Chiming in, I'm from the ostomy forum.
I'm not definitely sure if life insurance is considered a 'countable asset.' From what I've just googled, it is. If it is, she wouldn't be illegible for Medicaid. Based on 'income', your allowed a certain percentage above the poverty level, depending on the number of members in the household, for example in my state it's approximately $39k for a family of 3. Other income, referred to as non-income, includes assets such as total $ in the bank, stocks, bonds, IRA's, insurance policies, gifts....this can not be more than $2000 in the state I live in. Not included is home, car, furnishings's. Depending on her age, in elder Medicaid cases, those non assets, a home, are in fact included and would need to be transferred.
If she does want Medicaid, they would indeed make her 'spend down' this asset. Basically cash it out and she wouldn't be a Medicaid recipient at this time, she'd have to provide all receipts to her case worker showing payments for medical expenditures, and when all of it is gone, she is eligible. If there isn't any cash value, upon death, Medicaid will indeed recover this money, less the funeral expenses.
My suggestion is calling several elder law attorneys that are Medicaid knowledgeable in asset planning. Some are more knowledgeable than others. Some host seminars, write books on elder care, those are the knowledgeable ones. Again, call several because you will get different answers every time, you'd be surprised. And if they don't know, ask them for a referral of an attorney that would. There are ways in providing health insurance to those in dire need without giving it ALL away to the government. Many attorney's will provide free consultations over the phone, some want you to come in and will provide a free in house consultation. This can become very time consuming. Be prepared. Also, you need to be very certain in obtaining a very experienced attorney, the wrong one will cost you in more ways than one. But not being insured, with a pre-existing AD condition, you will lose more in the end without proper medical assistance.
Best of luck..........