In order to qualify for Medicaid coverage a nursing home stay, an elder's assets cannot exceed $2,000 for a single person, or $109,560 for married couples. However, not all assets are "countable" for these purposes. The biggest exemptions are the person's home, car, and personal property. Another exemption is life insurance owned by the elder. The rule states that only the "cash surrender value" of a life insurance policy is countable, but only if the total face value of all life insurance policies exceeds $1,500. ("Cash surrender value" is the amount the life insurance company will pay out if the policy were cancelled. It's also known as the "cash value." The "face value" is what the company would pay out to beneficiaries if the elder died, assuming the policy was still in effect.)
So if your parent has a $1,000 policy with cash value of $800, he or she can keep it and it will not count towards the $2,000/$106,400 limit.
What if an elder has a term policy with a face value of $100,000? It's completely exempt since a term policy by definition has no cash value. Of course, the elder (or another family member) has to pay the premium each year to keep it in force.
What should be done with existing policies? If your parent has an existing policy and their health is not good, you may decide to keep the policy rather than cancel it. After all, the elder may be uninsurable, and if you keep the policy in force, family members could benefit from the proceeds upon the elder's death.
Assuming the total face values exceed $1,500 and the elder's countable assets put him or her over the limit to qualify for Medicaid, it could be a good idea to have the children purchase the policy from them and keep it in effect (by paying the annual premiums). You see, it's not who is insured or who is the beneficiary that matters—it's who is the owner of the policy. The reasoning for this Medicaid rule is that the owner could simply cash in the policy at any time, and thus it is counted the same as if he or she already did so. But if a child is the owner, the elder has no ability to cash in or cancel the policy, so it would no longer count against the elder's assets.
Another option is to assign the policy to a child, as a gift. This will cause a penalty period, so in many cases this is not the best solution. However, as part of an overall plan that includes other gifting, it could make sense.