or under no fault insurance.[27]

 

CMS' position is based on its interpretation of the MSP statute as providing that a PI settlement that closes out future medical expenses represents a situation in which "payment has been made" for an item or service otherwise covered by Medicare “under an automobile or liability insurance policy or plan (including a self-insured plan) or under no fault insurance.” 

 

However, CMS' power to determine whether an allocation to future medical and prescription drug expenses in a settlement represents a reasonable consideration of Medicare's interests is based upon the MSP regulations that apply only to WC settlements.  The MSP WC regulations provide the only authority for CMS to review the "reasonableness" of an allocation for future medical expenses or to disregard a settlement if it appears to be an attempt to shift responsibility for future medical expenses to Medicare.  The same is true of the regulation that allows CMS to determine its own "reasonable allocation" of a settlement.[28]  

 

CMS arguably appears to have the statutory authority, following a PI settlement, to consider a portion of any PI settlement allocated to future medical and prescription drug expenses as being a "payment that has been made" for an item or service covered by Medicare.  CMS does not appear to have, however, any authority under any statute or regulation to independently determine which portion of a PI settlement represents payment for a future "item or service" absent an allocation in the settlement itself.  Further, CMS appears to have no authority in a PI settlement to determine the reasonableness of the settlement's allocation to future medical expenses or to calculate its own allocation.

 

            CMS currently has no official procedure for review of Medicare Set-Aside Arrangements in PI settlements but CMS does require that the parties "reasonably consider Medicare's interests" in PI settlements.  Thus, it is necessary to notify CMS of any PI settlement in which future medical expenses are a consideration or in which there is a specific provision for past or future medical expenses.  Medicare also requires that any funds which are allocated to future medical expenses in the settlement be spent on injury related medical expenses before any claims are submitted to Medicare.                       

 

Medicare Set-Aside Trusts

 

            A Medicare Set-Aside Trust is a Medicare Set-Aside Arrangement in the form of a formal trust agreement, administered by a trustee.  Consequently, such trusts are subject to state and federal fiduciary laws applicable to trusts and trustees.  These laws provide significant protections, both for the claimant, who is the beneficiary of the trust, and for Medicare. 

 

            The funds in a Medicare Set-Aside Trust should be placed in low risk, highly liquid investments to ensure continued growth of the funds; and to ensure that funds will be available when needed to cover medical costs. 

 

            Although a properly and carefully drafted Medicare Set-Aside Trust under the administration of an experienced trustee provides the safest vehicle for administration of set aside funds, it is no longer the only such vehicle that is recognized or approved by CMS.

 

Medicare Set-Aside Custodial Agreements

 

            It has taken more than 10 years for CMS to gradually develop its current official policies and procedures regarding the use of Medicare Set-Aside Arrangements in WC settlements.  At first, CMS indicated that a Medicare Set-Aside Trust was the preferred method of reasonably considering Medicare’s interests.  The use of a formal trust was seen as the only vehicle which would provide sufficient protections to ensure proper administration of Medicare Set-Aside funds. 

 

            Unfortunately, Medicare Set-Aside Trusts have two significant drawbacks.  Many of the medical claims administrators with the expertise in Medicare needed to ensure proper trust distributions for Medicare covered services are not licensed as professional trustees.  Thus, proper administration requires both a trustee and a professional medical claims administrator, which results in increased costs of administration. 

 

            Further, professional trustees typically charge fees based upon a minimum annual amount, plus a percentage of the value of the monies in the trust.  Because many professional trustees will only agree to administer trusts with at least $100,000 in assets, if the Medicare Set-Aside amount is less than $100,000, it is difficult to find a professional trustee willing to serve, and the fees charged by professional trustees who will agree to serve are disproportionately large compared to the size of the fund being administered. 

 

            Only a small percentage of WC claims for future medical expenses are settled for more than $100,000.  As a result, most WC claimants sought a less costly type of Medicare Set-Aside Arrangement to ensure proper administration of the set aside funds.  In response to this need, medical claims administrators began to offer their services under Medicare Set-Aside Custodial Agreements, which are now routinely accepted by CMS in lieu of a formal trust.  These custodial agreements are drafted to contain guidelines and protections similar to those found in trust agreements, but because custodial agreements are not trusts, a medical claims administrator can administer the funds without being licensed as a professional trustee.  Moreover, the custodians charge significantly less in fees than do professional trustees.

