Another day, another hallucination and delusion. How do we help my MIL with delusory cleptoparasitosis? In simpler terms, imaginary bug bites.

This sort of super sensitivity to perceived rashes/bug bites that results in obsessive scratching until skin is truly damaged does occur fairly often with advancing dementia disorders. A different approach might be to have a consult with palliative care - balancing risks and benefits of very low doses of risky medications with her poor quality of life now, and the risk that her behavior may lead to issues with the memory care facility as well.
Topical creams can be helpful, as well as a good moisturizer (such as Cetaphil or Eucerin cream) but I'd check to see how often memory care med techs actually apply them, and to what areas of her body.
Hospice may be a good resource, as the focus here is on her comfort and quality of living, but not necessarily extending the length of her life - if you feel that is what she would choose for herself if she understood her situation.
Will be thinking of you - this is such a hard place to be.

VERY important with Lewy Body to what medicine she is taking or given!!!

I would have her seen by a geriatric specialist to see if some mild medication may relieve these thoughts before she gets a really bad skin infection.

If she can still read, I would print a label that says something like "miracle bug killer and itch alleviator cream!!"

Then put that label on a big lotion bottle and tell her to us as needed. This might give her a different obsession but, at least it will not be potentially dangerous to her health.

This disease just sucks.

My father had Lewy Body Dementia. He had the same complaint. He called the type of bug "no see ums". His care facility had an exterminator come in and treat his room. That seemed to work.

Please seek out a Geriatric Psychiatrist so that she can get medication.

Google this: geriatric psychiatry in seattle wa

I am truly sorry that you and your MIL are having to suffer through this. My mother was diagnosed with dementia 5 years ago and started with the bug bites last year and threatened to call the ambulance to be taken to the hospital. I took her to a dermatologist, primary care, urgent care and her neurologist. We tried itching creams, sprays and allergy medications but they did not help. Her neurologist increased her seroquel from 25 mg to 50 mg and that eased the daily complaints, however, she still has episodes of bugs biting her and thinks she has bugs biting her occasionally instead of daily.

Thanks for posting this question. I don't have an answer for you, but hope more people post suggestions. My mother who has dementia is doing the same thing. She lives with us and does go outside a lot. She does get bit by bugs sometimes (we live in the country), but often she tells me she has bug bites when she doesn't. I've bought her tons of bug spray and anti-itch ointments/sprays, but rarely uses them. I also tell her she should cover up when she goes out, but that's not working either. She complains all the time and it's frustrating! She hasn't scratched the walls, but has ruined the paint and screens in her room with a fly swatter. I've had to buy her another fly swatter because she demolished the first one. She will pick and itch her arms and legs until they are bleeding. She tells me she has to pick them to get the "infection" out. Twice I've had to take her to the doctor because she has picked and scratched until they truly do become infected. Her doctor talked to her about this, but that hasn't worked either.

Has her vision been checked lately. Some eye problems can cause you to see floaters that can look like bugs. As a result anything you look at can appear to have bugs on them.

What causes floaters?

Eye infections.
Eye injuries.
Uveitis (inflammation in the eye)
Bleeding in the eye.
Vitreous detachment (when the vitreous pulls away from the retina)
Retinal tear (when vitreous detachment tears a hole in the retina)
Retinal detachment (when the retina gets pulled away from the back of the eye)

https://www.nei.nih.gov/learn-about-eye-health/eye-conditions-and-diseases/floaters

You can get MIL some mittens here:

https://www.amazon.com/s?k=alzheimers+mittens&crid=3G0E2H132M3F7&sprefix=alzheimers+mittens%2Caps%2C116&ref=nb_sb_ss_retrain-deeppltr_1_18

IF she will keep them on her hands, that will prevent bleeding skin. Keep her nails very short also.

My aunt with advanced Alz would pick at her scalp until there was no hair left in certain areas. It's a sign of agitation in a person with dementia. Have you spoken to MILs doctor about medication to calm her down? While you say there are 'limited hallucination and delusional medication options', I'm quite sure there are calming medications available to her that WOULD address the agitation she is experiencing. Ativan worked quite well for my mother during the advanced stages of dementia when she was very agitated and insisting things were happening that weren't.

Also, at mom's Memory Care, the caregivers would come get her dressed and out of her room every morning by 10 am. They'd bring her into the activity room to keep her occupied and engaged with the other residents doing a puzzle, eating, or an arts and crafts project of some sort. Such a thing may help MIL keep her mind OFF of these bugs she's obsessing about in her room. Have you spoken to the staff about what THEIR plan is to prevent her from decimating the walls and herself?

Wishing you the best of luck with a very difficult situation.

Unfortunately, somatic delusions are difficult to treat. Counseling or any type of talking therapy is useless. The only alternative is antipsychotic medicines, like Seroquel, Haldol, Olanzapine, Risperidone and others. Even antipsychotics may fail, but they are worth a trial. Talk with her doctor.

Let the MC handle it. They're being paid well to take care of such situations.