 

Self-Administered Medicare Set-Aside Arrangements

 

            Even formal Medicare Set-Aside Custodial agreements can become disproportionately expensive to administer in smaller WC settlements.  The vast majority of WC claims for future medical expenses settle for less than $50,000.  In fact, most will settle for under $20,000.  In these cases, even the fees of professional medical claims administrators can be prohibitive.

 

            As a result, CMS was virtually flooded with requests to allow claimants to “self-administer” their Medicare Set-Aside Arrangements.  Self-administration provides the advantage of eliminating most administration costs altogether.  On the other hand, it eliminates the protection of having an experienced medical claims administrator to determine what claims are properly payable as injury related medical expenses that would normally be covered by Medicare.

 

            In a policy memorandum released on April 23, 2003, CMS announced that self-administration of Medicare Set-Aside Arrangements is permitted, so long as this is allowed under state law.  However, CMS requires that self-administered arrangements will be subject to the same guidelines for administration as arrangements being administered professionally.  

 

            Claimants are using self-administered arrangements at an increased rate, especially since the ban on payment of administrative fees from Medicare Set-Aside Arrangements went into effect on May 7, 2004.  As more and more Medicare Set-Aside Arrangements are being self-administered, many practitioners have become increasingly concerned over the possible problems with self-administration.

 

            The simple truth is that, even though self-administration is permitted, it is not always advisable.  Many claimants will simply not make appropriate administrators due to lack of sophistication or poor money-management skills.  Because CMS’ guidelines regarding self-administration do not contain specific provisions regarding administration, a formal custodial agreement should be used.  The claimant or other non-professional administrator should also sign a written acknowledgment of the guidelines and agree to abide by them.

 

Limitations on Use of Custodial and Self-Administered Arrangements: The Medicare Set-Aside Special Needs Trust

 

            Medicare Set-Aside Custodial Agreements and self-administered Medicare Set-Aside Arrangements can problems for plaintiffs or claimants who may also need to preserve eligibility for Medicaid or SSI.  Even formal Medicare Set-Aside Trusts are problematic if they are only drafted to reasonably consider Medicare’s interests.  Since Medicare Set-Aside Trusts, Custodial Agreements and Self-Administered Arrangements are all funded with property belonging to the plaintiff or claimant, each will be subject to SSI and Medicaid restrictions applicable to self-settled trusts.

 

            As a result, funds held in such arrangements will generally be considered available resources for purposes of determining Medicaid or SSI eligibility; or the funding of such arrangements will be treated as transfers without fair consideration, resulting in the imposition of a period of ineligibility.  Where the plaintiff must preserve Medicaid or SSI eligibility, a formal Medicare Set-Aside Trust should be created that also complies with the Medicaid or SSI criteria applicable to Special Needs Trusts – in other words, a “Medicare Set-Aside Special Needs Trust.”

 

            The Medicare Set-Aside Special Needs Trust must be irrevocable.  Any payments from the trust for support items will be treated as income to the plaintiff.  Finally, the plaintiff may neither act as the settlor of the Medicare Set-Aside Special Needs Trust nor serve as the trustee.

 

            In WC cases where CMS review criteria apply, the Medicare Set-Aside Special Needs Trust arrangement must still be submitted to CMS for approval, although this is currently not required in PI settlements.  However, in both WC and PI settlements, the trust will have to be submitted separately for approval, either to the state Medicaid agency, the Social Security Administration or both.

 

            Even a Medicare Set-Aside Special Needs Trust specially drafted to comply with the requirements of OBRA ’93 and/or the FCIA will still be limited to payment of future, injury related medical expenses of the type normally covered by Medicare.  Therefore, a separate Special Needs Trust or Pooled Trust account will also need to be created and funded from settlement proceeds to pay for expenses and services not covered by Medicaid, SSI or Medicare.

 

Trust Drafting Issues

 

            The plaintiff will be recognized as the grantor of a Special Needs Trust, even if a third party, such as a court or legal guardian, creates the trust. 

 

            As a practical matter, virtually all Special Needs Trusts will be treated as “grantor trusts” for income tax purposes,[29] since the trustee will be given the power to make distributions of income and principal to the grantor.  When a Special Needs Trust is classified as a grantor trust, all net income earned by the trust will be treated as taxable income to the beneficiary of the trust.   The income, deductions, and credits of the trust are reported on the plaintiff's personal tax return each year, and not by the trust on an IRS Form 1041 (fiduciary income tax return), even if the earnings of the trust are not actually paid to or on behalf of the plaintiff.  As a result, the payment of the plaintiff’s income taxes by the trust do not constitute additional income to the plaintiff. 

 

            Another way to ensure that the Special Needs Trust will be treated as a grantor trust is for the trust document to retain a testamentary power of appointment, executable by the grantor/plaintiff.  Including a testamentary power of appointment also serves to prevent the funding of the trust to be treated as a completed gift for gift tax purposes.

 

            The Special Needs Trust must describe when the trustee can make distributions.  Special language should be included to clarify that the trust’s primary purpose is to supplement, rather than supplant, public benefits.  That is, the trust should be used to pay for items or services which are not covered under any public benefits for which the plaintiff may qualify. 

 

            An OBRA ’93 Special Needs Trust must provide that assets remaining in the trust upon the death of the beneficiary must be made available to repay the state for any Medicaid benefits provided to the plaintiff/beneficiary.  However, at least one court has held that the trustee may pay state and federal taxes and expenses of administration prior to repaying the state.[30] 

 

            The trust should be a discretionary trust, rather than a support trust.  The trust should be drafted to clarify that the trustee has sole and absolute discretion as to whether or not to make distributions and not permit the plaintiff/beneficiary to compel distributions of income or principal, which may result in trust assets being treated as available resources or income.

 

The trust should not state that the trustee is to make distributions for support or maintenance.  Rather, the trust should provide that distributions from the trust be limited to non-cash distributions to the beneficiary or cash distributions paid to third parties on behalf of the beneficiary for non-support items or supplemental needs not covered by public benefits, such as:  a specially equipped van or other vehicle for transportation, a color television or other entertainment appliance, a computer, periodical subscriptions, personal care goods, an electric wheelchair or other supportive device, or professional health-care services not otherwise covered by Medicaid.  Distributions for non-support or supplemental needs will not be counted as either cash income or in-kind income to the beneficiary for purposes of maintaining eligibility for Medicaid or SSI.

 

            The distribution of in-kind income to an individual who may not be receiving the full SSI benefit of $603 per month can cause problems.  Under the presumed value rule,[31] if the individual’s monthly SSI benefit is equal to an amount less than $20 plus one-third of the maximum SSI benefit, the offset from in-kind income will reduce the individual’s SSI benefit to $0 and will result in ineligibility.  Under the one-third reduction rule,[32] the same result will occur if the individual’s monthly SSI benefit is less than one-third of the maximum SSI benefit before the offset. 

 

            Thus, cash distributions from the Special Needs Trust to third parties to purchase support items constituting in-kind income should be limited to situations where the SSI reduction for in-kind income will not result in a complete offset of the beneficiary’s monthly SSI benefit.  This requires that the trustee know which rule will apply to the calculation of the individual’s benefit reduction for in-kind income and that the trustee know the exact amount of the individual’s monthly SSI benefits.

 

Government Claims and Liens

 

            In any settlement involving a plaintiff who was eligible for Medicare, Medicaid or VA benefits at any time following his or her injury, there may be a Medicare Secondary Payer (MSP) claim, a Medicaid lien or a VA claim that must be satisfied from settlement proceeds.  Therefore, it is essential in such cases to give notice of the plaintiff’s claim and any potential settlement to the Medicare Coordination of Benefits Contractor, the VA and the Medicaid agencies in any states where the plaintiff may have received those benefits.

 

            Notice of the plaintiff’s WC or PI claim should be given as soon as the plaintiff knows of its existence.  Early notification can help to prevent or minimize overpayments where a third party, such as a WC or no-fault carrier, has the responsibility to provide for the plaintiff’s medical care on an ongoing basis.  Further, the sooner Medicare and Medicaid are on notice of the existence of a claim, the more quickly they can determine the total amounts of any payments they may have made for injury related medical care.

 

            The plaintiff should also notify both Medicare and Medicaid of a potential settlement as soon as the real possibility of settlement arises.  This will increase the likelihood that at an accurate estimate of any potential MSP claim, Medicaid lien or VA claim amounts can be known before the parties negotiate the final settlement terms.  This is important because satisfaction of the MSP claim, the Medicaid lien and the VA claim is required before any distributions from settlement can be made to the plaintiff or to fund a Medicaid or SSI exempt trust under OBRA ‘93.[33]  A plaintiff who agrees to a settlement amount without knowing what the MSP claim, Medicaid lien or VA claim amounts are, takes the risk that those government claims and liens could exhaust the settlement proceeds and leave little or nothing for the plaintiff’s needs. 

 

Medicare Secondary Payer Claims

 

            The Medicare Secondary Payer statute was originally enacted in 1980 at 42 U.S.C. §1395y(b) and was amended by the Omnibus Budget Reconciliation Act of 1989 (OBRA ‘89); and again by the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA). [34]

 

            Any payments by Medicare for the plaintiff’s injury related medical expenses prior to settlement, even if payments were made by mistake, result in an MSP claim which must be satisfied as part of the settlement.  If not, CMS can bring suit for repayment of Medicare’s claim against the WC or liability insurance carrier, a self-insured defendant or employer, or any entity which receives proceeds from the settlement, including the plaintiff and his or her attorney. 

 

            In a suit against an insurance carrier to recover its MSP claim, CMS can seek double damages.  A similar private right to sue the carrier for double damages is also granted under

federal law to the WC claimant who is eligible for Medicare benefits.

 

            Medicare’s claim for repayment from settlement proceeds always has priority, even before any state Medicaid liens that may exist, though Medicare will reduce its claim to take into account the plaintiff’s costs and attorney’s fees in procuring the settlement. 

 

            There are essentially three methods that can be employed to seek full or partial waivers of Medicare’s claim.  The MSP claim can be either compromised or waived, pursuant to the Federal Claims Collection Act,[35] under the MSP statute,[36] or under 42 U.S.C. §1395gg(c).

 

            The bases for a compromise under the Federal Claims Collection Act are: 1) the claimant does not have the money to repay the claim within a reasonable period of time; 2) CMS would find it difficult to prevail on the claim in a court of law; or 3) the costs to CMS of collecting the claim exceeds the value of the claim.  Under 42 U.S.C. §1395gg, claims can be compromised for economic hardship, for equity and good conscience, and for reasons beyond the fault of the claimant.

 

            Under the MSP statute, claims can be waived, in whole or in part, if waiver is determined to be in the best interests of the MSP program.  A denial of a waiver request under this provision is not appealable. 

 

Medicaid Liens

 

            The ability of the states to recover liens from WC and PI settlements for Medicaid benefits provided to the plaintiff has its origins in two federal statutory provisions.[37]  However, the federal “anti-lien” statute contains a seemingly conflicting provision.[38]

 

            The “anti-lien” statute raised the issues of whether it prohibited states from executing Medicaid liens against the proceeds of WC and PI settlements.  The U.S. Department of Health and Human Services, Departmental Appeals Board issued two decisions in the mid-1990's addressing this issue.  Those decisions each stated that federal law permits states to seek recovery from all settlement proceeds; and that these proceeds are not considered “property of the individual” because the state’s Medicaid lien attaches while the settlement proceeds are still property of the defendant (or the defendant’s insurance carrier).[39] 

 

            The courts in several states were quick to adopt HHS’s position.  A line of cases ensued in which it was held that the effect of 42 U.S.C. §1396a(a)(25)(H), 42 U.S.C. §1396k(a)(1) and HHS’s construction of 42 U.S.C. §1396P(a)(1) was to render the Medicaid lien statute inapplicable to PI settlements.  Thus, the states were empowered to recover their liens from all settlement proceeds under statutorily mandated assignments by Medicaid beneficiaries of all of their rights to recovery against third parties.[40]  In 2002, however, the Minnesota Supreme Court rejected the position of HHS and the courts in New York, New Jersey, Washington and Utah.[41] 

 

            In 2005, the first decision on this issue by a federal appellate court was issued.[42]  In Ahlborn v. Arkansas Dept. of Human Services, the plaintiff had been seriously injured and permanently disabled in a motor vehicle accident in 1996.  She applied and qualified for Medicaid benefits in the State of Arkansas. 

 

            According to Arkansas law, she was required, as a condition of Medicaid eligibility, to assign “any settlement, judgment, or award which may be obtained against any third party” to the Arkansas Department of Human Services (ADHS), the state Medicaid agency, “to the full extent of any amount which may be paid by Medicaid” for her benefit.[43]  By the time Ms. Ahlborn settled her third party tort claim, Medicaid had made payments totaling $215,645.30 for her care.  The net amount of Ms. Ahlborn’s settlement was $550,000, of which $35,581.47 represented settlement of her claim for past medical expenses.  Based upon state law and the required assignment, ADHS attempted to assert its $215,645.30 Medicaid lien against the entire settlement.

 

            Ms. Ahlborn sued ADHS in federal court, seeking a declaratory judgment that ADHS could only recover its lien from the portion of her settlement representing payment for past medical expenses.  Her argument was based upon the “anti-lien statute.”  ADHS argued that the Arkansas statute requiring the assignment of all rights against third parties was required by 42 U.S.C. §1396a(a)(25)(H) and 42 U.S.C. §1396k(a)(1).  Those provisions, argued ADHS, allowed the state to recover its lien from all settlement proceeds, rather than just that portion of proceeds meant to compensate the beneficiary for medical expenses.  Further, ADHS argued that the federal “anti-lien statute” did not prohibit this because the settlement proceeds were not Ms. Ahlborn’s property when the state’s lien attached, since the proceeds were still in the hands of the defendants.   

 

The United States Court of Appeals for the Eighth Circuit held that, to the extent that the Arkansas statutes require an assignment of rights to third party claims or payments other than for medical care, the Arkansas statutes are pre-empted by federal law.  On May 1, 2006, the U.S. Supreme Court affirmed the decision of the Eighth Circuit.[44] 

 

The Supreme Court based its decision primarily upon its plain reading of the language of 42 U.S.C. §1396a(a)(25)(H) and 42 U.S.C. §1396k(a)(1) as limiting the states to recovery of only that portion of the settlement representing settlement of the defendant’s third party liability for medical expenses.[45]  The Court also found that the federal anti-lien statute specifically prohibited the state from attaching or encumbering the remainder of the settlement, since Ms. Ahlborn retained her ownership to the claim in spite of the “assignment” of recovery rights mandated by state statute.[46]

 

The Court declined to give deference to HHS’s interpretation of 42 U.S.C. §1396a(a)(25)(H) and 42 U.S.C. §1396k(a)(1), as contained in the two Departmental Appeals Board decisions:  Calif. Dep’t. of Health Servs., D.A.B. No. 1504. 1995 WL 66334 (HHS Jan. 5, 1995); and Wash. State Dep’t of Soc. and Health Servs., D.A.B. No. 1561, 1996 WL 157123 (HHS Feb. 7, 1996).  According to the Court, deference was not appropriate because those decisions did not address the same question presented in Ahlborn, those decisions did not mention the federal “anti-lien” statute, and the decisions were based upon “questionable construction of the federal third-party liability provisions.”[47]

 

            Finally, the Supreme Court cautioned that states retain the right to challenge the reasonableness of the settlement allocation to past medical expenses, either by participating in the settlement negotiations or by seeking relief in state court to modify or approve the settlement allocations.[48]  As a result, it is likely that states will impose new notice requirements in the future, requiring notification to the state whenever a beneficiary wishes to participate in negotiations to settle a third party claim. 

  

            This groundbreaking decision will apply to Medicaid beneficiaries who receive settlements in all states.  For large settlements where a state Medicaid agency may attempt to assert a lien significantly greater than the portion of the settlement reasonably allocated to past medical expenses, the Ahlborn case will be an effective tool to ensure that the greatest possible portion of settlement proceeds will remain available to the plaintiff.  However, the state should be included in the settlement process to ensure that a fair amount of the settlement is allocated to compensation for the beneficiary’s future medical expenses; and to ensure that the state cannot later challenge the validity of the settlement in court.   

 

VA Claims

 

The “VA claim statute” and its corresponding regulation grant the United States the right to recover reasonable charges in repayment for health care benefits provided to a veteran through the U.S. Department of Veterans Affairs (VA) from certain third parties who would otherwise be liable for the veteran's medical care.[49]

 

The VA has authority, similar to that provided to CMS under the MSP statute, to recover from third parties for payments it has made for injury-related medical care for nonservice-connected disabilities.  However, that authority is limited to recovery from the employer or carrier in a WC claim; from a health plan contract; or from an automobile liability policy. 

 

Finally, the VA’s right to recover from third parties is limited to payments for nonservice-connected disabilities.  This means that the claimant’s disease, injury or other physical or mental defect cannot have been “incurred or aggravated . . . in the line of duty in the active military, naval or air service.”[51]         

 

While the statute and regulation are silent regarding the VA’s right to recover third party payments received by the claimant, the statute does grant the VA a right of subrogation.  Further, the statute grant’s the VA the right to intervene in the WC case as a party.  It would seem logical that this would imply a duty on the claimant to inform the VA of the existence of the claim in sufficient time to allow it to exercise its right to either institute or intervene in the WC case. 

 

There is no provision under the statute or the regulations that would permit the VA to recover from any third party after there has been a settlement.  However, it would also seem to follow that if a claimant settles a WC claim for medical benefits without notifying the VA, the VA would have the ability to enforce its right against the settlement proceeds in the hands of the claimant.

 

            The Supplemental Appropriations Act of 2002 provides that, as between Medicare and VA medical benefits, Medicare is the secondary payer.  Thus, Medicare’s secondary payer claim for Medicare overpayments must be satisfied before any VA claim against the settlement.[52]

 

Tax Treatment of Settlement Proceeds Under IRS §104(a)

 

            The Internal Revenue Code (IRC) provides that proceeds of a WC settlement or settlement of a PI claim involving physical injury or sickness (except for punitive damages) are not taxable.[53]  However, income earned by plaintiffs on lump sum settlements of such claims is taxable. 

 

Qualified Assignments and Qualified Funding Assets under IRC §130

 

            The Periodic Payment Act created IRC §130, providing that periodic payments of settlement proceeds through a qualified assignment under IRC §130 are also tax-free.[54]  Under the original IRC §130, the income from an annuity that made periodic payments as part of a settlement of a PI claim for physical injury or sickness was exempt from income tax if there was a qualified assignment of the obligation to make the annuity payments.  Section 130 was amended in August, 1997, to permit the use of qualified assignments in WC settlements as well.  Since that time, the use of structured settlements has become more and more common, both in WC settlements and in settlements of PI claims involving physical injury or sickness.

 

            The assignment of the obligation to make periodic payments constitutes a “qualified assignment” if the following requirements are met:

 

            (1) assignee must assume liability from a person who is a party to the suit or agreement, or the WC claim, and

  (2) 

    (A) such periodic payments are fixed and determinable as to amount and time of payment,

    (B) such periodic payments cannot be accelerated, deferred, increased, or decreased by the recipient of such payments,

    (C) the assignee's obligation on account of the personal injuries or sickness is no greater than the obligation of the person who assigned the liability, and

    (D) the periodic payments must be excludable from the gross income of the recipient under IRC §§104(a)(1) & (2).[55]

 

            Further, the periodic payments must be funded with a commercial annuity issued by a life insurance company; and the annuity payments cannot be more that the periodic payments under the qualified assignment.  Finally, the annuity must be purchased with settlement proceeds within 60 days before or after the qualified assignment and must be designated specifically to payment of the qualified assignment.

 

            Once there is a qualified assignment of an annuity funding a structured WC or PI settlement, the plaintiff cannot change the terms of the annuity, including the payment amounts or the payee.  The annuity must be purchased directly by the defendant or the defendant’s insurance carrier to avoid constructive receipt of the settlement funds by the plaintiff.[56]  The plaintiff also be treated as having constructive receipt of the settlement funds if he or she has the option of receiving a lump sum in lieu of an annuity, or the ability to direct the use of the settlement proceeds to purchase an annuity.[57]   

 

            Qualified assignments under §130 are only available in the settlement of WC or PI claims, and only with regard to settlement proceeds that are exempt from taxation under Sections 104(a)(1) & (2) of the IRC.   

 

Tax Treatment of Attorney’s Fees

 

            Plaintiffs are not required to report WC or PI settlement awards as income, to the extent that the proceeds are not includable in “gross income” under IRC §104(a).  However, plaintiffs who settle claims not arising from a physical injury or sickness are required to claim their entire settlement or award, including the portion allocated to attorney’s contingent fees, as income; but may deduct their attorney’s fees as a miscellaneous itemized deduction on their personal income tax returns.[58]  In a WC or PI settlement, there is no real advantage to the plaintiff in structuring attorney’s fees, since they will not treated as gross income as part of the settlement.  However, in non-physical injury settlements, structuring the plaintiff’s attorney’s fees can provide a tax benefit.  

 

            Section 703 of the American Jobs Creation Act of 2004 (AJCA), signed by President Bush on October 22, 2004,[59] granted some relief for plaintiffs who receive a settlement or award as the result of a civil rights or employment discrimination case.  In these cases, regardless of whether the plaintiff itemizes deductions on his or her tax return, the plaintiff is allowed to deduct the full amount of attorney’s fees and costs rather than deducting those attorney’s fees as a miscellaneous itemized deduction.

 

            This relief is only available for settlements or awards occurring after October 22, 2004, the date this legislation was enacted.  Further, this relief does not apply to other PI settlements or WC settlements, even where a portion of the settlement may be considered taxable income to the plaintiff.  Section 703(c) of the AJCA states: “The amendments made by this section shall apply to fees and costs paid after the date of the enactment of this Act with respect to any judgment or settlement occurring after such date.”  A plain reading of the statute suggests that it applies to civil rights or employment discrimination cases where both the settlement and the payment of attorney’s fees and costs occurred after October 22, 2004, the date of enactment, regardless of when the cases may have been commenced.

 

            Since attorney’s fees would be deducted from the settlement proceeds one way or the other, whether or not the entire settlement is considered taxable to the plaintiff, it would seem that the tax consequences in either situation would be the same.  However, the complex and often forgotten Alternative Minimum Tax (AMT) rules come into play. 

 

            The AMT is only due if it is more than normal income taxes.  The AMT rates are less than the top income tax rates, but under the AMT rules, miscellaneous itemized deductions, such as attorney’s fees, are disregarded.[60]  Therefore, the larger the settlement and the lower the plaintiff’s other income, the more likely the AMT will apply.

 

            Section 703 of the AJCA eliminated this problem for plaintiffs settling civil rights or employment discrimination cases after October 22, 2004.  However, in taxable settlements other than those involving civil rights or employment discrimination cases occurring after October 22, 2004, there is a potential tax benefit to the plaintiff if the attorney receives his or her fees in the form of a structure instead of in a lump sum.  If the attorney fees are structured along with the plaintiff’s settlement, taxes on all the payments will be deferred and spread out over multiple years.  Since the income is spread over multiple years, the impact of the AMT on the plaintiff may be reduced or eliminated altogether.

 

Special Funding Issues

 

Medicaid Annuities under the Deficit Reduction Act of 2005

 

            In many WC and physical injury cases, the plaintiff’s future medical expenses may “spike” in later years.  For example, a plaintiff may anticipate the need for surgery or replacement of certain durable medical equipment many years after the settlement.  In these instances, it is not unusual for the structured settlement to include an annuity that might pay out large payments in fixed amounts at 5 or 10 year intervals, specifically to provide extra funds in those years when unusually large medical costs are expected.  By deferring payment for large and infrequent costs until needed, the defendant can reduce the costs of funding the settlement while still providing the plaintiff with sufficient settlement funds to meet his or her needs for future care.

 

            The Deficit Reduction Act of 2005 (DRA) amended federal Medicaid law to provide that the purchase of an annuity from the assets of a Medicaid recipient (or the recipient’s spouse) is a transfer without fair consideration, unless the annuity is irrevocable and non-assignable; is actuarially sound; and provides for substantially equal payments over the life of the annuity with no deferral or balloon payments; or the annuity must name the state as death beneficiary up to the amount of Medicaid benefits paid on behalf of the annuitant.[61]  However, the DRA does not provide for any further consequence in the treatment of deferred or balloon annuities.  Thus, even a deferred or balloon annuity still should not be treated as a “resource” if it is annuitized, but rather, the payments should continue to be treated as income in the month received. 

 

            Under IRC §130, an annuity that funds a qualified assignment must be fixed as to the amount and time of periodic payments.  However, those payments need not be made monthly or even annually.  On the other hand, the DRA restrictions on annuities require that a Medicaid-exempt annuity must be actuarially sound and provide for substantially equal payments.  The DRA specifically provides that the purchase of deferred annuities and balloon annuities by the Medicaid recipient or the recipient’s spouse will result in a transfer penalty.  Does this mean that only IRC §130 immediate annuities may be used in a structured settlement where the annuity will be used to fund a Medicaid Special Needs Trust for the plaintiff?  Not necessarily.

 

            As discussed above, a qualified annuity under IRC §130 must be purchased directly by the defendant or the defendant’s insurance carrier.  The plaintiff cannot even have the option of receiving an annuity or a lump sum payment without having constructive receipt of the settlement funds and running afoul of IRC §130.  In other words, any annuity that would be used to fund a Special Needs Trust in the context of a WC or PI settlement is purchased with assets of the defendant, and not with assets that could be considered “available” to the plaintiff/Medicaid recipient.   

 

            The DRA’s restrictions on the purchase of deferred or balloon annuities only apply to purchases of annuities with assets of the Medicaid recipient (or the recipient’s spouse).  Further, the DRA does not apply to SSI.   Therefore, the DRA annuity provisions should not affect the ability to fund Medicaid or SSI Special Needs Trusts with IRC §130, deferred or balloon annuities as part of a WC or PI settlement.  In fact, the DRA annuity provisions arguably would not be applicable to this situation at all, so that it should not be necessary for the IRC §130 annuity funding a Special Needs Trust to be actuarially sound or to name the state as remainder beneficiary. 

 

            It may be safest to fix annuity payments under a deferred IRC §130 annuity such that the payments will be substantially equal in amounts; and to have the annuity to pay out during the plaintiff’s remaining life expectancy; or else to designate the state as a death beneficiary up to the amount of Medicaid benefits paid on behalf of the plaintiff.  However, this may not strictly be necessary, since the annuity would not be purchased with assets of the plaintiff or the plaintiff’s spouse.    

 

Use of Annuities to Fund Medicare Set-Aside Special Needs Trusts

 

            On October 15, 2004, CMS issued a policy memorandum[62] that essentially ended the use of deferred annuities to fund Medicare Set-Aside Arrangements.  That memorandum, under FAQ #5, states that, while annuities may be used to fund Medicare Set-Aside Arrangements, their use will be restricted and subject to the following requirements:

 

            1.         The Medicare Set-Aside Arrangement must be funded with seed money sufficient to cover the first anticipated surgery and/or replacement, plus two years of anticipated annual payments;

 

            2.         The annuity payments of the remainder of the approved set aside amount must be divided over the plaintiff’s remaining life expectancy, or a shorter period if CMS agrees; and

 

            3.         The annuity payments have to be made on or before a set anniversary date beginning no more than 1 year after the settlement.

 

            In other words, CMS will only allow the use of immediate annuities to fund Medicare Set-Aside Arrangements and only when a significant lump sum amount is also used to seed the Medicare Set-Aside Arrangement at the outset.

 

Use of Annuities to Fund SSI and Medicaid Special Needs Trusts

 

            Unlike Medicare, SSI and Medicaid do not prohibit the use of either deferred or balloon  annuities to fund exempt Special Needs Trusts if the annuities comply with IRC §130.  If the plaintiff expects to incur future medical expenses on a fairly regular basis, an immediate annuity can be used to provide the necessary funding over time.  If large expenses are expected periodically in the future, a deferred or balloon annuity may be appropriate as well.  However, all annuity payments into an exempt Special Needs Trust must be completed before the plaintiff reaches age 65.[63]  Further, the Special Needs Trust should also be funded initially with a lump sum sufficient to provide immediate liquid funds for unexpected costs, the annuity payments should be large enough to ensure that funds in the trust will not be exhausted before the next payment date, and payments should be indexed to keep pace with inflation. 

 

Naming the Trust as the Annuitant

 

            Since both SSI and Medicaid eligibility are based partly upon the individual’s level of income, a structured annuity that makes periodic payments directly to the beneficiary could prevent the individual from qualifying for those benefits for the lifetime of the annuity.  Further, if the annuity is the subject of a qualified assignment, the individual will not be able to amend the annuity at a later time to redirect payments into a Medicaid or SSI exempt trust.  

 

            Since there will virtually always be a qualified assignment of any annuities in any WC and PI settlement, careful planning is required to preserve the plaintiff’s ability to qualify for Medicaid or SSI.  In these cases, the annuity generally should not be set up with the individual plaintiff as payee.  Rather, the annuity should pay out to either an exempt Special Needs Trust or an exempt Medicare Set-Aside Special Needs Trust.

 

Conclusion

 

            Whenever a settling plaintiff is considered disabled under the Social Security Act and the plaintiff suffers from serious disabilities, multiple public benefit eligibility issues are likely to arise in the context of the settlement.   Settlements, by nature, will almost always require compromise.  As a result, settlement proceeds will seldom be sufficient to pay for all of the plaintiff’s injury related medical care for the remainder of his or her lifetime. 

 

            A seriously disabled plaintiff will need to look to public benefits to fill the gap between the costs of future lifetime care and the limited amount of actual settlement proceeds that will be available to pay for that care.  Where Medicare will not cover a significant portion of the plaintiff’s future medical care, the plaintiff must to preserve the ability to qualify for Medicaid and SSI.

 

            In settlements where multiple public benefit eligibility issues exist, common settlement strategies, such as the use of structures, trusts and informal custodial or self-administered accounts, can produce uncommon problems.  In these types of complex settlement situations, practitioners must be familiar with the features and benefits provided by each of the major public benefit plans, as well as with their varied criteria for eligibility.

 

            Even more importantly, practitioners must understand the interaction between the differing features and laws that govern the various available public benefit plans, as well as those that govern the use of trusts and structures to settle WC and PI claims generally.  Devising a settlement package that will work as intended in such a complex environment requires special knowledge, experience and skill. 

 

            Structured settlement components will need to be carefully considered and prepared.  Trust instruments will need to be carefully drafted and may require the assistance of a court for creation.  Medicare claims, VA claims and state Medicaid liens will need to be determined, negotiated and satisfied.  Reliable projections for the plaintiff’s future medical care will be needed.  The approval of multiple government agencies may be required.  In the end, each different aspect of the settlement package will need to address its respective purpose, without interfering with the proper functioning of the others. 

                  

 

 End Notes

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